Vol. 79 Friday, 

No. 21 January 31, 2014 

Part III 

Commodity Futures Trading Commission 

17 CFR Part 75 

Prohibitions and Restrictions on Proprietary Trading and Certain Interests 

in, and Relationships With, Hedge Funds and Private Equity Funds; Final 

Rule 


emcdonald on DSK67QTVN1PROD with RULES3
5808 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

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 Private Equity Funds 

AGENCY: Commodity Futures Trading 

Commission. 

ACTION: Final rule. 

SUMMARY: The Commodity Futures 

Trading Commission (‘‘CFTC’’ or 

‘‘Commission’’) is adopting a final rule 

to implement Section 619 of the DoddFrank Wall Street Reform and Consumer 

Protection Act (the ‘‘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. Section 619 also 

requires the Board, the Federal Deposit 

Insurance Corporation, the Office of the 

Comptroller of the Currency, and the 

Securities and Exchange Commission to 

also issue regulations implementing 

section 619 and directs the CFTC and 

those four agencies to consult and 

coordinate with each other, as 

appropriate, in developing and issuing 

the implementing rules, for the 

purposes of assuring, to the extent 

possible, that such rules are comparable 

and provide for consistent application 

and implementation. To that end, 

although the Commission is adopting a 

final rule that is not a joint rule with the 

other agencies, the CFTC and the other 

agencies have worked closely together 

to develop the same rule text and 

supplementary information, except for 

information specific to the CFTC or the 

other agencies, as applicable. In 

particular, the CFTC’s final rule is 

numbered as part 75 of the 

Commission’s regulations, the rule text 

refers to the ‘‘Commission’’ instead of 

the ‘‘[Agency]’’ and one section of the 

regulations addresses authority, 

purpose, scope, and relationship to 

other authorities with respect to the 

Commission. Furthermore, it is noted 

that the supplementary information 

generally refers to the ‘‘Agencies’’ 

collectively when referring to 

deliberations and considerations in 

developing the final rule by the CFTC 

together with the other four agencies 

and references to the ‘‘final rule’’ should 

be deemed to refer to the final rule of 

the Commission as herein adopted. 

DATES: The final rule is effective April 

1, 2014. 

FOR FURTHER INFORMATION CONTACT: Erik 

Remmler, Deputy Director, Division of 

Swap Dealer and Intermediary 

Oversight (‘‘DSIO’’), (202) 418–7630, 

eremmler@cftc.gov; Paul Schlichting, 

Assistant General Counsel, Office of the 

General Counsel (‘‘OGC’’), (202) 418– 

5884, pschlichting@cftc.gov; Mark 

Fajfar, Assistant General Counsel, OGC, 

(202) 418–6636, mfajfar@cftc.gov; 

Michael Barrett, Attorney-Advisor, 

DSIO, (202) 418–5598, mbarrett@

cftc.gov; Stephen Kane, Research 

Economist, Office of the Chief 

Economist (‘‘OCE’’), (202) 418–5911, 

skane@cftc.gov; or Stephanie Lau, 

Research Economist, OCE, (202) 418– 

5218, slau@cftc.gov; Commodity 

Futures Trading Commission, Three 

Lafayette Centre, 1155 21st Street NW., 

Washington, DC 20581. 

SUPPLEMENTARY INFORMATION:

Table of Contents 

I. Background 

II. Notice of Proposed Rulemaking: Summary 

of General Comments 

III. Scope 

IV. CFTC-Specific Comments 

V. Overview of Final Rule 

A. General Approach and Summary of 

Final Rule 

B. Proprietary Trading Restrictions 

C. Restrictions on Covered Fund Activities 

and Investments 

D. Metrics Reporting Requirement 

E. Compliance Program Requirement 

VI. Final Rule 

A. Subpart B—Proprietary Trading 

Restrictions 

1. Section 75.3: Prohibition on Proprietary 

Trading and Related Definitions 

a. Definition of ‘‘Trading Account’’ 

b. Rebuttable Presumption for the ShortTerm Trading Account 

c. Definition of ‘‘Financial Instrument’’ 

d. Proprietary Trading Exclusions 

1. Repurchase and Reverse Repurchase 

Arrangements and Securities Lending 

2. Liquidity management activities 

3. Transactions of Derivatives Clearing 

Organizations and Clearing Agencies 

4. Excluded Clearing-Related Activities of 

Clearinghouse Members 

5. Satisfying an Existing Delivery 

Obligation 

6. Satisfying an Obligation in Connection 

With a Judicial, Administrative, SelfRegulatory Organization, or Arbitration 

Proceeding 

7. Acting Solely as Agent, Broker, or 

Custodian 

8. Purchases or Sales Through a Deferred 

Compensation or Similar Plan 

9. Collecting a Debt Previously Contracted 

10. Other Requested Exclusions 

2. Section 75.4(a): Underwriting Exemption 

a. Introduction 

b. Overview 

1. Proposed Underwriting Exemption 

2. Comments on Proposed Underwriting 

Exemption 

3. Final Underwriting Exemption 

c. Detailed Explanation of the 

Underwriting Exemption 

1. Acting as an Underwriter for a 

Distribution of Securities 

a. Proposed Requirements That the 

Purchase or Sale Be Effected Solely in 

Connection With a Distribution of 

Securities for Which the Banking Entity 

Acts as an Underwriter and That the 

Covered Financial Position Be a Security 

i. Proposed Definition of ‘‘Distribution’’ 

ii. Proposed Definition of ‘‘Underwriter’’ 

iii. Proposed Requirement That the 

Covered Financial Position Be a Security 

b. Comments on the Proposed 

Requirements That the Trade Be Effected 

Solely in Connection With a Distribution 

for Which the Banking Entity is Acting 

as an Underwriter and That the Covered 

Financial Position Be a Security 

i. Definition of ‘‘Distribution’’ 

ii. Definition of ‘‘Underwriter’’ 

iii. ‘‘Solely in Connection With’’ Standard 

c. Final Requirement That the Banking 

Entity Act as an Underwriter for a 

Distribution of Securities and the 

Trading Desk’s Underwriting Position Be 

Related to Such Distribution 

i. Definition of ‘‘Underwriting Position’’ 

ii. Definition of ‘‘Trading Desk’’ 

iii. Definition of ‘‘Distribution’’ 

iv. Definition of ‘‘Underwriter’’ 

v. Activities Conducted ‘‘In Connection 

With’’ a Distribution 

2. Near Term Customer Demand 

Requirement 

a. Proposed Near Term Customer Demand 

Requirement 

b. Comments Regarding the Proposed Near 

Term Customer Demand Requirement 

c. Final Near Term Customer Demand 

Requirement 

3. Compliance Program Requirement 

a. Proposed Compliance Program 

Requirement 

b. Comments on the Proposed Compliance 

Program Requirement 

c. Final Compliance Program Requirement 

4. Compensation Requirement 

a. Proposed Compensation Requirement 

b. Comments on the Proposed 

Compensation Requirement 

c. Final Compensation Requirement 

5. Registration Requirement 

a. Proposed Registration Requirement 

b. Comments on Proposed Registration 

Requirement 

c. Final Registration Requirement 

6. Source of Revenue Requirement 

a. Proposed Source of Revenue 

Requirement 

b. Comments on the Proposed Source of 

Revenue Requirement 

c. Final Rule’s Approach to Assessing 

Source of Revenue 

3. Section 75.4(b): Market-Making 

Exemption 

a. Introduction 

b. Overview 

1. Proposed Market-Making Exemption 

2. Comments on the Proposed MarketMaking Exemption 


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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 5809 

a. Comments on the Overall Scope of the 

Proposed Exemption 

b. Comments Regarding the Potential 

Market Impact of the Proposed 

Exemption 

3. Final Market-Making Exemption 

c. Detailed Explanation of the MarketMaking Exemption 

1. Requirement to Routinely Stand Ready 

to Purchase and Sell 

a. Proposed Requirement to Hold Self Out 

b. Comments on the Proposed Requirement 

to Hold Self Out 

i. The Proposed Indicia 

ii. Treatment of Block Positioning Activity 

iii. Treatment of Anticipatory Market 

Making 

iv. High-Frequency Trading 

c. Final Requirement to Routinely Stand 

Ready to Purchase and Sell 

i. Definition of ‘‘Trading Desk’’ 

ii. Definitions of ‘‘Financial Exposure’’ and 

‘‘Market-Maker Inventory’’ 

iii. Routinely Standing Ready to Buy and 

Sell 

2. Near Term Customer Demand 

Requirement 

a. Proposed Near Term Customer Demand 

Requirement 

b. Comments Regarding the Proposed Near 

Term Customer Demand Requirement 

i. The Proposed Guidance for Determining 

Compliance With the Near Term 

Customer Demand Requirement 

ii. Potential Inventory Restrictions and 

Differences Across Asset Classes 

iii. Predicting Near Term Customer 

Demand 

iv. Potential Definitions of ‘‘Client,’’ 

‘‘Customer,’’ or ‘‘Counterparty’’ 

v. Interdealer Trading and Trading for 

Price Discovery or To Test Market Depth 

vi. Inventory Management 

vii. Acting as an Authorized Participant or 

Market Maker in Exchange-Traded 

Funds 

viii. Arbitrage or Other Activities That 

Promote Price Transparency and 

Liquidity 

ix. Primary Dealer Activities 

x. New or Bespoke Products or Customized 

Hedging Contracts 

c. Final Near Term Customer Demand 

Requirement 

i. Definition of ‘‘Client,’’ ‘‘Customer,’’ and 

‘‘Counterparty’’ 

ii. Impact of the Liquidity, Maturity, and 

Depth of the Market on the Analysis 

iii. Demonstrable Analysis of Certain 

Factors 

iv. Relationship to Required Limits 

3. Compliance Program Requirement 

a. Proposed Compliance Program 

Requirement 

b. Comments on the Proposed Compliance 

Program Requirement 

c. Final Compliance Program Requirement 

4. Market Making-Related Hedging 

a. Proposed Treatment of Market MakingRelated Hedging 

b. Comments on the Proposed Treatment of 

Market Making-Related Hedging 

c. Treatment of Market Making-Related 

Hedging in the Final Rule 

5. Compensation Requirement 

a. Proposed Compensation Requirement 

b. Comments Regarding the Proposed 

Compensation Requirement 

c. Final Compensation Requirement 

6. Registration Requirement 

a. Proposed Registration Requirement 

b. Comments on the Proposed Registration 

Requirement 

c. Final Registration Requirement 

7. Source of Revenue Analysis 

a. Proposed Source of Revenue 

Requirement 

b. Comments Regarding the Proposed 

Source of Revenue Requirement 

i. Potential Restrictions on Inventory, 

Increased Costs for Customers, and Other 

Changes to Market-Making Services 

ii. Certain Price Appreciation-Related 

Profits Are an Inevitable or Important 

Component of Market Making 

iii. Concerns Regarding the Workability of 

the Proposed Standard in Certain 

Markets or asset classes 

iv. Suggested Modifications to the 

Proposed Requirement 

v. General Support for the Proposed 

Requirement or for Placing Greater 

Restrictions on a Market Maker’s Sources 

of Revenue 

c. Final Rule’s Approach to Assessing 

Revenues 

8. Appendix B of the Proposed Rule 

a. Proposed Appendix B Requirement 

b. Comments on Proposed Appendix B 

c. Determination to not Adopt Proposed 

Appendix B 

9. Use of Quantitative Measurements 

4. Section 75.5: Permitted Risk-Mitigating 

Hedging Activities 

a. Summary of Proposal’s Approach to 

Implementing the Hedging Exemption 

b. Manner of Evaluating Compliance with 

the Hedging Exemption 

c. Comments on the Proposed Rule and 

Approach to Implementing the Hedging 

Exemption 

d. Final Rule 

1. Compliance Program Requirement 

2. Hedging of Specific Risks and 

Demonstrable Reduction of Risk 

3. Compensation 

4. Documentation Requirement 

5. Section 75.6(a)–(b): Permitted Trading in 

Certain Government and Municipal 

Obligations 

a. Permitted Trading in U.S. Government 

Obligations 

b. Permitted Trading in Foreign 

Government Obligations 

c. Permitted Trading in Municipal 

Securities 

d. Determination to Not Exempt 

Proprietary Trading in Multilateral 

Development Bank Obligations 

6. Section 75.6(c): Permitted Trading on 

Behalf of Customers 

a. Proposed Exemption for Trading on 

Behalf of Customers 

b. Comments on the Proposed Rule 

c. Final Exemption for Trading on Behalf 

of Customers 

7. Section 75.6(d): Permitted Trading by a 

Regulated Insurance Company 

8. Section 75.6(e): Permitted Trading 

Activities of a Foreign Banking Entity 

a. Foreign Banking Entities Eligible for the 

Exemption 

b. Permitted Trading Activities of a Foreign 

Banking Entity 

9. Section 75.7: Limitations on Permitted 

Trading Activities 

a. Scope of ‘‘Material Conflict of Interest’’ 

1. Proposed rule 

2. Comments on the Proposed Limitation 

on Material Conflicts of Interest 

a. Disclosure 

b. Information Barriers 

3. Final rule 

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

‘‘High-Risk Trading Strategy’’ 

1. Proposed Rule 

2. Comments on Proposed Limitations on 

High-Risk Assets and Trading Strategies 

3. Final Rule 

c. Limitations on Permitted Activities That 

Pose a Threat to Safety and Soundness 

of the Banking Entity or the Financial 

Stability of the United States 

B. Subpart C—Covered Fund Activities and 

Investments 

1. Section 75.10: Prohibition on 

Acquisition or Retention of Ownership 

Interests in, and Certain Relationships 

With, a Covered Fund 

a. Prohibition Regarding Covered Fund 

Activities and Investments 

b. ‘‘Covered Fund’’ Definition 

1. Foreign Covered Funds 

2. Commodity Pools 

3. Entities Regulated Under the Investment 

Company Act 

c. Entities Excluded From Definition of 

Covered Fund 

1. Foreign Public Funds 

2. Wholly-Owned Subsidiaries 

3. Joint Ventures 

4. Acquisition Vehicles 

5. Foreign Pension or Retirement Funds 

6. Insurance Company Separate Accounts 

7. Bank Owned Life Insurance Separate 

Accounts 

8. Exclusion for Loan Securitizations and 

Definition of Loan 

a. Definition of Loan 

b. Loan Securitizations 

i. Loans 

ii. Contractual Rights or Assets 

iii. Derivatives 

iv. SUBIs and Collateral Certificates 

v. Impermissible Assets 

9. Asset-Backed Commercial Paper 

Conduits 

10. Covered Bonds 

11. Certain Permissible Public Welfare and 

Similar Funds 

12. Registered Investment Companies and 

Excluded Entities 

13. Other Excluded Entities 

d. Entities Not Specifically Excluded From 

the Definition of Covered Fund 

1. Financial Market Utilities 

2. Cash Collateral Pools 

3. Pass-Through REITS 

4. Municipal Securities Tender Option 

Bond Transactions 

5. Venture Capital Funds 

6. Credit Funds 

7. Employee Securities Companies 

e. Definition of ‘‘Ownership Interest’’ 

f. Definition of ‘‘Resident of the United 

States’’ 

g. Definition of ‘‘Sponsor’’ 

1. Definition of Sponsor With Respect to 

Securitizations 


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5810 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

1 Dodd-Frank Wall Street Reform and Consumer 

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

(2010). 

2See 12 U.S.C. 1851. 

3See 12 U.S.C. 1851(a)(2) and (f)(4). The Agencies 

note that two of the three companies currently 

designated by FSOC for supervision by the Board 

are affiliated with insured depository institutions, 

and are therefore currently banking entities for 

purposes of section 13 of the BHC Act. The 

Agencies are continuing to review whether the 

remaining company engages in any activity subject 

to section 13 of the BHC Act and what, if any, 

requirements apply under section 13. 

4See 12 U.S.C. 1851(a)(1)(A) and (B). 

5See id. at 1851(d)(1). 

6See 12 U.S.C. 1851(a)(2) and (d)(4). 

7See 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 

2. Section 75.11: Activities Permitted in 

Connection With Organizing and 

Offering a Covered Fund 

a. Scope of Exemption 

1. Fiduciary Services 

2. Compliance With Investment 

Limitations 

3. Compliance With Section 13(f) of the 

BHC Act 

4. No Guarantees or Insurance of Fund 

Performance 

5. Limitation on Name Sharing With a 

Covered Fund 

6. Limitation on Ownership by Directors 

and Employees 

7. Disclosure Requirements 

b. Organizing and Offering an Issuing 

Entity of Asset-Backed Securities 

c. Underwriting and Market Making for a 

Covered Fund 

3. Section 75.12: Permitted Investment in 

a Covered Fund 

a. Proposed Rule 

b. Duration of Seeding Period for New 

Covered Funds 

c. Limitations on Investments in a Single 

Covered Fund (‘‘Per-Fund Limitation’’) 

d. Limitation on Aggregate Permitted 

Investments in all Covered funds 

(‘‘Aggregate Funds Limitation’’) 

e. Capital Treatment of an Investment in a 

Covered Fund 

f. Attribution of Ownership Interests to a 

Banking Entity 

g. Calculation of Tier 1 Capital 

h. Extension of Time To Divest Ownership 

Interest in a Single Fund 

4. Section 75.13: Other Permitted Covered 

Fund Activities 

a. Permitted Risk-Mitigating Hedging 

Activities 

b. Permitted Covered Fund Activities and 

Investments Outside of the United States 

1. Foreign Banking Entities Eligible for the 

Exemption 

2. Activities or Investments Solely Outside 

of the United States 

3. Offered for Sale or Sold to a Resident of 

the United States 

4. Definition of ‘‘Resident of the United 

States’’ 

c. Permitted Covered Fund Interests and 

Activities by a Regulated Insurance 

Company 

5. Section 75.14: Limitations on 

Relationships With a Covered Fund 

a. Scope of Application 

b. Transactions That Would Be a ‘‘Covered 

Transaction’’ 

c. Certain Transactions and Relationships 

Permitted 

1. Permitted Investments and Ownerships 

Interests 

2. Prime Brokerage Transactions 

d. Restrictions on Transactions With Any 

Permitted Covered Fund 

6. Section 75.15: Other Limitations on 

Permitted Covered Fund Activities 

C. Subpart D and Appendices A and B— 

Compliance Program, Reporting, and 

Violations 

1. Section 75.20: Compliance Program 

Mandate 

a. Program Requirement 

b. Compliance Program Elements 

c. Simplified Programs for Less Active 

Banking Entities 

d. Threshold for Application of Enhanced 

Minimum Standards 

2. Appendix B: Enhanced Minimum 

Standards for Compliance Programs 

a. Proprietary Trading Activities 

b. Covered Fund Activities or Investments 

c. Enterprise-Wide Programs 

d. Responsibility and Accountability 

e. Independent Testing 

f. Training 

g. Recordkeeping 

3. Section 75.20(d) and Appendix A: 

Reporting and Recordkeeping 

Requirements Applicable to Trading 

Activities 

a. Approach to Reporting and 

Recordkeeping Requirements Under the 

Proposal 

b. General Comments on the Proposed 

Metrics 

c. Approach of the Final Rule 

d. Proposed Quantitative Measurements 

and Comments on Specific Metrics 

4. Section 75.21: Termination of Activities 

or Investments; Authorities for 

Violations 

VII. Administrative Law Matters 

A. Paperwork Reduction Act Analysis 

B. Regulatory Flexibility Act Analysis 

I. Background 

The Dodd-Frank Act was enacted on 

July 21, 2010.1 Section 619 of the DoddFrank Act added a new section 13 to the 

Bank Holding Company Act of 1956 

(‘‘BHC Act’’) (codified at 12 U.S.C. 1851) 

that generally prohibits any banking 

entity from engaging in proprietary 

trading or from acquiring or retaining an 

ownership interest in, sponsoring, or 

having certain relationships with a 

hedge fund or private equity fund 

(‘‘covered fund’’), subject to certain 

exemptions.2 New section 13 of the BHC 

Act also provides that a nonbank 

financial company designated by the 

Financial Stability Oversight Council 

(‘‘FSOC’’) for supervision by the Board 

(while not a banking entity under 

section 13 of the BHC Act) would be 

subject to additional capital 

requirements, quantitative limits, or 

other restrictions if the company 

engages in certain proprietary trading or 

covered fund activities.3

Section 13 of the BHC Act generally 

prohibits banking entities from engaging 

as principal in proprietary trading for 

the purpose of selling financial 

instruments in the near term or 

otherwise with the intent to resell in 

order to profit from short-term price 

movements.4 Section 13(d)(1) expressly 

exempts from this prohibition, subject 

to conditions, certain activities, 

including: 

• Trading in U.S. government, agency 

and municipal obligations; 

• Underwriting and market makingrelated activities; 

• Risk-mitigating hedging activities; 

• Trading on behalf of customers; 

• Trading for the general account of 

insurance companies; and 

• Foreign trading by non-U.S. 

banking entities.5

Section 13 of the BHC Act also 

generally prohibits banking entities 

from acquiring or retaining an 

ownership interest in, or sponsoring, a 

hedge fund or private equity fund. 

Section 13 contains several exemptions 

that permit banking entities to make 

limited investments in hedge funds and 

private equity funds, subject to a 

number of restrictions designed to 

ensure that banking entities do not 

rescue investors in these funds from loss 

and are not themselves exposed to 

significant losses from investments or 

other relationships with these funds. 

Section 13 of the BHC Act does not 

prohibit a nonbank financial company 

supervised by the Board from engaging 

in proprietary trading, or from having 

the types of ownership interests in or 

relationships with a covered fund that a 

banking entity is prohibited or restricted 

from having under section 13 of the 

BHC Act. However, section 13 of the 

BHC Act provides that these activities 

be subject to additional capital charges, 

quantitative limits, or other 

restrictions.6

II. Notice of Proposed Rulemaking: 

Summary of General Comments 

Authority for developing and 

adopting regulations to implement the 

prohibitions and restrictions of section 

13 of the BHC Act is divided among the 

Board, the Federal Deposit Insurance 

Corporation (‘‘FDIC’’), the Office of the 

Comptroller of the Currency (‘‘OCC’’), 

the Securities and Exchange 

Commission (‘‘SEC’’), and the 

Commodity Futures Trading 

Commission (‘‘CFTC’’).7 As required by 


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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. 

8See 76 FR 68846 (Nov. 7, 2011) (‘‘Joint 

Proposal’’). 

9See 77 FR 23 (Jan. 23, 2012) (extending the 

comment period to February 13, 2012). 

10See 77 FR 8332 (Feb 14, 2012) (‘‘CFTC 

Proposal’’). 

11See 12 U.S.C. 1851(b)(2)(B)(ii). The Secretary of 

the Treasury, as Chairperson of the FSOC, is 

responsible for coordinating the Agencies’ 

rulemakings under section 13 of the BHC Act. See 

id. 

12See http://www.regulations.gov/#!docketDetail;

D=OCC-2011-0014 (OCC); http://www.federal

reserve.gov/newsevents/reform_systemic.htm 

(Board); http://www.fdic.gov/regulations/laws/

federal/2011/11comAD85.html (FDIC); http://

www.sec.gov/comments/s7-41-11/s74111.shtml 

(SEC); and http://www.cftc.gov/LawRegulation/

DoddFrankAct/Rulemakings/DF_28_VolckerRule/

index.htm (CFTC). 

13See Commodity Futures Trading Commission, 

CFTC Staff to Host a Public Roundtable to Discuss 

the Proposed Volcker Rule (May 24, 2012), available 

at http://www.cftc.gov/PressRoom/PressReleases/

pr6263-12; transcript available at http://

www.cftc.gov/ucm/groups/public/@newsroom/

documents/file/transcript053112.pdf. 

14See 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%20

study%20final%201%2018%2011%20rg.pdf. 

(‘‘FSOC study’’). See 12 U.S.C. 1851(b)(1). Prior to 

publishing its study, FSOC requested public 

comment on a number of issues to assist in 

conducting its study. See 75 FR 61758 (Oct. 6, 

2010). Approximately 8,000 comments were 

received from the public, including from members 

of Congress, trade associations, individual banking 

entities, consumer groups, and individuals. 

15See FSOC study at 5–6. 

section 13(b)(2) of the BHC Act, the 

Board, OCC, FDIC, and SEC in October 

2011 invited the public to comment on 

proposed rules implementing that 

section’s requirements.8 The period for 

filing public comments on this proposal 

was extended for an additional 30 days, 

until February 13, 2012.9 In January 

2012, the CFTC requested comment on 

a proposal for the same common rule to 

implement section 13 with respect to 

those entities for which it is the primary 

financial regulatory agency and invited 

public comment on its proposed 

implementing rule through April 16, 

2012.10 The statute requires the 

Agencies, in developing and issuing 

implementing rules, to consult and 

coordinate with each other, as 

appropriate, for the purposes of 

assuring, to the extent possible, that 

such rules are comparable and provide 

for consistent application and 

implementation of the applicable 

provisions of section 13 of the BHC 

Act.11

The proposed rules invited comment 

on a multi-faceted regulatory framework 

to implement section 13 consistent with 

the statutory language. In addition, the 

Agencies invited comments on the 

potential economic impacts of the 

proposed rule and posed a number of 

questions seeking information on the 

costs and benefits associated with each 

aspect of the proposal, as well as on any 

significant alternatives that would 

minimize the burdens or amplify the 

benefits of the proposal in a manner 

consistent with the statute. The 

Agencies also encouraged commenters 

to provide quantitative information and 

data about the impact of the proposal on 

entities subject to section 13, as well as 

on their clients, customers, and 

counterparties, specific markets or asset 

classes, and any other entities 

potentially affected by the proposed 

rule, including non-financial small and 

mid-size businesses. 

The Agencies received over 18,000 

comments addressing a wide variety of 

aspects of the proposal, including 

definitions used by the proposal and the 

exemptions for market making-related 

activities, risk-mitigating hedging 

activities, covered fund activities and 

investments, the use of quantitative 

metrics, and the reporting proposals. 

The vast majority of these comments 

were from individuals using a version of 

a short form letter to express support for 

the proposed rule. More than 600 

comment letters were unique comment 

letters, including from members of 

Congress, domestic and foreign banking 

entities and other financial services 

firms, trade groups representing 

banking, insurance, and the broader 

financial services industry, U.S. state 

and foreign governments, consumer and 

public interest groups, and individuals. 

To improve understanding of the issues 

raised by commenters, the Agencies met 

with a number of these commenters to 

discuss issues relating to the proposed 

rule, and summaries of these meetings 

are available on each of the Agency’s 

public Web sites.12 The CFTC staff also 

hosted a public roundtable on the 

proposed rule.13 Many of the 

commenters generally expressed 

support for the broader goals of the 

proposed rule. At the same time, many 

commenters expressed concerns about 

various aspects of the proposed rule. 

Many of these commenters requested 

that one or more aspects of the proposed 

rule be modified in some manner in 

order to reflect their viewpoints and to 

better accommodate the scope of 

activities that they argued were 

encompassed within section 13 of the 

BHC Act. The comments addressed all 

major sections of the proposed rule. 

Section 13 of the BHC Act also 

required the FSOC to conduct a study 

(‘‘FSOC study’’) and make 

recommendations to the Agencies by 

January 21, 2011 on the implementation 

of section 13 of the BHC Act. The FSOC 

study was issued on January 18, 2011. 

The FSOC study included a detailed 

discussion of key issues related to 

implementation of section 13 and 

recommended that the Agencies 

consider taking a number of specified 

actions in issuing rules under section 13 

of the BHC Act.14 The FSOC study also 

recommended that the Agencies adopt a 

four-part implementation and 

supervisory framework for identifying 

and preventing prohibited proprietary 

trading, which included a programmatic 

compliance regime requirement for 

banking entities, analysis and reporting 

of quantitative metrics by banking 

entities, supervisory review and 

oversight by the Agencies, and 

enforcement procedures for violations.15

The Agencies carefully considered the 

FSOC study and its recommendations. 

In formulating this final rule, the 

Agencies carefully reviewed all 

comments submitted in connection with 

the rulemaking and considered the 

suggestions and issues they raise in light 

of the statutory restrictions and 

provisions as well as the FSOC study. 

The Agencies have sought to reasonably 

respond to all of the significant issues 

commenters raised. The Agencies 

believe they have succeeded in doing so 

notwithstanding the complexities 

involved. The Agencies also carefully 

considered different options suggested 

by commenters in light of potential 

costs and benefits in order to effectively 

implement section 13 of the BHC Act. 

The Agencies made numerous changes 

to the final rule in response to the issues 

and information provided by 

commenters. These modifications to the 

rule and explanations that address 

comments are described in more detail 

in the section-by-section description of 

the final rule. To enhance uniformity in 

both rules that implement section 13 

and administration of the requirements 

of that section, the Agencies have been 

regularly consulting with each other in 

the development of this final rule. 

Some commenters requested that the 

Agencies repropose the rule and/or 

delay adoption pending the collection of 


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5812 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

16See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); ABA (Keating); Chamber (Nov. 2011); 

Chamber (Nov. 2013); Members of Congress (Dec. 

2011); IIAC; Real Estate Roundtable; Ass’n. of 

German Banks; Allen & Overy (Clearing); JPMC; 

Goldman (Prop. Trading); BNY Mellon et al.; State 

Street (Feb. 2012); ICI Global; Chamber (Feb. 2012); 

Socie ́te ́ Ge ́ne ́rale; HSBC; Western Asset Mgmt.; 

Abbott Labs et al. (Feb. 2012); PUC Texas; Columbia 

Mgmt.; ICI (Feb. 2012); IIB/EBF; British Bankers’ 

Ass’n.; ISDA (Feb. 2012); Comm. on Capital Markets 

Regulation; Ralph Saul (Apr. 2012); BPC. 

17See 75 FR 61758 (Oct. 6, 2010). 

18 If any provision of this rule, or the application 

thereof to any person or circumstance, is held to be 

invalid, such invalidity shall not affect other 

provisions or application of such provisions to 

other persons or circumstances that can be given 

effect without the invalid provision or application. 

19See 12 U.S.C. 1851(c)(1). 20See 12 U.S.C. 1851(c)(2); see also Conformance 

Period for Entities Engaged in Prohibited 

Proprietary Trading or Private Equity Fund or 

Hedge Fund Activities, 76 FR 8265 (Feb. 14, 2011) 

(citing 156 Cong. Rec. S5898 (daily ed. July 15, 

2010) (statement of Sen. Merkley)). 

21See, Board Order Approving Extension of 

Conformance Period, available at http://

www.federalreserve.gov/newsevents/press/bcreg/

bcreg20131210b1.pdf. 

22See, e.g., Oliver Wyman (Dec. 2011); Chamber 

(Dec. 2011); Thakor Study; Prof. Duffie; IHS. 

23See Prof. Duffie. 

24See IHS. 

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

Oliver Wyman (Dec. 2011); IHS. 

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

(Covered Funds). 

additional information.16 As described 

in part above, the Agencies have 

provided many and various types of 

opportunities for commenters to provide 

input on implementation of section 13 

of the BHC Act and have collected 

substantial information in the process. 

In addition to the official comment 

process described above, members of 

the public submitted comment letters in 

advance of the official comment period 

for the proposed rules and met with 

staff of the Agencies to explain issues of 

concern; the public also provided 

substantial comment in response to a 

request for comment from the FSOC 

regarding its findings and 

recommendations for implementing 

section 13.17 The Agencies provided a 

detailed proposal and posed numerous 

questions in the preamble to the 

proposal to solicit and explore 

alternative approaches in many areas. In 

addition, the Agencies have continued 

to receive comment letters after the 

extended comment period deadline, 

which the Agencies have considered. 

Thus, the Agencies believe interested 

parties have had ample opportunity to 

review the proposed rules, as well as the 

comments made by others, and to 

provide views on the proposal, other 

comment letters, and data to inform our 

consideration of the final rules. 

In addition, the Agencies have been 

mindful of the importance of providing 

certainty to banking entities and 

financial markets and of providing 

sufficient time for banking entities to 

understand the requirements of the final 

rule and to design, test, and implement 

compliance and reporting systems. The 

further substantial delay that would 

necessarily be entailed by reproposing 

the rule would extend the uncertainty 

that banking entities would face, which 

could prove disruptive to banking 

entities and the financial markets. 

The Agencies note, as discussed more 

fully below, that the final rule 

incorporates a number of modifications 

designed to address the issues raised by 

commenters in a manner consistent 

with the statute. The preamble below 

also discusses many of the issues raised 

by commenters and explains the 

Agencies’ response to those comments. 

To achieve the purpose of the statute, 

without imposing unnecessary costs, the 

final rule builds on the multi-faceted 

approach in the proposal, which 

includes development and 

implementation of a compliance 

program at each banking entity engaged 

in trading activities or that makes 

investments subject to section 13 of the 

BHC Act; the collection and evaluation 

of data regarding these activities as an 

indicator of areas meriting additional 

attention by the banking entity and the 

relevant agency; appropriate limits on 

trading, hedging, investment and other 

activities; and supervision by the 

Agencies. To allow banking entities 

sufficient time to develop appropriate 

systems, the Agencies have provided for 

a phased-in schedule for the collection 

of data, limited data reporting 

requirements only to banking entities 

that engage in significant trading 

activity, and agreed to review the merits 

of the data collected and revise the data 

collection as appropriate over the next 

21 months. Importantly, as explained in 

detail below, the Agencies have also 

reduced the compliance burden for 

banking entities with total assets of less 

than $10 billion. The final rule also 

eliminates compliance burden for firms 

that do not engage in covered activities 

or investments beyond investing in U.S. 

government obligations, agency 

guaranteed obligations, or municipal 

obligations. 

Moreover, the Agencies believe the 

data that will be collected in connection 

with the final rule, as well as the 

compliance efforts made by banking 

entities and the supervisory experience 

that will be gained by the Agencies in 

reviewing trading and investment 

activity under the final rule, will 

provide valuable insights into the 

effectiveness of the final rule in 

achieving the purpose of section 13 of 

the BHC Act. The Agencies remain 

committed to implementing the final 

rule, and revisiting and revising the rule 

as appropriate, in a manner designed to 

ensure that the final rule faithfully 

implements the requirements and 

purposes of the statute.18

Finally, the Board has determined, in 

accordance with section 13 of the BHC 

Act, to provide banking entities with 

additional time to conform their 

activities and investments to the statute 

and the final rule. The restrictions and 

prohibitions of section 13 of the BHC 

Act became effective on July 21, 2012.19

The statute provided banking entities a 

period of two years to conform their 

activities and investments to the 

requirement of the statute, until July 21, 

2014. Section 13 also permits the Board 

to extend this conformance period, one 

year at a time, for a total of no more than 

three additional years.20 Pursuant to this 

authority and in connection with this 

rulemaking, the Board has in a separate 

action extended the conformance period 

for an additional year until July 21, 

2015.21 The Board will continue to 

monitor developments to determine 

whether additional extensions of the 

conformance period are in the public 

interest, consistent with the statute. 

Accordingly, the Agencies do not 

believe that a reproposal or further 

delay is necessary or appropriate. 

Commenters have differing views on 

the overall economic impacts of section 

13 of the BHC Act. 

Some commenters remarked that 

proprietary trading restrictions will 

have detrimental impacts on the 

economy such as: Reduction in 

efficiency of markets, economic growth, 

and in employment due to a loss in 

liquidity.22 In particular, a commenter 

expressed concern that there may be 

high transition costs as non-banking 

entities replace some of the trading 

activities currently performed by 

banking entities.23 Another commenter 

focused on commodity markets 

remarked about the potential reduction 

in commercial output and curtailed 

resource exploration due to a lack of 

hedging counterparties.24 Several 

commenters stated that section 13 of the 

BHC Act will reduce access to debt 

markets—especially for smaller 

companies—raising the costs of capital 

for firms and lowering the returns on 

certain investments.25 Further, some 

commenters mentioned that U.S. banks 

may be competitively disadvantaged 

relative to foreign banks due to 

proprietary trading restrictions and 

compliance costs.26


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27See, e.g., Profs. Admati & Pfleiderer; AFR (Nov. 

2012); Better Markets (Dec. 2011); Better Markets 

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

Volcker. 

28See Occupy. 

29See Profs. Admati & Pfleiderer; Better Markets 

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

Volcker. 

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

Stiglitz. 

31See AFR et al. (Feb. 2012); Better Markets (Apr. 

16, 2012); David McClean; Public Citizen; Occupy. 

32See Johnson & Prof. Stiglitz (citing Thomas 

Phillipon (2011)); AFR et al. (Feb. 2012); Occupy. 

33See SIFMA et al. (Covered Funds) (Feb. 2012); 

BoA; ABA (Keating); Chamber (Feb. 2012); Socie ́te ́

Ge ́ne ́rale; FTN; SVB; ISDA (Feb. 2012); Comm. on 

Capital Market Regulation; Real Estate Roundtable. 

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

Pilo. 

35For example, with respect to the CFTC, Section 

15(a) of the CEA requires such consideration only 

when ‘‘promulgating a regulation under this 

[Commodity Exchange] Act.’’ This final rule is not 

promulgated under the CEA, but under the BHC 

Act. CEA section 15(a), therefore, does not apply. 

36This CFTC Rule is being promulgated 

exclusively under section 13 of the BHC. Therefore, 

the Commission did not conduct a cost benefit 

consideration under Section 15(a) of the 

Commodity Exchange Act. Similarly, Executive 

Orders 12866 and 13563, referenced by some 

commenters, do not impose obligations on the 

CFTC. 

37See final rule § 75.2(c). 

38The CFTC notes that provisionally registered 

swap dealers are registered swap dealers subject to 

all of the regulatory requirements applicable to 

registered swap dealers except as may otherwise be 

expressly provided in the CFTC’s regulations. 

39See 77 FR 8332 (Feb 14, 2012). 

40See, e.g., SIFMA (March Letter); Alfred Brock; 

Occupy the SEC. 

On the other hand, other commenters 

stated that restricting proprietary 

trading activity by banking entities may 

reduce systemic risk emanating from the 

financial system and help to lower the 

probability of the occurrence of another 

financial crisis.27 One commenter 

contended that large banking entities 

may have a moral hazard incentive to 

engage in risky activities without 

allocating sufficient capital to them, 

especially if market participants believe 

these institutions will not be allowed to 

fail.28 Commenters argued that large 

banking entities may engage in activities 

that increase the upside return at the 

expense of downside loss exposure 

which may ultimately be borne by 

Federal taxpayers 29 and that subsidies 

associated with bank funding may 

create distorted economic outcomes.30

Furthermore, some commenters 

remarked that non-banking entities may 

fill much of the void in liquidity 

provision left by banking entities if 

banking entities reduce their current 

trading activities.31 Finally, some 

commenters mentioned that hyperliquidity that arises from, for instance, 

speculative bubbles, may harm the 

efficiency and price discovery function 

of markets.32

The Agencies have taken these 

concerns into account in the final rule. 

As described below with respect to 

particular aspects of the final rule, the 

Agencies have addressed these issues by 

reducing burdens where appropriate, 

while at the same time ensuring that the 

final rule serves its purpose of 

promoting healthy economic activity. In 

that regard, the Agencies have sought to 

achieve the balance intended by 

Congress under section 13 of the BHC 

Act. Several comments suggested that a 

costs and benefits analysis be performed 

by the Agencies.33 On the other hand, 

some commenters34 correctly stated that 

a costs and benefits analysis is not 

legally required.35 However, the 

Agencies find certain of the information 

submitted by commenters concerning 

costs and benefits and economic effects 

to be relevant to consideration of the 

rule, and so have considered this 

information as appropriate, and, on the 

basis of these and other considerations, 

sought to achieve the balance intended 

by Congress in section 619 of the DoddFrank Act. The relevant comments are 

addressed therein.36

III. Scope 

Under section 13 of the BHCA, the 

CFTC’s final rule will be applicable to 

a banking entity for which the CFTC is 

a ‘‘primary financial regulatory agency’’ 

for that banking entity, as the term is 

defined by section 2(12) of the DoddFrank Act. Accordingly, the final rule 

may apply to banking entities 37 that are, 

for example, registered swap dealers,38

futures commission merchants, 

commodity trading advisors and 

commodity pool operators. The CFTC’s 

final rule may also apply to other types 

of CFTC registrants that are banking 

entities, but it is likely that many such 

other registrants will have little or no 

activities that would implicate the 

provisions of the final rule. For 

example, registered introducing brokers 

are not likely to undertake proprietary 

trading or invest in covered funds 

because their activities are generally 

limited to brokering. Furthermore, the 

CFTC’s final rule will not apply to CFTC 

registrants who are not banking entities. 

In addition, it is noted that the CFTC 

may have overlapping jurisdiction with 

other Agencies in exercising authority 

under each Agency’s respective final 

rules. Finally, it is important to note 

that the jurisdictional scope of the final 

rule does not limit the regulatory 

authority of the CFTC or the other 

Agencies under other applicable 

provisions of law. 

The CFTC believes that many 

affiliated banking entities would 

undertake some or all of the compliance 

activities under the final rule on an 

affiliated enterprise-wide basis. As of 

the adoption of the final rule, the CFTC 

estimates that there are approximately 

110 registered swap dealers and futures 

commission merchants that would be 

banking entities individually and that 

grouping these banking entities together 

based on legal affiliation would result in 

about 45 different business enterprises. 

IV. CFTC-specific comments 

In addition to the information sought 

both by the other Agencies and the 

CFTC, the CFTC’s proposal 39 included 

15 additional questions specifically 

regarding the approach the CFTC should 

take in regards to certain sections of the 

rule. The relevant sections included 

provisions that were either directly 

related to the CFTC (e.g., definition of 

commodity pool, clearing exemption) 

and others that appeared not to be (e.g., 

underwriting, market making of SEC 

entities, securitization). Many 

commenters sent general responses that 

touched on issues related to these 15 

CFTC-specific questions, while other 

commenters organized their responses 

by question.40 The CFTC has considered 

these commenters’ views, and has 

responded as set forth in the relevant 

sections below. 

V. Overview of Final Rule 

The Agencies are adopting this final 

rule to implement section 13 of the BHC 

Act with a number of changes to the 

proposal, as described further below. 

The final rule adopts a risk-based 

approach to implementation that relies 

on a set of clearly articulated 

characteristics of both prohibited and 

permitted activities and investments 

and is designed to effectively 

accomplish the statutory purpose of 

reducing risks posed to banking entities 

by proprietary trading activities and 

investments in or relationships with 

covered funds. As explained more fully 

below in the section-by-section analysis, 

the final rule has been designed to 

ensure that banking entities do not 

engage in prohibited activities or 

investments and to ensure that banking 

entities engage in permitted trading and 

investment activities in a manner 

designed to identify, monitor and limit 

the risks posed by these activities and 

investments. For instance, the final rule 

requires that any banking entity that is 

engaged in activity subject to section 13 

develop and administer a compliance 

program that is appropriate to the size, 


emcdonald on DSK67QTVN1PROD with RULES3
5814 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

41See final rule § 75.3(a). 

42See final rule § 75.3(b). 

43See final rule § 75.3(b)(1)(i). 

44See final rule § 75.3(b)(2). 

45See final rule § 75.3(b)(1)(ii). 

46See final rule § 75.3(b)(1)(iii). 

scope and risk of its activities and 

investments. The rule requires the 

largest firms engaged in these activities 

to develop and implement enhanced 

compliance programs and regularly 

report data on trading activities to the 

Agencies. The Agencies believe this will 

permit banking entities to effectively 

engage in permitted activities, and the 

Agencies to enforce compliance with 

section 13 of the BHC Act. In addition, 

the enhanced compliance programs will 

help both the banking entities and the 

Agencies identify, monitor, and limit 

risks of activities permitted under 

section 13, particularly involving 

banking entities posing the greatest risk 

to financial stability. 

A. General Approach and Summary of 

Final Rule 

The Agencies have designed the final 

rule to achieve the purposes of section 

13 of the BHC Act, which include 

prohibiting banking entities from 

engaging in proprietary trading or 

acquiring or retaining an ownership 

interest in, or having certain 

relationships with, a covered fund, 

while permitting banking entities to 

continue to provide, and to manage and 

limit the risks associated with 

providing, client-oriented financial 

services that are critical to capital 

generation for businesses of all sizes, 

households and individuals, and that 

facilitate liquid markets. These clientoriented financial services, which 

include underwriting, market making, 

and asset management services, are 

important to the U.S. financial markets 

and the participants in those markets. 

At the same time, providing appropriate 

latitude to banking entities to provide 

such client-oriented services need not 

and should not conflict with clear, 

robust, and effective implementation of 

the statute’s prohibitions and 

restrictions. 

As noted above, the final rule takes a 

multi-faceted approach to implementing 

section 13 of the BHC Act. In particular, 

the final rule includes a framework that 

clearly describes the key characteristics 

of both prohibited and permitted 

activities. The final rule also requires 

banking entities to establish a 

comprehensive compliance program 

designed to ensure compliance with the 

requirements of the statute and rule in 

a way that takes into account and 

reflects the banking entity’s activities, 

size, scope and complexity. With 

respect to proprietary trading, the final 

rule also requires the large firms that are 

active participants in trading activities 

to calculate and report meaningful 

quantitative data that will assist both 

banking entities and the Agencies in 

identifying particular activity that 

warrants additional scrutiny to 

distinguish prohibited proprietary 

trading from otherwise permissible 

activities. 

As a matter of structure, the final rule 

is generally divided into four subparts 

and contains two appendices, as 

follows: 

• Subpart A of the final rule describes 

the authority, scope, purpose, and 

relationship to other authorities of the 

rule and defines terms used commonly 

throughout the rule; 

• Subpart B of the final rule prohibits 

proprietary trading, defines terms 

relevant to covered trading activity, 

establishes exemptions from the 

prohibition on proprietary trading and 

limitations on those exemptions, and 

requires certain banking entities to 

report quantitative measurements with 

respect to their trading activities; 

• Subpart C of the final rule prohibits 

or restricts acquiring or retaining an 

ownership interest in, and certain 

relationships with, a covered fund, 

defines terms relevant to covered fund 

activities and investments, as well as 

establishes exemptions from the 

restrictions on covered fund activities 

and investments and limitations on 

those exemptions; 

• Subpart D of the final rule generally 

requires banking entities to establish a 

compliance program regarding 

compliance with section 13 of the BHC 

Act and the final rule, including written 

policies and procedures, internal 

controls, a management framework, 

independent testing of the compliance 

program, training, and recordkeeping; 

• Appendix A of the final rule details 

the quantitative measurements that 

certain banking entities may be required 

to compute and report with respect to 

certain trading activities; 

• Appendix B of the final rule details 

the enhanced minimum standards for 

programmatic compliance that certain 

banking entities must meet with respect 

to their compliance program, as 

required under subpart D. 

B. Proprietary Trading Restrictions 

Subpart B of the final rule implements 

the statutory prohibition on proprietary 

trading and the various exemptions to 

this prohibition included in the statute. 

Section 75.3 of the final rule contains 

the core prohibition on proprietary 

trading and defines a number of related 

terms, including ‘‘proprietary trading’’ 

and ‘‘trading account.’’ The final rule’s 

definition of proprietary trading 

generally parallels the statutory 

definition and covers engaging as 

principal for the trading account of a 

banking entity in any transaction to 

purchase or sell specified types of 

financial instruments.41

The final rule’s definition of trading 

account also is consistent with the 

statutory definition.42 In particular, the 

definition of trading account in the final 

rule includes three classes of positions. 

First, the definition includes the 

purchase or sale of one or more 

financial instruments taken principally 

for the purpose of short-term resale, 

benefitting from short-term price 

movements, realizing short-term 

arbitrage profits, or hedging another 

trading account position.43 For purposes 

of this part of the definition, the final 

rule also contains a rebuttable 

presumption that the purchase or sale of 

a financial instrument by a banking 

entity is for the trading account of the 

banking entity if the banking entity 

holds the financial instrument for fewer 

than 60 days or substantially transfers 

the risk of the financial instrument 

within 60 days of purchase (or sale).44

Second, with respect to a banking entity 

subject to the Federal banking agencies’ 

Market Risk Capital Rules, the 

definition includes the purchase or sale 

of one or more financial instruments 

subject to the prohibition on proprietary 

trading that are treated as ‘‘covered 

positions and trading positions’’ (or 

hedges of other market risk capital rule 

covered positions) under those capital 

rules, other than certain foreign 

exchange and commodities positions.45

Third, the definition includes the 

purchase or sale of one or more 

financial instruments by a banking 

entity that is licensed or registered or 

required to be licensed or registered to 

engage in the business of a dealer, swap 

dealer, or security-based swap dealer to 

the extent the instrument is purchased 

or sold in connection with the activities 

that require the banking entity to be 

licensed or registered as such or is 

engaged in those businesses outside of 

the United States, to the extent the 

instrument is purchased or sold in 

connection with the activities of such 

business.46

The definition of proprietary trading 

also contains clarifying exclusions for 

certain purchases and sales of financial 

instruments that generally do not 

involve the requisite short-term trading 

intent, such as the purchase and sale of 

financial instruments arising under 

certain repurchase and reverse 

repurchase arrangements or securities 


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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 5815 

47See final rule § 75.3(d). 

48See final rule § 75.3(c). 

49See final rule § 75.4(a), (b). 

50See final rule § 75.5. 

51See final rule § 75.5(c). 

52See final rule § 75.6(a). 

53See final rule § 75.6(b). 

54See final rule § 75.6(c). 

55See final rule § 75.6(d). 

56See final rule § 75.6(e). 

57See final rule § 75.7. 

58See final rule § 75.10(b). 

59The Agencies believe that most securitization 

transactions are currently structured so that the 

issuing entity with respect to the securitization is 

not an affiliate of a banking entity under the BHC 

Act. However, with respect to any securitization 

that is an affiliate of a banking entity and that does 

not meet the requirements of the loan securitization 

exclusion, the related banking entity will need to 

Continued 

lending transactions and securities 

acquired or taken for bona fide liquidity 

management purposes.47

In section 75.3, the final rule also 

defines a number of other relevant 

terms, including the term ‘‘financial 

instrument.’’ This term is used to define 

the scope of financial instruments 

subject to the prohibition on proprietary 

trading. Consistent with the statutory 

language, such financial instruments 

include securities, derivatives, 

commodity futures, and options on such 

instruments, but do not include loans, 

spot foreign exchange or spot physical 

commodities.48

In section 75.4, the final rule 

implements the statutory exemptions for 

underwriting and market making-related 

activities. For each of these permitted 

activities, the final rule defines the 

exempt activity and provides a number 

of requirements that must be met in 

order for a banking entity to rely on the 

applicable exemption. As more fully 

discussed below, these include 

establishment and enforcement of a 

compliance program targeted to the 

activity; limits on positions, inventory 

and risk exposure addressing the 

requirement that activities be designed 

not to exceed the reasonably expected 

near term demands of clients, 

customers, or counterparties; limits on 

the duration of holdings and positions; 

defined escalation procedures to change 

or exceed limits; analysis justifying 

established limits; internal controls and 

independent testing of compliance with 

limits; senior management 

accountability and limits on incentive 

compensation. In addition, the final rule 

requires firms with significant marketmaking or underwriting activities to 

report data involving several metrics 

that may be used by the banking entity 

and the Agencies to identify trading 

activity that may warrant more detailed 

compliance review. 

These requirements are generally 

designed to ensure that the banking 

entity’s trading activity is limited to 

underwriting and market making-related 

activities and does not include 

prohibited proprietary trading.49 These 

requirements are also intended to work 

together to ensure that banking entities 

identify, monitor and limit the risks 

associated with these activities. 

In section 75.5, the final rule 

implements the statutory exemption for 

risk-mitigating hedging. As with the 

underwriting and market-making 

exemptions, § 75.5 of the final rule 

contains a number of requirements that 

must be met in order for a banking 

entity to rely on the exemption. These 

requirements are generally designed to 

ensure that the banking entity’s hedging 

activity is limited to risk-mitigating 

hedging in purpose and effect.50 Section 

75.5 also requires banking entities to 

document, at the time the transaction is 

executed, the hedging rationale for 

certain transactions that present 

heightened compliance risks.51 As with 

the exemptions for underwriting and 

market making-related activity, these 

requirements form part of a broader 

implementation approach that also 

includes the compliance program 

requirement and the reporting of 

quantitative measurements. 

In section 75.6, the final rule 

implements statutory exemptions for 

trading in certain government 

obligations, trading on behalf of 

customers, trading by a regulated 

insurance company, and trading by 

certain foreign banking entities outside 

of the United States. Section 75.6(a) of 

the final rule describes the government 

obligations in which a banking entity 

may trade, which include U.S. 

government and agency obligations, 

obligations and other instruments of 

specified government sponsored 

entities, and State and municipal 

obligations.52 Section 75.6(b) of the final 

rule permits trading in certain foreign 

government obligations by affiliates of 

foreign banking entities in the United 

State and foreign affiliates of a U.S. 

banking entity abroad.53 Section 75.6(c) 

of the final rule describes permitted 

trading on behalf of customers and 

identifies the types of transactions that 

would qualify for the exemption.54

Section 75.6(d) of the final rule 

describes permitted trading by a 

regulated insurance company or an 

affiliate thereof for the general account 

of the insurance company, and also 

permits those entities to trade for a 

separate account of the insurance 

company.55 Finally, § 75.6(e) of the final 

rule describes trading permitted outside 

of the United States by a foreign banking 

entity.56 The exemption in the final rule 

clarifies when a foreign banking entity 

will qualify to engage in such trading 

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

the BHC Act, as required by the statute, 

including with respect to a foreign 

banking entity not currently subject to 

the BHC Act. As explained in detail 

below, the exemption also provides that 

the risk as principal, the decisionmaking, and the accounting for this 

activity must occur solely outside of the 

United States, consistent with the 

statute. 

In section 75.7, the final rule prohibits 

a banking entity from relying on any 

exemption to the prohibition on 

proprietary trading if the permitted 

activity would involve or result in a 

material conflict of interest, result in a 

material exposure to high-risk assets or 

high-risk trading strategies, or pose a 

threat to the safety and soundness of the 

banking entity or to the financial 

stability of the United States.57 This 

section also describes the terms material 

conflict of interest, high-risk asset, and 

high-risk trading strategy for these 

purposes. 

C. Restrictions on Covered Fund 

Activities and Investments 

Subpart C of the final rule implements 

the statutory prohibition on, directly or 

indirectly, acquiring and retaining an 

ownership interest in, or having certain 

relationships with, a covered fund, as 

well as the various exemptions to this 

prohibition included in the statute. 

Section 75.10 of the final rule contains 

the core prohibition on covered fund 

activities and investments and defines a 

number of related terms, including 

‘‘covered fund’’ and ‘‘ownership 

interest.’’58 The definition of covered 

fund contains a number of exclusions 

for entities that may rely on exclusions 

from the Investment Company Act of 

1940 contained in section 3(c)(1) or 

3(c)(7) of that Act but that are not 

engaged in investment activities of the 

type contemplated by section 13 of the 

BHC Act. These include, for example, 

exclusions for wholly owned 

subsidiaries, joint ventures, foreign 

pension or retirement funds, insurance 

company separate accounts, and public 

welfare investment funds. The final rule 

also implements the statutory rule of 

construction in section 13(g)(2) and 

provides that a securitization of loans, 

which would include loan 

securitization, qualifying asset backed 

commercial paper conduit, and 

qualifying covered bonds, is not covered 

by section 13 or the final rule.59


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determine how to bring the securitization into 

compliance with this rule. 60See final rule § 75.10(d)(6). 61See final rule § 75.10(b)(6)(ii). 62See 156 Cong. Rec. S5889 (daily ed. July 15, 

2010) (statement of Sen. Hagan). 63See final rule § 75.12. 

64See final rule § 75.13(a)–(c). 

65See 12 U.S.C. 371c; see also final rule § 75.14. 

66 12 U.S.C. 371c–1. 

67See final rule § 75.15. 

The definition of ‘‘ownership 

interest’’ in the final rule provides 

further guidance regarding the types of 

interests that would be considered to be 

an ownership interest in a covered 

fund.60 As described in this 

Supplementary Information, these 

interests may take various forms. The 

definition of ownership interest also 

explicitly excludes from the definition 

‘‘restricted profit interest’’ that is solely 

performance compensation for services 

provided to the covered fund by the 

banking entity (or an employee or 

former employee thereof), under certain 

circumstances.61 Section 75.10 of the 

final rule also defines a number of other 

relevant terms, including the terms 

‘‘prime brokerage transaction,’’ 

‘‘sponsor,’’ and ‘‘trustee.’’ 

In section 75.11, the final rule 

implements the exemption for 

organizing and offering a covered fund 

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

of the BHC Act. Section 75.11(a) of the 

final rule outlines the conditions that 

must be met in order for a banking 

entity to organize and offer a covered 

fund under this authority. These 

requirements are contained in the 

statute and are intended to allow a 

banking entity to engage in certain 

traditional asset management and 

advisory businesses, subject to certain 

limits contained in section 13 of the 

BHC Act.62 The requirements are 

discussed in detail in Part VI.B.2. of this 

Supplementary Information. Section 

75.11 also explains how these 

requirements apply to covered funds 

that are issuing entities of asset-backed 

securities, as well as implements the 

statutory exemption for underwriting 

and market-making ownership interests 

of a covered fund, including explaining 

the limitations imposed on such 

activities under the final rule. 

In section 75.12, the final rule permits 

a banking entity to acquire and retain, 

as an investment in a covered fund, an 

ownership interest in a covered fund 

that the banking entity organizes and 

offers or holds pursuant to other 

authority under § 75.11.63 This section 

implements section 13(d)(4) of the BHC 

Act and related provisions. Section 

13(d)(4)(A) of the BHC Act permits a 

banking entity to make an investment in 

a covered fund that the banking entity 

organizes and offers, or for which it acts 

as sponsor, for the purposes of (i) 

establishing the covered fund and 

providing the fund with sufficient 

initial equity for investment to permit 

the fund to attract unaffiliated investors, 

or (ii) making a de minimis investment 

in the covered fund in compliance with 

applicable requirements. Section 75.12 

of the final rule implements this 

authority and related limitations, 

including limitations regarding the 

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

of all such permitted investments. In 

addition, § 75.12 requires that the 

aggregate value of all investments in 

covered funds, plus any earnings on 

these investments, be deducted from the 

capital of the banking entity for 

purposes of the regulatory capital 

requirements, and explains how that 

deduction must occur. Section 75.12 of 

the final rule also clarifies how a 

banking entity must calculate its 

compliance with these investment 

limitations (including by deducting 

such investments from applicable 

capital, as relevant), and sets forth how 

a banking entity may request an 

extension of the period of time within 

which it must conform an investment in 

a single covered fund. This section also 

explains how a banking entity must 

apply the covered fund investment 

limits to a covered fund that is an 

issuing entity of asset backed securities 

or a covered fund that is part of a 

master-feeder or fund-of-funds 

structure. 

In section 75.13, the final rule 

implements the statutory exemptions 

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

(F), and (I) of the BHC Act that permit 

a banking entity: (i) To acquire and 

retain an ownership interest in a 

covered fund as a risk-mitigating 

hedging activity related to employee 

compensation; (ii) in the case of a nonU.S. banking entity, to acquire and 

retain an ownership interest in, or act as 

sponsor to, a covered fund solely 

outside the United States; and (iii) to 

acquire and retain an ownership interest 

in, or act as sponsor to, a covered fund 

by an insurance company for its general 

or separate accounts.64

In section 75.14, the final rule 

implements section 13(f) of the BHC Act 

and generally prohibits a banking entity 

from entering into certain transactions 

with a covered fund that would be a 

covered transaction as defined in 

section 23A of the Federal Reserve 

Act.65 Section 75.14(a)(2) of the final 

rule describes the transactions between 

a banking entity and a covered fund that 

remain permissible under the statute 

and the final rule. Section 75.14(b) of 

the final rule implements the statute’s 

requirement that any transaction 

permitted under section 13(f) of the 

BHC Act (including a prime brokerage 

transaction) between the banking entity 

and a covered fund is subject to section 

23B of the Federal Reserve Act,66 which, 

in general, requires that the transaction 

be on market terms or on terms at least 

as favorable to the banking entity as a 

comparable transaction by the banking 

entity with an unaffiliated third party. 

In section 75.15, the final rule 

prohibits a banking entity from relying 

on any exemption to the prohibition on 

acquiring and retaining an ownership 

interest in, acting as sponsor to, or 

having certain relationships with, a 

covered fund, if the permitted activity 

or investment would involve or result in 

a material conflict of interest, result in 

a material exposure to high-risk assets 

or high-risk trading strategies, or pose a 

threat to the safety and soundness of the 

banking entity or to the financial 

stability of the United States.67 This 

section also describes material conflict 

of interest, high-risk asset, and high-risk 

trading strategy for these purposes. 

D. Metrics Reporting Requirement 

Under the final rule, a banking entity 

that meets relevant thresholds specified 

in the rule must furnish the following 

quantitative measurements for each of 

its trading desks engaged in covered 

trading activity calculated in accordance 

with Appendix A: 

• Risk and Position Limits and Usage; 

• Risk Factor Sensitivities; 

• Value-at-Risk and Stress VaR; 

• Comprehensive Profit and Loss 

Attribution; 

• Inventory Turnover; 

• Inventory Aging; and 

• Customer Facing Trade Ratio. 

The final rule raises the threshold for 

metrics reporting from the proposal to 

capture only firms that engage in 

significant trading activity, identified at 

specified aggregate trading asset and 

liability thresholds, and delays the dates 

for reporting metrics through a phasedin approach based on the size of trading 

assets and liabilities. Specifically, the 

Agencies have delayed the reporting of 

metrics until June 30, 2014 for the 

largest banking entities that, together 

with their affiliates and subsidiaries, 

have trading assets and liabilities the 

average gross sum of which equal or 

exceed $50 billion on a worldwide 

consolidated basis over the previous 

four calendar quarters (excluding 

trading assets and liabilities involving 

obligations of or guaranteed by the 


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68See final rule § 75.20(d)(3). The final rule 

includes a shorter period of time for reporting 

quantitative measurements than was proposed for 

the largest banking entities. Like the monthly 

reporting requirement for these firms, this is 

intended to allow for more effective supervision of 

their large-scale trading operations. 

69See final rule § 75.20. 

70See final rule § 75.20(f)(1). 

71See final rule § 75.20(f)(2). 

72 12 U.S.C. 1851(a)(1)(A). 

73 12 U.S.C. 1851(h)(4). 

74See Joint Proposal, 76 FR at 68857. 

75See, e.g., Ass’n. of Institutional Investors (Feb. 

2012); Capital Group; Comm. on Capital Markets 

Regulation; IAA; SIFMA et al. (Prop. Trading) (Feb. 

2012); SVB; Chamber (Feb. 2012); Wellington. 

76See Ass’n. of Institutional Investors (Feb. 2012); 

GE (Feb. 2012); Invesco; Sen. Corker; Chamber (Feb. 

2012). 

United States or any agency of the 

United States). Banking entities with 

$25 billion or more in trading assets and 

liabilities and banking entities with $10 

billion or more in trading assets and 

liabilities would also be required to 

report these metrics beginning on April 

30, 2016, and December 31, 2016, 

respectively. 

Under the final rule, a banking entity 

required to report metrics must 

calculate any applicable quantitative 

measurement for each trading day. Each 

banking entity required to report must 

report each applicable quantitative 

measurement to its primary supervisory 

Agency on the reporting schedule 

established in the final rule unless 

otherwise requested by the primary 

supervisory Agency for the entity. The 

largest banking entities with $50 billion 

in consolidated trading assets and 

liabilities must report the metrics on a 

monthly basis. Other banking entities 

required to report metrics must do so on 

a quarterly basis. All quantitative 

measurements for any calendar month 

must be reported no later than 10 days 

after the end of the calendar month 

required by the final rule unless another 

time is requested by the primary 

supervisory Agency for the entity except 

for a transitional six month period 

during which reporting will be required 

no later than 30 days after the end of the 

calendar month. Banking entities 

subject to quarterly reporting will be 

required to report quantitative 

measurements within 30 days of the end 

of the quarter, unless another time is 

requested by the primary supervisory 

Agency for the entity in writing.68

E. Compliance Program Requirement 

Subpart D of the final rule requires a 

banking entity engaged in covered 

trading activities or covered fund 

activities to develop and implement a 

program reasonably designed to ensure 

and monitor compliance with the 

prohibitions and restrictions on covered 

trading activities and covered fund 

activities and investments set forth in 

section 13 of the BHC Act and the final 

rule.69 To reduce the overall burden of 

the rule, the final rule provides that a 

banking entity that does not engage in 

covered trading activities (other than 

trading in U.S. government or agency 

obligations, obligations of specified 

government sponsored entities, and 

state and municipal obligations) or 

covered fund activities and investments 

need only establish a compliance 

program prior to becoming engaged in 

such activities or making such 

investments.70 In addition, to reduce the 

burden on smaller banking entities, a 

banking entity with total consolidated 

assets of $10 billion or less that engages 

in covered trading activities and/or 

covered fund activities or investments 

may satisfy the requirements of the final 

rule by including in its existing 

compliance policies and procedures 

appropriate references to the 

requirements of section 13 and the final 

rule and adjustments as appropriate 

given the activities, size, scope and 

complexity of the banking entity.71

For banking entities with total assets 

greater than $10 billion and less than 

$50 billion, the final rule specifies six 

elements that each compliance program 

established under subpart D must, at a 

minimum, include. These requirements 

focus on written policies and 

procedures reasonably designed to 

ensure compliance with the final rules, 

including limits on underwriting and 

market-making; a system of internal 

controls; clear accountability for 

compliance and review of limits, 

hedging, incentive compensation, and 

other matters; independent testing and 

audits; additional documentation for 

covered funds; training; and 

recordkeeping requirements. 

A banking entity with $50 billion or 

more total consolidated assets (or a 

foreign banking entity that has total U.S. 

assets of $50 billion or more) or that is 

required to report metrics under 

Appendix A is required to adopt an 

enhanced compliance program with 

more detailed policies, limits, 

governance processes, independent 

testing and reporting. In addition, the 

Chief Executive Officer of these larger 

banking entities must attest that the 

banking entity has in place a program 

reasonably designed to achieve 

compliance with the requirements of 

section 13 of the BHC Act and the final 

rule. 

The application of detailed minimum 

standards for these types of banking 

entities is intended to reflect the 

heightened compliance risks of large 

covered trading activities and covered 

fund activities and investments and to 

provide clear, specific guidance to such 

banking entities regarding the 

compliance measures that would be 

required for purposes of the final rule. 

VI. Final Rule 

A. Subpart B—Proprietary Trading 

Restrictions 

1. Section 75.3: Prohibition on 

Proprietary Trading and Related 

Definitions 

Section 13(a)(1)(A) of the BHC Act 

prohibits a banking entity from engaging 

in proprietary trading unless otherwise 

permitted in section 13.72 Section 

13(h)(4) of the BHC Act defines 

proprietary trading, in relevant part, as 

engaging as principal for the trading 

account of the banking entity in any 

transaction to purchase or sell, or 

otherwise acquire or dispose of, a 

security, derivative, contract of sale of a 

commodity for future delivery, or other 

financial instrument that the Agencies 

include by rule.73

Section 75.3(a) of the proposed rule 

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

BHC Act by prohibiting a banking entity 

from engaging in proprietary trading 

unless otherwise permitted under 

§§ 75.4 through 75.6 of the proposed 

rule. Section 75.3(b)(1) of the proposed 

rule defined proprietary trading in 

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

BHC Act and clarified that proprietary 

trading does not include acting solely as 

agent, broker, or custodian for an 

unaffiliated third party. The preamble to 

the proposed rule explained that acting 

in these types of capacities does not 

involve trading as principal.74

Several commenters expressed 

concern about the breadth of the ban on 

proprietary trading.75 Some of these 

commenters stated that proprietary 

trading must be carefully and narrowly 

defined to avoid prohibiting activities 

that Congress did not intend to limit 

and to preclude significant, unintended 

consequences for capital markets, 

capital formation, and the broader 

economy.76 Some commenters asserted 

that the proposed definition could result 

in banking entities being unwilling to 

take principal risk to provide liquidity 

for institutional investors; could 

unnecessarily constrain liquidity in 

secondary markets, forcing asset 

managers to service client needs 

through alternative non-U.S. markets; 

could impose substantial costs for all 

institutions, especially smaller and midsize institutions; and could drive riskVerDate Mar<15>2010 23:00 Jan 30, 2014 Jkt 232001 PO 00000 Frm 00011 Fmt 4701 Sfmt 4700 E:\FR\FM\31JAR3.SGM 31JAR3

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77See Chamber (Feb. 2012). 

78See Japanese Bankers Ass’n. 

79See, e.g., ABA (Keating); Ass’n. of Institutional 

Investors (Feb. 2012); BOK; George Bollenbacher; 

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

2012); JPMC. 

80See Public Citizen. 

81See Sens. Merkley & Levin (Feb. 2012). 

82See generally Occupy; Public Citizen; AFR et 

al. (Feb. 2012). The Agencies received over fifteen 

thousand form letters in support of a rule with few 

exemptions, many of which expressed a desire to 

return to the regulatory scheme as governed by the 

Glass-Steagall affiliation provisions of the U.S. 

Banking Act of 1933, as repealed through the 

Graham-Leach-Bliley Act of 1999. See generally 

Sarah McGee; Christopher Wilson; Michael Itlis; 

Barry Rein; Edward Bright. Congress rejected such 

an approach, however, opting instead for the more 

narrowly tailored regulatory approach embodied in 

section 13 of the BHC Act. 

83See final rule § 75.3(a). The final rule also 

replaces all references to the proposed term 

‘‘covered financial position’’ with the term 

‘‘financial instrument.’’ This change has no 

substantive impact because the definition of 

‘‘financial instrument’’ is substantially identical to 

the proposed definition of ‘‘covered financial 

position.’’ Consistent with this change, the final 

rule replaces the undefined verbs ‘‘acquire’’ or 

‘‘take’’ with the defined terms ‘‘purchase’’ or ‘‘sale’’ 

and ‘‘sell.’’ See final rule §§ 75.3(c), 75.2(u), (x). 

84See, e.g., Ass’n. of Institutional Investors (Feb. 

2012); GE (Feb. 2012); Invesco; Sen. Corker; 

Chamber (Feb. 2012); JPMC. 

85See 156 Cong. Rec. S5895–96 (daily ed. July 15, 

2010) (statement of Sen. Merkley) (stating the 

statute ‘‘permits underwriting and market-makingrelated transactions that are technically trading for 

the account of the firm but, in fact, facilitate the 

provision of near-term client-oriented financial 

services.’’). 

86See ABA (Keating); Ass’n. of Institutional 

Investors (Feb. 2012); BOK; George Bollenbacher; 

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

2012); JPMC. 

87See, e.g., AllianceBernstein; Obaid Syed; Rep. 

Bachus et al.; EMTA; NASP; Sen. Hagan; Investure; 

Lord Abbett; Sumitomo Trust; EFAMA; Morgan 

Stanley; Barclays; BoA; Citigroup (Feb. 2012); 

STANY; ABA (Keating); ICE; ICSA; SIFMA (Asset 

Mgmt.) (Feb. 2012); Putnam; ACLI (Feb. 2012); 

Wells Fargo (Prop. Trading); Capital Group; RBC; 

Columbia Mgmt.; SSgA (Feb. 2012); Fidelity; ICI 

(Feb. 2012); ISDA (Feb. 2012); Comm. on Capital 

Markets Regulation; Clearing House Ass’n.; Thakor 

Study. See also CalPERS (acknowledging that the 

systemic protections afforded by the Volcker Rule 

come at a price, including reduced liquidity to all 

markets). 

88See, e.g., AllianceBernstein; Obaid Syed; 

NASP; Investure; Lord Abbett; CalPERS; Credit 

Suisse (Seidel); Citigroup (Feb. 2012); ABA 

(Keating); SIFMA (Asset Mgmt.) (Feb. 2012); 

Putnam; Wells Fargo (Prop. Trading); Comm. on 

Capital Markets Regulation. 

89See, e.g., Rep. Bachus et al.; Members of 

Congress (Dec. 2011); Lord Abbett; Morgan Stanley; 

Barclays; BoA; Citigroup (Feb. 2012); ABA 

(Abernathy); ICSA; SIFMA (Asset Mgmt.) (Feb. 

2012); Chamber (Feb. 2012); Putnam; ACLI (Feb. 

2012); UBS; Wells Fargo (Prop. Trading); Capital 

Group; Sen. Carper et al.; Fidelity; Invesco; Clearing 

House Ass’n.; Thakor Study. 

90See, e.g., CalPERS (expressing the belief that a 

decline in banking entity proprietary trading will 

increase the volatility of the corporate bond market, 

especially during times of economic weakness or 

periods where risk taking declines, but noting that 

portfolio managers have experienced many different 

periods of market illiquidity and stating that the 

market will adapt post-implementation (e.g., 

portfolio managers will increase their use of CDS 

to reduce economic risk to specific bond positions 

as the liquidation process of cash bonds takes more 

time, alternative market matching networks will be 

developed)); Morgan Stanley; Capital Group; 

Fidelity; British Bankers’ Ass’n.; Invesco. 

91See David McClean; Public Citizen; Occupy. In 

response to commenters who expressed concern 

about risks associated with proprietary trading 

activities moving to non-banking entities, the 

Agencies note that section 13’s prohibition on 

proprietary trading and related exemptions apply 

only to banking entities. See, e.g., Chamber (Feb. 

2012). 

92See final rule § 75.3(d). 

93See 12 U.S.C. 1851(h)(6). 

taking to the shadow banking system.77

Others urged the Agencies to determine 

that trading as agent, broker, or 

custodian for an affiliate was not 

proprietary trading.78

Commenters also suggested 

alternative approaches for defining 

proprietary trading. In general, these 

approaches sought to provide a brightline definition to provide increased 

certainty to banking entities 79 or make 

the prohibition easier to apply in 

practice.80 One commenter stated the 

Agencies should focus on the economics 

of banking entities’ transactions and ban 

trading if the banking entity is exposed 

to market risk for a significant period of 

time or is profiting from changes in the 

value of the asset.81 Several 

commenters, including individual 

members of the public, urged the 

Agencies to prohibit banking entities 

from engaging in any kind of proprietary 

trading and require separation of trading 

from traditional banking activities.82

After carefully considering comments, 

the Agencies are defining proprietary 

trading as engaging as principal for the 

trading account of the banking entity in 

any purchase or sale of one or more 

financial instruments.83 The Agencies 

believe this effectively restates the 

statutory definition. The Agencies are 

not adopting commenters’ suggested 

modifications to the proposed definition 

of proprietary trading or the general 

prohibition on proprietary trading 

because they generally appear to be 

inconsistent with Congressional intent. 

For instance, some commenters 

appeared to suggest an approach to 

defining proprietary trading that would 

capture only bright-line, speculative 

proprietary trading and treat the 

activities covered by the statutory 

exemptions as completely outside the 

rule.84 However, such an approach 

would appear to be inconsistent with 

Congressional intent because, for 

instance, it would not give effect to the 

limitations on permitted activities in 

section 13(d) of the BHC Act.85 For 

similar reasons, the Agencies are not 

adopting a bright-line definition of 

proprietary trading.86

A number of commenters expressed 

concern that, as a whole, the proposed 

rule may result in certain negative 

economic impacts, including: (i) 

Reduced market liquidity; 87 (ii) wider 

spreads or otherwise increased trading 

costs; 88 (iii) higher borrowing costs for 

businesses or increased cost of 

capital; 89 and/or (iv) greater market 

volatility.90 The Agencies have carefully 

considered commenters’ concerns about 

the proposed rule’s potential impact on 

overall market liquidity and quality. As 

discussed in more detail in Parts VI.A.2. 

and VI.A.3., the final rule will permit 

banking entities to continue to provide 

beneficial market-making and 

underwriting services to customers, and 

therefore provide liquidity to customers 

and facilitate capital-raising. However, 

the statute upon which the final rule is 

based prohibits proprietary trading 

activity that is not exempted. As such, 

the termination of non-exempt 

proprietary trading activities of banking 

entities may lead to some general 

reductions in liquidity of certain asset 

classes. Although the Agencies cannot 

say with any certainty, there is good 

reason to believe that to a significant 

extent the liquidity reductions of this 

type may be temporary since the statute 

does not restrict proprietary trading 

activities of other market participants.91

Thus, over time, non-banking entities 

may provide much of the liquidity that 

is lost by restrictions on banking 

entities’ trading activities. If so, 

eventually, the detrimental effects of 

increased trading costs, higher costs of 

capital, and greater market volatility 

should be mitigated. 

To respond to concerns raised by 

commenters while remaining consistent 

with Congressional intent, the final rule 

has been modified to provide that 

certain purchases and sales are not 

proprietary trading as described in more 

detail below.92

a. Definition of ‘‘Trading Account’’ 

As explained above, section 13 

defines proprietary trading as engaging 

as principal ‘‘for the trading account of 

the banking entity’’ in certain types of 

transactions. Section 13(h)(6) of the 

BHC Act defines trading account as any 

account used for acquiring or taking 

positions in financial instruments 

principally for the purpose of selling in 

the near-term (or otherwise with the 

intent to resell in order to profit from 

short-term price movements), and any 

such other accounts as the Agencies 

may, by rule, determine.93

The proposed rule defined trading 

account to include three separate 

accounts. First, the proposed definition 


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94See proposed rule § 75.3(b)(2)(i)(A). 

95See proposed rule § 75.3(b)(2)(ii). 

96See proposed rule §§ 75.3(b)(2)(i)(B); 75.3(b)(3). 

97See proposed rule § 75.3(b)(2)(i)(C). 

98See proposed rule § 75.3(b)(2)(i)(C)(5). 

99See Joint Proposal, 76 FR 68860. 

100See proposed rule § 75.3(b)(2)(iii). 101See ABA (Keating); JPMC. 102See AFR et al. (Feb. 2012); Paul Volcker; 

Credit Suisse (Seidel); ISDA (Feb. 2012); Japanese 

Bankers Ass’n. 103See ABA (Keating); Allen & Overy (on behalf 

of Large Int’l Banks with U.S. Operations); Am. 

Express; BoA; Goldman (Prop. Trading); ISDA (Feb. 

2012); Japanese Bankers Ass’n.; JPMC; SIFMA et al. 

(Prop. Trading) (Feb. 2012); State Street (Feb. 2012). 104See ABA (Keating); JPMC; SIFMA et al. (Prop. 

Trading) (Feb. 2012); State Street (Feb. 2012). 105See ABA (Keating); Credit Suisse (Seidel). 106See ABA (Keating); Ass’n. of Institutional 

Investors (Feb. 2012); BoA; Capital Group; IAA; 

Credit Suisse (Seidel); ICI (Feb. 2012); ISDA (Feb. 

2012); NAIB et al.; SIFMA et al. (Prop. Trading) 

(Feb. 2012); SVB; Wellington. 

107See ABA (Keating). 

108See NAIB et al.; Occupy; but see Alfred Brock. 

109See ABA; BoA; Goldman (Prop. Trading); 

ISDA (Feb. 2012); JPMC; SIFMA et al. (Prop. 

Trading) (Feb. 2012). 

110See BoA; SIFMA et al. (Prop. Trading) (Feb. 

2012). 

111See ISDA (Feb. 2012). 

112See ABA (Keating); BoA; Goldman (Prop. 

Trading); ISDA (Feb. 2012); JPMC. The banking 

agencies adopted a final rule that amends their 

respective market risk capital rules on August 30, 

2012. See 77 FR 53060 (Aug. 30, 2012). The 

Agencies continued to receive and consider 

comments on the proposed rule to implement 

section 13 of the BHC Act after that time. 

113See ABA (Keating); Allen & Overy (on behalf 

of Large Int’l Banks with U.S. Operations); Am. 

Express; Goldman (Prop. Trading); ISDA (Feb. 

2012); Japanese Bankers Ass’n.; JPMC; SIFMA et al. 

(Prop. Trading) (Feb. 2012). 

114See ABA (Keating); Allen & Overy (on behalf 

of Large Int’l Banks with U.S. Operations); JPMC; 

State Street (Feb. 2012); ISDA (Feb. 2012); SIFMA 

et al. (Prop. Trading) (Feb. 2012). 

115See ABA (Keating); Am. Express; Goldman 

(Prop. Trading); ISDA (Feb. 2012); JPMC. 

of trading account included, consistent 

with the statute, any account that is 

used by a banking entity to acquire or 

take one or more covered financial 

positions for short-term trading 

purposes (the ‘‘short-term trading 

account’’).94 The proposed rule 

identified four purposes that would 

indicate short-term trading intent: (i) 

Short-term resale; (ii) benefitting from 

actual or expected short-term price 

movements; (iii) realizing short-term 

arbitrage profits; or (iv) hedging one or 

more positions described in (i), (ii) or 

(iii). The proposed rule presumed that 

an account is a trading account if it is 

used to acquire or take a covered 

financial position (other than a position 

in the market risk rule trading account 

or the dealer trading account) that the 

banking entity holds for 60 days or 

less.95

Second, the proposed definition of 

trading account included, for certain 

entities, any account that contains 

positions that qualify for trading book 

capital treatment under the banking 

agencies’ market risk capital rules other 

than positions that are foreign exchange 

derivatives, commodity derivatives or 

contracts of sale of a commodity for 

delivery (the ‘‘market risk rule trading 

account’’).96 ‘‘Covered positions’’ under 

the banking agencies’ market-risk 

capital rules are positions that are 

generally held with the intent of sale in 

the short-term. 

Third, the proposed definition of 

trading account included any account 

used by a banking entity that is a 

securities dealer, swap dealer, or 

security-based swap dealer to acquire or 

take positions in connection with its 

dealing activities (the ‘‘dealer trading 

account’’).97 The proposed rule also 

included as a trading account any 

account used to acquire or take any 

covered financial position by a banking 

entity in connection with the activities 

of a dealer, swap dealer, or securitybased swap dealer outside of the United 

States.98 Covered financial positions 

held by banking entities that register or 

file notice as securities or derivatives 

dealers as part of their dealing activity 

were included because such positions 

are generally held for sale to customers 

upon request or otherwise support the 

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

its dealing positions).99

The proposed rule also set forth four 

clarifying exclusions from the definition 

of trading account. The proposed rule 

provided that no account is a trading 

account to the extent that it is used to 

acquire or take certain positions under 

repurchase or reverse repurchase 

arrangements, positions under securities 

lending transactions, positions for bona 

fide liquidity management purposes, or 

positions held by derivatives clearing 

organizations or clearing agencies.100

Overall, commenters did not raise 

significant concerns with or objections 

to the short-term trading account. 

Several commenters argued that the 

definition of trading account should be 

limited to only this portion of the 

proposed definition of trading 

account.101 However, a few commenters 

raised concerns regarding the treatment 

of arbitrage trading under the proposed 

rule.102 Several commenters asserted 

that the proposed definition of trading 

account was too broad and covered 

trading not intended to be covered by 

the statute.103 Some of these 

commenters maintained that the 

Agencies exceeded their statutory 

authority under section 13 of the BHC 

Act in defining trading account to 

include the market risk rule trading 

account and dealer trading account, and 

argued that the definition should be 

limited to the short-term trading 

account definition.104 Commenters 

argued, for example, that an overly 

broad definition of trading account may 

cause traditional bank activities 

important to safety and soundness of a 

banking entity to fall within the 

prohibition on proprietary trading to the 

detriment of banking organizations, 

customers, and financial markets.105 A 

number of commenters suggested 

modifying and narrowing the trading 

account definition to remove the 

implicit negative presumption that any 

position creates a trading account, or 

that all principal trading constitutes 

prohibited proprietary trading unless it 

qualifies for a narrowly tailored 

exemption, and to clearly exempt 

activities important to safety and 

soundness.106 For example, one 

commenter recommended that a 

covered financial position be considered 

a trading account position only if it 

qualifies as a GAAP trading position.107

A few commenters requested the 

Agencies define the phrase ‘‘short term’’ 

in the rule.108

Several commenters argued that the 

market risk rule should not be 

referenced as part of the definition of 

trading account.109 A few of these 

commenters argued instead that the 

capital treatment of a position be used 

only as an indicative factor rather than 

a dispositive test.110 One commenter 

thought that the market risk rule trading 

account was redundant because it 

includes only positions that have shortterm trading intent.111 Commenters also 

contended that it was difficult to 

consider and comment on this aspect of 

the proposal because the market risk 

capital rules had not been finalized.112

A number of commenters objected to 

the dealer trading account prong of the 

definition.113 Commenters asserted that 

this prong was an unnecessary and 

unhelpful addition that went beyond 

the requirements of section 13 of the 

BHC Act, and that it made the trading 

account determination more complex 

and difficult.114 In particular, 

commenters argued that the dealer 

trading account was too broad and 

introduced uncertainty because it 

presumed that dealers always enter into 

positions with short-term intent.115

Commenters also expressed concern 

about the difficulty of applying this test 

outside the United States and requested 

that, if this account is retained, the final 

rule be explicit about how it applies to 

a swap dealer outside the United States 


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116See Allen & Overy (on behalf of Large Int’l 

Banks with U.S. Operations); Am. Express; JPMC. 

117See Sens. Merkley & Levin (Feb. 2012); 

Occupy. 

118See, e.g., Public Citizen. 

119See AFR et al. (Feb. 2012). 

120See Alfred Brock. 

121See AFR et al. (Feb. 2012). 

122See ABA (Keating); Goldman (Prop. Trading); 

NAIB et al. 

123See Japanese Bankers Ass’n.; Norinchukin. 

124See Japanese Bankers Ass’n. 

125See Alfred Brock. 

126See AFR et al. (Feb. 2012); Paul Volcker. 

127See NAIB et al. See infra Part VI.A.1.d.2. 

(discussing the liquidity management exclusion). 

128 12 U.S.C. 1851(h)(6). 

129 In response to commenters’ concerns about the 

meaning of account, the Agencies note the term 

‘‘trading account’’ is a statutory concept and does 

not necessarily refer to an actual account. Trading 

account is simply nomenclature for the set of 

transactions that are subject to the final rule’s 

restrictions on proprietary trading. See ABA 

(Keating); Goldman (Prop. Trading); NAIB et al. 

130For example, several commenters’ concerns 

about the potential impact of the proposed 

definition of trading account were tied to the 

perceived narrowness of the proposed exemptions. 

See ABA (Keating); Ass’n. of Institutional Investors 

(Feb. 2012); BoA; Capital Group; IAA; Credit Suisse 

(Seidel); ICI (Feb. 2012); ISDA (Feb. 2012); NAIB et 

al.; SIFMA et al. (Prop. Trading) (Feb. 2012); SVB; 

Wellington. 

131See Sens. Merkley & Levin (Feb. 2012). 

However, as discussed in this SUPPLEMENTARY

INFORMATION, the Agencies are not prohibiting any 

trading that involves profiting from changes in the 

value of the asset, as suggested by this commenter, 

because permitted activities, such as market 

making, can involve price appreciation-related 

revenues. See infra Part VI.A.3. (discussing the final 

market-making exemption). 

132See Joint Proposal, 76 FR at 68857–68858. 

133As a result, the Agencies are not excluding 

arbitrage trading from the trading account 

definition, as suggested by at least one commenter. 

See, e.g., Alfred Brock. 

and treat U.S. swap dealers 

consistently.116

In contrast, other commenters 

contended that the proposed rule’s 

definition of trading account was too 

narrow, particularly in its focus on 

short-term positions,117 or should be 

simplified.118 One commenter argued 

that the breadth of the trading account 

definition was critical because positions 

excluded from the trading account 

definition would not be subject to the 

proposed rule.119 One commenter 

supported the proposed definition of 

trading account.120 Other commenters 

believed that reference to the marketrisk rule was an important addition to 

the definition of trading account. Some 

expressed the view that it should 

include all market risk capital rule 

covered positions and not just those 

requiring short-term trading intent.121

Certain commenters proposed 

alternate definitions. Several 

commenters argued against using the 

term ‘‘account’’ and instead advocated 

applying the prohibition on proprietary 

trading to trading positions.122 Foreign 

banks recommended applying the 

definition of trading account applicable 

to such banks in their home country, if 

the home country provided a clear 

definition of this term.123 These 

commenters argued that new definitions 

in the proposed rule, like trading 

account, would require foreign banking 

entities to develop new and complex 

procedures and expensive systems.124

Commenters also argued that various 

types of trading activities should be 

excluded from the trading account 

definition. For example, one commenter 

asserted that arbitrage trading should 

not be considered trading account 

activity,125 while other commenters 

argued that arbitrage positions and 

strategies are proprietary trading and 

should be included in the definition of 

trading account and prohibited by the 

final rule.126 Another commenter argued 

that the trading account should include 

only positions primarily intended, when 

the position is entered into, to profit 

from short-term changes in the value of 

the assets, and that liquidity 

investments that do not have price 

changes and that can be sold whenever 

the banking entity needs cash should be 

excluded from the trading account 

definition.127

After carefully reviewing the 

comments, the Agencies have 

determined to retain in the final rule the 

proposed approach for defining trading 

account that includes the short-term, 

market risk rule, and dealer trading 

accounts with modifications to address 

issues raised by commenters. The 

Agencies believe that this multi-prong 

approach is consistent with both the 

language and intent of section 13 of the 

BHC Act, including the express 

statutory authority to include ‘‘any such 

other account’’ as determined by the 

Agencies.128 The final definition 

effectuates Congress’s purpose to 

generally focus on short-term trading 

while addressing commenters’ desire for 

greater certainty regarding the definition 

of the trading account.129 In addition, 

the Agencies believe commenters’ 

concerns about the scope of the 

proposed definition of trading account 

are substantially addressed by the 

refined exemptions in the final rule for 

customer-oriented activities, such as 

market making-related activities, and 

the exclusions from proprietary 

trading.130 Moreover, the Agencies 

believe that it is appropriate to focus on 

the economics of a banking entity’s 

trading activity to help determine 

whether it is engaged in proprietary 

trading, as discussed further below.131

As explained above, the short-term 

trading prong of the definition largely 

incorporates the statutory provisions. 

This prong covers trading involving 

short-term resale, price movements, and 

arbitrage profits, and hedging positions 

that result from these activities. 

Specifically, the reference to short-term 

resale is taken from the statute’s 

definition of trading account. The 

Agencies continue to believe it is also 

appropriate to include in the short-term 

trading prong an account that is used by 

a banking entity to purchase or sell one 

or more financial instruments 

principally for the purpose of 

benefitting from actual or expected 

short-term price movements, realizing 

short-term arbitrage profits, or hedging 

one or more positions captured by the 

short-term trading prong. The 

provisions regarding price movements 

and arbitrage focus on the intent to 

engage in transactions to benefit from 

short-term price movements (e.g., 

entering into a subsequent transaction 

in the near term to offset or close out, 

rather than sell, the risks of a position 

held by the banking entity to benefit 

from a price movement occurring 

between the acquisition of the 

underlying position and the subsequent 

offsetting transaction) or to benefit from 

differences in multiple market prices, 

including scenarios where movement in 

those prices is not necessary to realize 

the intended profit.132 These types of 

transactions are economically 

equivalent to transactions that are 

principally for the purpose of selling in 

the near term or with the intent to resell 

to profit from short-term price 

movements, which are expressly 

covered by the statute’s definition of 

trading account. Thus, the Agencies 

believe it is necessary to include these 

provisions in the final rule’s short-term 

trading prong to provide clarity about 

the scope of the definition and to 

prevent evasion of the statute and final 

rule.133 In addition, like the proposed 

rule, the final rule’s short-term trading 

prong includes hedging one or more of 

the positions captured by this prong 

because the Agencies assume that a 

banking entity generally intends to hold 

the hedging position for only so long as 

the underlying position is held. 

The remaining two prongs to the 

trading account definition apply to 

types of entities that engage actively in 

trading activities. Each prong focuses on 

analogous or parallel short-term trading 

activities. A few commenters stated 

these prongs were duplicative of the 

short-term trading prong, and argued the 

Agencies should not include these 

prongs in the definition of trading 


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134See ISDA (Feb. 2012); JPMC; ABA (Keating); 

BoA; SIFMA et al. (Prop. Trading) (Feb. 2012). 

135See Occupy. 

136 12 CFR 225, Appendix E. 

137Accordingly, the Agencies are not using a 

position’s capital treatment as merely an indicative 

factor, as suggested by a few commenters. 

138See Joint Proposal, 76 FR at 68860. 

139See final rule § 75.3(b)(1)(iii). 

140An insured depository institution may be 

registered as a swap dealer, but only the swap 

dealing activities that require it to be so registered 

are covered by the dealer trading account. If an 

insured depository institution purchases or sells a 

financial instrument in connection with activities of 

the insured depository institution that do not trigger 

registration as a swap dealer, such as lending, 

deposit-taking, the hedging of business risks, or 

other end-user activity, the financial instrument is 

included in the trading account only if the 

instrument falls within the statutory trading 

account under § 75.3(b)(1)(i) or the market risk rule 

trading account under § 75.3(b)(1)(ii) of the final 

rule. 

141See final rule §§ 75.3(b)(1)(i) and (ii). 

142See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); Goldman (Prop. Trading). 

143See, e.g., Goldman (Prop. Trading) (‘‘For 

instance, a banking entity’s market making-related 

activities with respect to credit trading may involve 

making a market in bonds (traded in a brokerdealer), single-name CDSs (in a security-based swap 

dealer) and CDS indexes (in a swap dealer). For 

regulatory or other reasons, these transactions could 

take place in different legal entities . . .’’). 

144See SIFMA et al. (Prop. Trading) (Feb. 2012); 

JPMC; Allen & Overy (on behalf of Large Int’l Banks 

with U.S. Operations). 

145See final rule § 75.6(e). 

146See Japanese Bankers Ass’n. 

account, or should only consider them 

as non-determinative factors.134 To the 

extent that an overlap exists between 

the prongs of this definition, the 

Agencies believe they are mutually 

reinforcing, strengthen the rule’s 

effectiveness, and may help simplify the 

analysis of whether a purchase or sale 

is conducted for the trading account.135

The market risk capital prong covers 

trading positions that are covered 

positions for purposes of the banking 

agency market-risk capital rules, as well 

as hedges of those positions. Trading 

positions under those rules are positions 

held by the covered entity ‘‘for the 

purpose of short-term resale or with the 

intent of benefitting from actual or 

expected short-term price movements, 

or to lock-in arbitrage profits.’’ 136 This 

definition largely parallels the 

provisions of section 13(h)(4) of the 

BHC Act and mirrors the short-term 

trading account prong of both the 

proposed and final rules. Covered 

positions are trading positions under the 

rule that subject the covered entity to 

risks and exposures that must be 

actively managed and limited—a 

requirement consistent with the 

purposes of the section 13 of the BHC 

Act. 

Incorporating this prong into the 

trading account definition reinforces the 

consistency between governance of the 

types of positions that banking entities 

identify as ‘‘trading’’ for purposes of the 

market risk capital rules and those that 

are trading for purposes of the final rule 

under section 13 of the BHC Act. 

Moreover, this aspect of the final rule 

reduces the compliance burden on 

banking entities with substantial trading 

activities by establishing a clear, brightline rule for determining that a trade is 

within the trading account.137

After reviewing comments, the 

Agencies also continue to believe that 

financial instruments purchased or sold 

by registered dealers in connection with 

their dealing activity are generally held 

with short-term intent and should be 

captured within the trading account. 

The Agencies believe the scope of the 

dealer prong is appropriate because, as 

noted in the proposal, positions held by 

a registered dealer in connection with 

its dealing activity are generally held for 

sale to customers upon request or 

otherwise support the firm’s trading 

activities (e.g., by hedging its dealing 

positions), which is indicative of shortterm intent.138 Moreover, the final rule 

includes a number of exemptions for the 

activities in which securities dealers, 

swap dealers, and security-based swap 

dealers typically engage, such as market 

making, hedging, and underwriting. 

Thus, the Agencies believe the broad 

scope of the dealer trading account is 

balanced by the exemptions that are 

designed to permit dealer entities to 

continue to engage in customer-oriented 

trading activities, consistent with the 

statute. This approach is designed to 

ensure that registered dealer entities are 

engaged in permitted trading activities, 

rather than prohibited proprietary 

trading. 

The final rule adopts the dealer 

trading account substantially as 

proposed,139 with streamlining that 

eliminates the specific references to 

different types of securities and 

derivatives dealers. The final rule 

adopts the proposed approach to 

covering trading accounts of banking 

entities that regularly engage in the 

business of a dealer, swap dealer, or 

security-based swap dealer outside of 

the United States. In the case of both 

domestic and foreign entities, this 

provision applies only to financial 

instruments purchased or sold in 

connection with the activities that 

require the banking entity to be licensed 

or registered to engage in the business 

of dealing, which is not necessarily all 

of the activities of that banking 

entity.140 Activities of a banking entity 

that are not covered by the dealer prong 

may, however, be covered by the shortterm or market risk rule trading 

accounts if the purchase or sale satisfies 

the requirements of §§ 75.3(b)(1)(i) or 

(ii).141

A few commenters stated that they do 

not currently analyze whether a 

particular activity would require dealer 

registration, so the dealer prong of the 

trading account definition would 

require banking entities to engage in a 

new type of analysis.142 The Agencies 

recognize that banking entities that are 

registered dealers may not currently 

engage in such an analysis with respect 

to their current trading activities and, 

thus, this may represent a new 

regulatory requirement for these 

entities. If the regulatory analysis 

otherwise engaged in by banking 

entities is substantially similar to the 

dealer prong analysis required under the 

trading account definition, then any 

increased compliance burden could be 

small or insubstantial.143

In response to commenters’ concerns 

regarding the application of this prong 

to banking entities acting as dealers in 

jurisdictions outside the United 

States,144 the Agencies continue to 

believe including the activities of a 

banking entity engaged in the business 

of a dealer, swap dealer, or securitybased swap dealer outside of the United 

States, to the extent the instrument is 

purchased or sold in connection with 

the activities of such business, is 

appropriate. As noted above, dealer 

activity generally involves short-term 

trading. Further, the Agencies are 

concerned that differing requirements 

for U.S. and foreign dealers may lead to 

regulatory arbitrage. For foreign banking 

entities acting as dealers outside of the 

United States that are eligible for the 

exemption for trading conducted by 

foreign banking entities, the Agencies 

believe the risk-based approach to this 

exemption in the final rule should help 

address the concerns about the scope of 

this prong of the definition.145

In response to one commenter’s 

suggestion that the Agencies define the 

term trading account to allow a foreign 

banking entity to use of the relevant 

foreign regulator’s definition of this 

term, where available, the Agencies are 

concerned such an approach could lead 

to regulatory arbitrage and otherwise 

inconsistent applications of the rule.146

The Agencies believe this commenter’s 

general concern about the impact of the 

statute and rule on foreign banking 

entities’ activities outside the United 

States should be substantially addressed 

by the exemption for trading conducted 

by foreign banking entities under 

§ 75.6(e) of the final rule. 


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147See ABA (Keating). 

148See Joint Proposal, 76 FR at 68859. 

149See Japanese Bankers Ass’n. 

150See Capital Group. 

151See AFR et al. (Feb. 2012). 

152See Sens. Merkley & Levin (Feb. 2012); Public 

Citizen (arguing that one-year demarks tax law 

covering short term capital gains). 

153See Sens. Merkley & Levin (Feb. 2012). 

154See Occupy. 155See Capital Group. 156See SIFMA et al. (Prop. Trading) (Feb. 2012). 157See ABA (Keating); Am. Express; Business 

Roundtable; Capital Group; ICI (Feb. 2012); 

Investure; JPMC; Liberty Global; STANY; Chamber 

(Feb. 2012). 158See ABA (Keating); JPMC; Chamber (Feb. 

2012). 159See Am. Express; ICI (Feb. 2012). 160See ABA (Keating); Chamber (Feb. 2012). 161See AllianceBernstein; Business Roundtable; 

ICI (Feb. 2012); Investure; Liberty Global; STANY. 

Because the rebuttable presumption does not 

impact the availability of the exemptions for 

underwriting, market making, and other permitted 

activities, the Agencies do not believe this 

provision creates any additional burdens on 

permissible activities. 

162See Am. Express (noting that most foreign 

exchange forward transactions settle in less than 

one week and are used as commercial payment 

instruments, and not speculative trades); Capital 

Group. 

163See ABA (Keating). As discussed below in Part 

VI.C., the Agencies expect to continue to coordinate 

their supervisory efforts related to section 13 of the 

BHC Act and to share information as appropriate in 

order to effectively implement the requirements of 

that section and the final rule. 

164See ABA (Keating); AllianceBernstein; Capital 

Group; Japanese Bankers Ass’n.; Liberty Global; 

JPMC. 

165See NAIB et al.; Capital Group. 

166See Japanese Bankers Ass’n. As noted above, 

the Agencies believe concerns about the impacts of 

the definition of trading account on foreign banking 

entity trading activity outside of the United States 

are substantially addressed by the final rule’s 

exemption for proprietary trading conducted by 

foreign banking entities in final rule § 75.6(e). 

167 Id. 

168See final rule § 75.3(b)(2). Commenters did not 

provide persuasive evidence of the benefits 

associated with a rebuttable presumption for 

positions held for greater or fewer than 60 days. 

169See, e.g., Am. Express; Capital Group; Sens. 

Merkley & Levin (Feb. 2012). 

170See Capital Group; AFR et al. (Feb. 2012); 

Sens. Merkley & Levin (Feb. 2012); Public Citizen; 

Occupy. 

Finally, the Agencies have declined to 

adopt one commenter’s 

recommendation that a position in a 

financial instrument be considered a 

trading account position only if it 

qualifies as a GAAP trading position.147

The Agencies continue to believe that 

formally incorporating accounting 

standards governing trading securities is 

not appropriate because: (i) The 

statutory proprietary trading provisions 

under section 13 of the BHC Act applies 

to financial instruments, such as 

derivatives, to which the trading 

security accounting standards may not 

apply; (ii) these accounting standards 

permit companies to classify, at their 

discretion, assets as trading securities, 

even where the assets would not 

otherwise meet the definition of trading 

securities; and (iii) these accounting 

standards could change in the future 

without consideration of the potential 

impact on section 13 of the BHC Act 

and these rules.148

b. Rebuttable Presumption for the ShortTerm Trading Account 

The proposed rule included a 

rebuttable presumption clarifying when 

a covered financial position, by reason 

of its holding period, is traded with 

short-term intent for purposes of the 

short-term trading account. The 

Agencies proposed this presumption 

primarily to provide guidance to 

banking entities that are not subject to 

the market risk capital rules or are not 

covered dealers or swap entities and 

accordingly may not have experience 

evaluating short-term trading intent. In 

particular, § 75.3(b)(2)(ii) of the 

proposed rule provided that an account 

would be presumed to be a short-term 

trading account if it was used to acquire 

or take a covered financial position that 

the banking entity held for a period of 

60 days or less. 

Several commenters supported the 

rebuttable presumption, but suggested 

either shortening the holding period to 

30 days or less,149 or extending the 

period to 90 days,150 to several 

months,151 or to one year.152 Some of 

these commenters argued that 

specifying an overly short holding 

period would be contrary to the statute, 

invite gamesmanship,153 and miss 

speculative positions held for longer 

than the specified period.154

Commenters also suggested turning the 

presumption into a safe harbor 155 or 

into guidance.156

Other commenters opposed the 

inclusion of the rebuttable presumption 

for a number of reasons and requested 

that it be removed.157 For example, 

these commenters argued that the 

presumption had no statutory basis; 158

was arbitrary; 159 was not supported by 

data, facts, or analysis; 160 would 

dampen market-making and 

underwriting activity; 161 or did not take 

into account the nature of trading in 

different types of securities.162 Some 

commenters also questioned whether 

the Agencies would interpret rebuttals 

of the presumption consistently,163 and 

stressed the difficulty and costliness of 

rebutting the presumption,164 such as 

enhanced documentation or other 

administrative burdens.165 One foreign 

banking association also argued that 

requiring foreign banking entities to 

rebut a U.S. regulatory requirement 

would be costly and inappropriate given 

that the trading activities of the banking 

entity are already reviewed by home 

country supervisors.166 This commenter 

also contended that the presumption 

could be problematic for financial 

instruments purchased for long-term 

investment purposes that are closed 

within 60 days due to market 

fluctuations or other changed 

circumstances.167

After carefully considering the 

comments received, the Agencies 

continue to believe the rebuttable 

presumption is appropriate to generally 

define the meaning of ‘‘short-term’’ for 

purposes of the short-term trading 

account, especially for small and 

regional banking entities that are not 

subject to the market risk capital rules 

and are not registered dealers or swap 

entities. The range of comments the 

Agencies received on what ‘‘short-term’’ 

should mean—from 30 days to one 

year—suggests that a clear presumption 

would ensure consistency in 

interpretation and create a level playing 

field for all banking entities with 

covered trading activities subject to the 

short-term trading account. Based on 

their supervisory experience, the 

Agencies find that 60 days is an 

appropriate cut off for a regulatory 

presumption.168 Further, because the 

purpose of the rebuttable presumption 

is to simplify the process of evaluating 

whether individual positions are 

included in the trading account, the 

Agencies believe that implementing 

different holding periods based on the 

type of financial instrument would 

insert unnecessary complexity into the 

presumption.169 The Agencies are not 

providing a safe harbor or a reverse 

presumption (i.e., a presumption for 

positions that are outside of the trading 

account), as suggested by some 

commenters, in recognition that some 

proprietary trading could occur outside 

of the 60 day period.170

Adopting a presumption allows the 

Agencies and affected banking entities 

to evaluate all the facts and 

circumstances surrounding trading 

activity in determining whether the 

activity implicates the purpose of the 

statute. For example, trading in a 

financial instrument for long-term 

investment that is disposed of within 60 

days because of unexpected 

developments (e.g., an unexpected 

increase in the financial instrument’s 

volatility or a need to liquidate the 

instrument to meet unexpected liquidity 

demands) may not be trading activity 

covered by the statute. To reduce the 

costs and burdens of rebutting the 


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171The Agencies believe this should help address 

commenters’ concerns about the burdens associated 

with rebutting the presumption. See ABA (Keating); 

AllianceBernstein; Capital Group; Japanese Bankers 

Ass’n.; Liberty Global; JPMC; NAIB et al.; Capital 

Group. 

172See, e.g., ABA (Keating); Clearing House 

Ass’n.; JPMC. 

173The rebuttable presumption covered these 

trades in the proposal, but the final rule’s use of 

‘‘financial instrument’’ rather than ‘‘covered 

financial position’’ necessitated clarifying this point 

in the rule text. See final rule § 75.3(b)(2). See also 

Public Citizen. 

174The Agencies do not believe these revisions 

have a substantive effect on the operation or scope 

of the final rule in comparison to the statute or 

proposed rule. 

175See 12 U.S.C. 1851(h)(4). 

176See proposed rule § 75.3(c)(3)(i). 

177See proposed rule § 75.3(c)(3)(ii). 

178See proposed rule § 75.2(l), (q), (w); 

§ 75.3(c)(1) and (2). 

179See 7 U.S.C. 1a(47) (defining ‘‘swap’’); 15 

U.S.C. 78c(a)(68) (defining ‘‘security-based swap’’). 

180 7 U.S.C. 1a(24), (25). 

181 7 U.S.C. 2(c)(2)(C)(i). 

182 7 U.S.C. 2(c)(2)(D)(i). 

183 7 U.S.C. 23. 

184See Sens. Merkley & Levin (Feb. 2012); Public 

Citizen; Occupy. 

185See Northern Trust; Morgan Stanley; JPMC; 

Credit Suisse (Seidel); Am. Express; see also AFR 

et al. (Feb. 2012) (arguing that the final rule should 

explicitly exclude ‘‘spot’’ commodities and foreign 

exchange). 

186See Alfred Brock. 

187See Credit Suisse (Seidel). 

presumption, the Agencies will allow a 

banking entity to rebut the presumption 

for a group of related positions.171

The final rule provides three 

clarifying changes to the proposed 

rebuttable presumption. First, in 

response to comments, the final rule 

replaces the reference to an ‘‘account’’ 

that is presumed to be a trading account 

with the purchase or sale of a ‘‘financial 

instrument.’’ 172 This change clarifies 

that the presumption only applies to the 

purchase or sale of a financial 

instrument that is held for fewer than 60 

days, and not the entire account that is 

used to make the purchase or sale. 

Second, the final rule clarifies that basis 

trades, in which a banking entity buys 

one instrument and sells a substantially 

similar instrument (or otherwise 

transfers the first instrument’s risk), are 

subject to the rebuttable 

presumption.173 Third, in order to 

maintain consistency with definitions 

used throughout the final rule, the 

references to ‘‘acquire’’ or ‘‘take’’ a 

financial position have been replaced 

with references to ‘‘purchase’’ or ‘‘sell’’ 

a financial instrument.174

c. Definition of ‘‘Financial Instrument’’ 

Section 13 of the BHC Act generally 

prohibits proprietary trading, which is 

defined in section 13(h)(4) to mean 

engaging as principal for the trading 

account in any purchase or sale of any 

security, any derivative, any contract of 

sale of a commodity for future delivery, 

any option on any such security, 

derivative, or contract, or any other 

security or financial instruments that 

the Agencies may, by rule, determine.175

The proposed rule defined the term 

‘‘covered financial position’’ to 

reference the instruments listed in 

section 13(h)(4), including: (i) A 

security, including an option on a 

security; (ii) a derivative, including an 

option on a derivative; or (iii) a contract 

of sale of a commodity for future 

delivery, or an option on such a 

contract.176 To provide additional 

clarity, the proposed rule also provided 

that, consistent with the statute, any 

position that is itself a loan, a 

commodity, or foreign exchange or 

currency was not a covered financial 

position.177

The proposal also defined a number 

of other terms used in the definition of 

covered financial position, including 

commodity, derivative, loan, and 

security.178 These terms were generally 

defined by reference to the Federal 

securities laws or the Commodity 

Exchange Act because these existing 

definitions are generally wellunderstood by market participants and 

have been subject to extensive 

interpretation in the context of 

securities, commodities, and derivatives 

trading. 

As noted above, the proposed rule 

included derivatives within the 

definition of covered financial position. 

Derivative was defined to include any 

swap (as that term is defined in the 

Commodity Exchange Act) and securitybased swap (as that term is defined in 

the Exchange Act), in each case as 

further defined by the CFTC and SEC by 

joint regulation, interpretation, 

guidance, or other action, in 

consultation with the Board pursuant to 

section 712(d) of the Dodd-Frank Act.179

The proposed rule also included within 

the definition of derivative certain other 

transactions that, although not included 

within the definition of swap or 

security-based swap, also appear to be, 

or operate in economic substance as, 

derivatives, and which if not included 

could permit banking entities to engage 

in proprietary trading that is 

inconsistent with the purpose of section 

13 of the BHC Act. Specifically, the 

proposed definition also included: (i) 

Any purchase or sale of a nonfinancial 

commodity for deferred shipment or 

delivery that is intended to be 

physically settled; (ii) any foreign 

exchange forward or foreign exchange 

swap (as those terms are defined in the 

Commodity Exchange Act); 180 (iii) any 

agreement, contract, or transaction in 

foreign currency described in section 

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

Act; 181 (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; 182 and (v) any transactions 

authorized under section 19 of the 

Commodity Exchange Act.183 In 

addition, the proposed rule excluded 

from the definition of derivative (i) any 

consumer, commercial, or other 

agreement, contract, or transaction that 

the CFTC and SEC have further defined 

by joint regulation, interpretation, 

guidance, or other action as not within 

the definition of swap or security-based 

swap, and (ii) any identified banking 

product, as defined in section 402(b) of 

the Legal Certainty for Bank Products 

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

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

U.S.C. 27a(a)). 

Commenters expressed a variety of 

views regarding the definition of 

covered financial position, as well as 

other defined terms used in that 

definition. For instance, some 

commenters argued that the definition 

should be expanded to include 

transactions in spot commodities or 

foreign currency, even though those 

instruments are not included by the 

statute.184 Other commenters strongly 

supported the exclusion of spot 

commodity and foreign currency 

transactions as consistent with the 

statute, arguing that these instruments 

are part of the traditional business of 

banking and do not represent the types 

of instruments that Congress designed 

section 13 to address. These 

commenters argued that including spot 

commodities and foreign exchange 

within the definition of covered 

financial position in the final rule 

would put U.S. banking entities at a 

competitive disadvantage and prevent 

them from conducting routine banking 

operations.185 One commenter argued 

that the proposed definition of covered 

financial position was effective and 

recommended that the definition should 

not be expanded.186 Another commenter 

argued that an instrument be considered 

to be a spot foreign exchange 

transaction, and thus not a covered 

financial position, if it settles within 5 

days of purchase.187 Another 

commenter argued that covered 

financial positions used in interaffiliate 

transactions should expressly be 

excluded because they are used for 


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5824 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

188See GE (Feb. 2012). 

189See JPMC; BoA; Citigroup (Feb. 2012). 

190See Govt. of Japan/Bank of Japan; Japanese 

Bankers Ass’n.; see also Norinchukin. 

191See Northern Trust; Citigroup (Feb. 2012). 

192See SIFMA et al. (Prop. Trading) (Feb. 2012). 

193See id. 

194See SIFMA et al. (Prop. Trading) (Feb. 2012); 

ISDA (Feb. 2012). 

195See Alfred Brock. 

196The definition of security under the final rule 

is the same as under the proposal. See final rule 

§ 75.2(y). 

197See final rule § 75.3(c)(1). 

198The definition of loan, as well as comments 

received regarding that definition, is discussed in 

detail below in Part VI.B.1.c.8.a. 

199See final rule § 75.3(c)(2). 

200See Sens. Merkley & Levin (Feb. 2012); Public 

Citizen; Occupy. 

201See Occupy. 

202Several commenters supported the exclusion 

of spot commodity and foreign currency 

transactions as consistent with the statute. See 

Northern Trust; Morgan Stanley; State Street (Feb. 

2012); JPMC; Credit Suisse (Seidel); Am. Express; 

see also AFR et al. (Feb. 2012) (arguing that the 

final rule should explicitly exclude ‘‘spot’’ 

commodities and foreign exchange). One 

commenter stated that the proposed definition 

should not be expanded. See Alfred Brock. With 

respect to the exclusion for loans, the Agencies note 

this is generally consistent with the rule of statutory 

construction regarding the sale and securitization of 

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

203See JPMC; BAC; Citigroup (Feb. 2012); Govt. 

of Japan/Bank of Japan; Japanese Bankers Ass’n.; 

Northern Trust; see also Norinchukin. 

204See final rule § 75.2(h), (y). 

205See SIFMA et al. (Prop. Trading) (Feb. 2012); 

ISDA (Feb. 2012). 

206See CFTC and SEC, Further Definition of 

‘‘Swap,’’ ‘‘Security-Based Swap,’’ and ‘‘SecurityBased Swap Agreement’’; Mixed swaps; Security 

Based Swap Agreement Recordkeeping, 78 FR 

48208 (Aug. 13, 2012). 

internal risk management purposes and 

not for proprietary trading.188

Some commenters requested that the 

final rule exclude additional 

instruments from the definition of 

covered financial position. For instance, 

some commenters requested that the 

Agencies exclude commodity and 

foreign exchange futures, forwards, and 

swaps, arguing that these instruments 

typically have a commercial and not 

financial purpose and that making them 

subject to the prohibitions of section 13 

would negatively affect the spot market 

for these instruments.189 A few 

commenters also argued that foreign 

exchange swaps and forwards are used 

in many jurisdictions to provide U.S. 

dollar-funding for foreign banking 

entities and that these instruments 

should be excluded since they 

contribute to the stability and liquidity 

of the market for spot foreign 

exchange.190 Other commenters 

contended that foreign exchange swaps 

and forwards should be excluded 

because they are an integral part of 

banking entities’ ability to provide trust 

and custody services to customers and 

are necessary to enable banking entities 

to deal in the exchange of currencies for 

customers.191

One commenter argued that the 

inclusion of certain instruments within 

the definition of derivative, such as 

purchases or sales of nonfinancial 

commodities for deferred shipment or 

delivery that are intended to be 

physically settled, was inappropriate.192

This commenter alleged that these 

instruments are not derivatives but 

should instead be viewed as contracts 

for purchase of specific commodities to 

be delivered at a future date. This 

commenter also argued that the 

Agencies do not have authority under 

section 13 to include these instruments 

as ‘‘other securities or financial 

instruments’’ subject to the prohibition 

on proprietary trading.193

Some commenters also argued that, 

because the CFTC and SEC had not yet 

finalized their definitions of swap and 

security-based swap, it was 

inappropriate to use those definitions as 

part of the proposed definition of 

derivative.194 One commenter argued 

that the definition of derivative was 

effective, although this commenter 

argued that the final rule should not 

cross-reference the definition of swap 

and security-based swap under the 

Federal commodities and securities 

laws.195

After carefully considering the 

comments received on the proposal, the 

final rule continues to apply the 

prohibition on proprietary trading to the 

same types of instruments as listed in 

the statute and the proposal, which the 

final rule defines as ‘‘financial 

instrument.’’ Under the final rule, a 

financial instrument is defined as: (i) A 

security, including an option on a 

security; 196 (ii) a derivative, including 

an option on a derivative; or (iii) a 

contract of sale of a commodity for 

future delivery, or option on a contract 

of sale of a commodity for future 

delivery.197 The final rule excludes from 

the definition of financial instrument: (i) 

A loan; 198 (ii) a commodity that is not 

an excluded commodity (other than 

foreign exchange or currency), a 

derivative, a contract of sale of a 

commodity for future delivery, or an 

option on a contract of sale of a 

commodity for future delivery; or (iii) 

foreign exchange or currency.199 An 

excluded commodity is defined to have 

the same meaning as in section 1a(19) 

of the Commodity Exchange Act. 

The Agencies continue to believe that 

these instruments and transactions, 

which are consistent with those 

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

BHC Act as part of the statutory 

definition of proprietary trading, 

represent the type of financial 

instruments which the proprietary 

trading prohibition of section 13 was 

designed to cover. While some 

commenters requested that this 

definition be expanded to include spot 

transactions 200 or loans,201 the 

Agencies do not believe that it is 

appropriate at this time to expand the 

scope of instruments subject to the ban 

on proprietary trading.202 Similarly, 

while some commenters requested that 

certain other instruments, such as 

foreign exchange swaps and forwards, 

be excluded from the definition of 

financial instrument,203 the Agencies 

believe that these instruments appear to 

be, or operate in economic substance as, 

derivatives (which are by statute 

included within the scope of 

instruments subject to the prohibitions 

of section 13). If these instruments were 

not included within the definition of 

financial instrument, banking entities 

could use them to engage in proprietary 

trading that is inconsistent with the 

purpose and design of section 13 of the 

BHC Act. 

As under the proposal, loans, 

commodities, and foreign exchange or 

currency are not included within the 

scope of instruments subject to section 

13. The exclusion of these types of 

instruments is intended to eliminate 

potential confusion by making clear that 

the purchase and sale of loans, 

commodities, and foreign exchange or 

currency—none of which are referred to 

in section 13(h)(4) of the BHC Act—are 

outside the scope of transactions to 

which the proprietary trading 

restrictions apply. For example, the spot 

purchase of a commodity would meet 

the terms of the exclusion, but the 

acquisition of a futures position in the 

same commodity would not qualify for 

the exclusion. 

The final rule also adopts the 

definitions of security and derivative as 

proposed.204 These definitions, which 

reference existing definitions under the 

Federal securities and commodities 

laws, are generally well-understood by 

market participants and have been 

subject to extensive interpretation in the 

context of securities and commodities 

trading activities. While some 

commenters argued that it would be 

inappropriate to use the definition of 

swap and security-based swap because 

those terms had not yet been finalized 

pursuant to public notice and 

comment,205 the CFTC and SEC have 

subsequently finalized those definitions 

after receiving extensive public 

comment on the rulemakings.206 The 


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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 5825 

207See proposed rule § 75.3(b)(2)(iii)(A). 

208See proposed rule § 75.3(b)(2)(iii)(B). The 

language that described securities lending 

transactions in the proposed rule generally mirrored 

that contained in Rule 3a5–3 under the Exchange 

Act. See 17 CFR 240.3a5–3. 

209See Joint Proposal, 76 FR at 68862. 

210See generally ABA (Keating); Alfred Brock; 

Citigroup (Feb. 2012); GE (Feb. 2012); Goldman 

(Prop. Trading); ICBA; Japanese Bankers Ass’n.; 

JPMC; Norinchukin; RBC; RMA; SIFMA et al. (Prop. 

Trading) (Feb. 2012); State Street (Feb. 2012); T. 

Rowe Price; UBS; Wells Fargo (Prop. Trading). See 

infra Part VI.A.d.10. for the discussion of 

commenters’ requests for additional exclusions 

from the trading account. 

211See SIFMA et al. (Prop. Trading) (Feb. 2012). 

212See FIA; SIFMA et al. (Prop. Trading) (Feb. 

2012). 

213See Goldman (Prop. Trading); JPMC; UBS. 

214See Goldman (Prop. Trading); UBS. For 

example, one commenter suggested that fully 

collateralized swap transactions should be 

exempted from the definition of trading account 

because they serve as funding transactions and are 

economically similar to repurchase agreements. See 

SIFMA et al. (Prop. Trading) (Feb. 2012). 

215See Goldman (Prop. Trading). 

216See AFR et al. (Feb. 2012); Occupy; Public 

Citizen; Sens. Merkley & Levin (Feb. 2012). 

217See AFR et al. (Feb. 2012). 

218See Public Citizen. 

Agencies believe that this notice and 

comment process provided adequate 

opportunity for market participants to 

comment on and understand those 

terms, and as such they are incorporated 

in the definition of derivative under this 

final rule. 

While some commenters requested 

that foreign exchange swaps and 

forwards be excluded from the 

definition of derivative or financial 

instrument, the Agencies have not done 

so for the reasons discussed above. 

However, as explained below in Part 

VI.A.1.d., the Agencies note that to the 

extent a banking entity purchases or 

sells a foreign exchange forward or 

swap, or any other financial instrument, 

in a manner that meets an exclusion 

from proprietary trading, that 

transaction would not be considered to 

be proprietary trading and thus would 

not be subject to the requirements of 

section 13 of the BHC Act and the final 

rule. This includes, for instance, the 

purchase or sale of a financial 

instrument by a banking entity acting 

solely as agent, broker, or custodian, or 

the purchase or sale of a security as part 

of a bona fide liquidity management 

plan. 

d. Proprietary Trading Exclusions 

The proposed rule contained four 

exclusions from the definition of trading 

account for categories of transactions 

that do not fall within the scope of 

section 13 of the BHC Act because they 

do not involve short-term trading 

activities subject to the statutory 

prohibition on proprietary trading. 

These exclusions covered the purchase 

or sale of a financial instrument under 

certain repurchase and reverse 

repurchase agreements and securities 

lending arrangements, for bona fide 

liquidity management purposes, and by 

a clearing agency or derivatives clearing 

organization in connection with clearing 

activities. 

As discussed below, the final rule 

provides exclusions for the purchase or 

sale of a financial instrument under 

certain repurchase and reverse 

repurchase agreements and securities 

lending agreements; for bona fide 

liquidity management purposes; by 

certain clearing agencies, derivatives 

clearing organizations in connection 

with clearing activities; by a member of 

a clearing agency, derivatives clearing 

organization, or designated financial 

market utility engaged in excluded 

clearing activities; to satisfy existing 

delivery obligations; to satisfy an 

obligation of the banking entity in 

connection with a judicial, 

administrative, self-regulatory 

organization, or arbitration proceeding; 

solely as broker, agent, or custodian; 

through a deferred compensation or 

similar plan; and to satisfy a debt 

previously contracted. After considering 

comments on these issues, which are 

discussed in more detail below, the 

Agencies believe that providing 

clarifying exclusions for these nonproprietary activities will likely 

promote more cost-effective financial 

intermediation and robust capital 

formation. Overly narrow exclusions for 

these activities would potentially 

increase the cost of core banking 

services, while overly broad exclusions 

would increase the risk of allowing the 

types of trades the statute was designed 

to prohibit. The Agencies considered 

these issues in determining the 

appropriate scope of these exclusions. 

Because the Agencies do not believe 

these excluded activities involve 

proprietary trading, as defined by the 

statute and the final rule, the Agencies 

do not believe it is necessary to use our 

exemptive authority in section 

13(d)(1)(J) of the BHC Act to deem these 

activities a form of permitted 

proprietary trading. 

1. Repurchase and Reverse Repurchase 

Arrangements and Securities Lending 

The proposed rule’s definition of 

trading account excluded an account 

used to acquire or take one or more 

covered financial positions that arise 

under (i) a repurchase or reverse 

repurchase agreement pursuant to 

which the banking entity had 

simultaneously agreed, in writing at the 

start of the transaction, to both purchase 

and sell a stated asset, at stated prices, 

and on stated dates or on demand with 

the same counterparty,207 or (ii) a 

transaction in which the banking entity 

lends or borrows a security temporarily 

to or from another party pursuant to a 

written securities lending agreement 

under which the lender retains the 

economic interests of an owner of such 

security and has the right to terminate 

the transaction and to recall the loaned 

security on terms agreed to by the 

parties.208 Positions held under these 

agreements operate in economic 

substance as a secured loan and are not 

based on expected or anticipated 

movements in asset prices. Accordingly, 

these types of transactions do not 

appear to be of the type the statutory 

definition of trading account was 

designed to cover.209

Several commenters expressed 

support for these exclusions and 

requested that the Agencies expand 

them.210 For example, one commenter 

requested clarification that all types of 

repurchase transactions qualify for the 

exclusion.211 Some commenters 

requested expanding this exclusion to 

cover all positions financed by, or 

transactions related to, repurchase and 

reverse repurchase agreements.212 Other 

commenters requested that the 

exclusion apply to all transactions that 

are analogous to extensions of credit 

and are not based on expected or 

anticipated movements in asset prices, 

arguing that the exclusion would be too 

limited in scope to achieve its objective 

if it is based on the legal form of the 

underlying contract.213 Additionally, 

some commenters suggested expanding 

the exclusion to cover transactions that 

are for funding purposes, including 

prime brokerage transactions, or for the 

purpose of asset-liability 

management.214 Commenters also 

recommended expanding the exclusion 

to include re-hypothecation of customer 

securities, which can produce financing 

structures that, like a repurchase 

agreement, are functionally loans.215

In contrast, other commenters argued 

that there was no statutory or policy 

justification for excluding repurchase 

and reverse repurchase agreements from 

the trading account, and requested that 

this exclusion be removed from the final 

rule.216 Some of these commenters 

argued that repurchase agreements 

could be used for prohibited proprietary 

trading 217 and suggested that, if 

repurchase agreements are excluded 

from the trading account, 

documentation detailing the use of 

liquidity derived from repurchase 

agreements should be required.218 These 


emcdonald on DSK67QTVN1PROD with RULES3
5826 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

219See Public Citizen. 220See AFR et al. (Feb. 2012); Occupy. 221See AFR et al. (Feb. 2012); Occupy. 222Congress recognized that repurchase 

agreements and securities lending agreements are 

loans or extensions of credit by including them in 

the legal lending limit. See Dodd–Frank Act section 

610 (amending 12 U.S.C. 84b). The Agencies believe 

the conditions of the final rule’s exclusions for 

repurchase agreements and securities lending 

agreements identify those activities that do not in 

normal practice represent proprietary trading and, 

thus, the Agencies decline to provide additional 

requirements for these activities, as suggested by 

some commenters. See Public Citizen; AFR et al. 

(Feb. 2012); Occupy. 

223See Goldman (Prop. Trading); JPMC; UBS. 

224See CFTC Proposal, 77 FR at 8348. 

225See proposed rule § 75.3(b)(2)(iii)(C). 

226 Id. 

227See proposed rule § 75.3(b)(2)(iii)(C)(1)–(5). 

228See Joint Proposal, 76 FR at 68862. 

229See ABA (Keating); BoA; CH/ABASA; JPMC. 

See supra Part VI.A.1.b. (discussing the rebuttable 

presumption under § 75.3(b)(2) of the final rule); see 

also supra Part VI.A.1.a. (discussing the market risk 

rule trading account under § 75.3(b)(1)(ii) of the 

final rule). 

230See CH/ABASA; Wells Fargo (Prop. Trading). 

231See CH/ABASA; JPMC; State Street (Feb. 

2012); Wells Fargo (Prop. Trading). See also BaFin/ 

Deutsche Bundesbank. 

232See BoA; JPMC; RBC. 

233See ABA (Keating); Allen & Overy (on behalf 

of Canadian Banks); JPMC; NAIB et al.; State Street 

(Feb. 2012); T. Rowe Price. 

234See ABA (Keating); CH/ABASA; JPMC. 

235See ABA (Keating); BoA; CH/ABASA; JPMC. 

236See ABA (Keating); Allen & Overy (on behalf 

of Canadian Banks); BoA; CH/ABASA. 

commenters suggested that unless the 

liquidity is used to secure a position for 

a willing customer, repurchase 

agreements should be regarded as a 

strong indicator of proprietary 

trading.219 As an alternative, 

commenters suggested that the Agencies 

instead use their exemptive authority 

pursuant to section 13(d)(1)(J) of the 

BHC Act to permit repurchase and 

reverse repurchase transactions so that 

such transactions must comply with the 

statutory limits on material conflicts of 

interests and high-risks assets and 

trading strategies, and compliance 

requirements under the final rule.220

These commenters urged the Agencies 

to specify permissible collateral types, 

haircuts, and contract terms for 

securities lending agreements and 

require that the investment of proceeds 

from securities lending transactions be 

limited to high-quality liquid assets in 

order to limit potential risks of these 

activities.221

After considering the comments 

received, the Agencies have determined 

to exclude repurchase and reverse 

repurchase agreements and securities 

lending agreements from the definition 

of proprietary trading under the final 

rule. The final rule defines these terms 

subject to the same conditions as were 

in the proposal. This determination 

recognizes that repurchase and reverse 

repurchase agreements and securities 

lending agreements excluded from the 

definition operate in economic 

substance as secured loans and do not 

in normal practice represent proprietary 

trading.222 The Agencies will, however, 

monitor these transactions to ensure this 

exclusion is not used to engage in 

prohibited proprietary trading activities. 

To avoid evasion of the rule, the 

Agencies note that, in contrast to certain 

commenters’ requests,223 only the 

transactions pursuant to the repurchase 

agreement, reverse repurchase 

agreement, or securities lending 

agreement are excluded. For example, 

the collateral or position that is being 

financed by the repurchase or reverse 

repurchase agreement is not excluded 

and may involve proprietary trading. 

The Agencies further note that if a 

banking entity uses a repurchase or 

reverse repurchase agreement to finance 

a purchase of a financial instrument, 

other transactions involving that 

financial instrument may not qualify for 

this exclusion.224 Similarly, short 

positions resulting from securities 

lending agreements cannot rely upon 

this exclusion and may involve 

proprietary trading. 

Additionally, the Agencies have 

determined not to exclude all 

transactions, in whatever legal form that 

may be construed to be an extension of 

credit, as suggested by commenters, 

because such a broad exclusion would 

be too difficult to assess for compliance 

and would provide significant 

opportunity for evasion of the 

prohibitions in section 13 of the BHC 

Act. 

2. Liquidity Management Activities 

The proposed definition of trading 

account excluded an account used to 

acquire or take a position for the 

purpose of bona fide liquidity 

management, subject to certain 

requirements.225 The preamble to the 

proposed rule explained that bona fide 

liquidity management seeks to ensure 

that the banking entity has sufficient, 

readily-marketable assets available to 

meet its expected near-term liquidity 

needs, not to realize short-term profit or 

benefit from short-term price 

movements.226

To curb abuse, the proposed rule 

required that a banking entity acquire or 

take a position for liquidity management 

in accordance with a documented 

liquidity management plan that meets 

five criteria.227 Moreover, the Agencies 

stated in the preamble that liquidity 

management positions that give rise to 

appreciable profits or losses as a result 

of short-term price movements would be 

subject to significant Agency scrutiny 

and, absent compelling explanatory 

facts and circumstances, would be 

considered proprietary trading.228

The Agencies received a number of 

comments regarding the exclusion. 

Many commenters supported the 

exclusion of liquidity management 

activities from the definition of trading 

account as appropriate and necessary. 

At the same time, some commenters 

expressed the view that the exclusion 

was too narrow and should be replaced 

with a broader exclusion permitting 

trading activity for asset-liability 

management (‘‘ALM’’). Commenters 

argued that two aspects of the proposed 

rule’s definition of ‘‘trading account’’ 

would cause ALM transactions to fall 

within the prohibition on proprietary 

trading—the 60-day rebuttable 

presumption and the reference to the 

market risk rule trading account.229 For 

example, commenters expressed 

concern that hedging transactions 

associated with a banking entity’s 

residential mortgage pipeline and 

mortgage servicing rights, and managing 

credit risk, earnings at risk, capital, 

asset-liability mismatches, and foreign 

exchange risks would be among 

positions that may be held for 60 days 

or less.230 These commenters contended 

that the exclusion for liquidity 

management and the activity 

exemptions for risk-mitigating hedging 

and trading in U.S. government 

obligations would not be sufficient to 

permit a wide variety of ALM 

activities.231 These commenters 

contended that prohibiting trading for 

ALM purposes would be contrary to the 

goals of enhancing sound risk 

management, the safety and soundness 

of banking entities, and U.S. financial 

stability,232 and would limit banking 

entities’ ability to manage liquidity.233

Some commenters argued that the 

requirements of the exclusion would not 

provide a banking entity with sufficient 

flexibility to respond to liquidity needs 

arising from changing economic 

conditions.234 Some commenters argued 

the requirement that any position taken 

for liquidity management purposes be 

limited to the banking entity’s near-term 

funding needs failed to account for 

longer-term liquidity management 

requirements.235 These commenters 

further argued that the requirements of 

the liquidity management exclusion 

might not be synchronized with the 

Basel III framework, particularly with 

respect to the liquidity coverage ratio if 

‘‘near-term’’ is considered less than 30 

days.236


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237See T. Rowe Price. 

238See State Street (Feb. 2012). 

239See State Street (Feb. 2012); JPMC. See also 

Part VI.A.1.d.10. (discussing commenter requests to 

exclude inter-affiliate transactions). 

240See AFR et al. (Feb. 2012); Occupy. 

241See Occupy. 

242See Sens. Merkley & Levin (Feb. 2012). 

243See Sens. Merkley & Levin (Feb. 2012). 

244See section 165(b)(1)(A)(ii) of the Dodd-Frank 

Act; Enhanced Prudential Standards, 77 FR 644 at 

645 (Jan. 5, 2012), available at http://www.gpo.gov/ 

fdsys/pkg/FR-2012-01-05/pdf/2011-33364.pdf; see 

also Enhanced Prudential Standards, 77 FR 76678 

at 76682 (Dec. 28, 2012), available at http://

www.gpo.gov/fdsys/pkg/FR-2012-12-28/pdf/2012- 

30734.pdf. 

245To ensure sufficient flexibility to respond to 

liquidity needs arising from changing economic 

times, a banking entity should envision and address 

a range of liquidity circumstances in its liquidity 

management plan, and provide a mechanism for 

periodically reviewing and revising the liquidity 

management plan. 

246The requirement to use highly liquid 

instruments is consistent with the focus of the 

clarifying exclusion on a banking entity’s near-term 

liquidity needs. Thus, the final rules do not include 

commenters’ suggested revisions to this 

requirement. See Clearing House Ass’n.; see also 

Occupy; Sens. Merkley & Levin (Feb. 2012). The 

Agencies decline to identify particular types of 

securities that will be considered highly liquid for 

purposes of the exclusion, as requested by some 

commenters, in recognition that such a 

determination will depend on the facts and 

circumstances. See T. Rowe Price; State Street (Feb. 

2012). 

247The Agencies plan to construe ‘‘near-term 

funding needs’’ in a manner that is consistent with 

the laws, regulations, and issuances related to 

liquidity risk management. See, e.g., Liquidity 

Coverage Ratio: Liquidity Risk Measurement, 

Standards, and Monitoring, 78 FR 71818 (Nov. 29, 

2013); Basel Committee on Bank Supervision, Basel 

III: The Liquidity Coverage Ratio and Liquidity Risk 

Management Tools (January 2013) available at 

http://www.bis.org/publ/bcbs238.htm. The 

Agencies believe this should help address 

commenters’ concerns about the proposed 

requirement. See, e.g., ABA (Keating); Allen & 

Overy (on behalf of Canadian Banks); CH/ABASA; 

BoA; JPMC. 

248See, e.g., Staff of S. Comm. on Homeland Sec. 

& Governmental Affairs Permanent Subcomm. on 

Investigations, 113th Cong., Report: JPMorgan 

Chase Whale Trades: A Case History of Derivatives 

Risks and Abuses (Apr. 11, 2013), available at 

http://www.hsgac.senate.gov/download/reportjpmorgan-chase-whale-trades-a-case-history-ofderivatives-risks-and-abuses-march-15-2013. 

Commenters also requested 

clarification on a number of other issues 

regarding the exclusion. For example, 

one commenter requested clarification 

that purchases and sales of U.S. 

registered mutual funds sponsored by a 

banking entity would be permissible.237

Another commenter requested 

clarification that the deposits resulting 

from providing custodial services that 

are invested largely in high-quality 

securities in conformance with the 

banking entity’s ALM policy would not 

be presumed to be ‘‘short-term trading’’ 

under the final rule.238 Commenters also 

urged that the final rule not prohibit 

interaffiliate transactions essential to the 

ALM function.239

In contrast, other commenters 

supported the liquidity management 

exclusion criteria 240 and suggested 

tightening these requirements. For 

example, one commenter recommended 

that the rule require that investments 

made under the liquidity management 

exclusion consist only of high-quality 

liquid assets.241 Other commenters 

argued that the exclusion for liquidity 

management should be eliminated.242

One commenter argued that there was 

no need to provide a special exemption 

for liquidity management or ALM 

activities given the exemptions for 

trading in government obligations and 

risk-mitigating hedging activities.243

After carefully reviewing the 

comments received, the Agencies have 

adopted the proposed exclusion for 

liquidity management with several 

important modifications. As limited 

below, liquidity management activity 

serves the important prudential 

purpose, recognized in other provisions 

of the Dodd-Frank Act and in rules and 

guidance of the Agencies, of ensuring 

banking entities have sufficient liquidity 

to manage their short-term liquidity 

needs.244

To ensure that this exclusion is not 

misused for the purpose of proprietary 

trading, the final rule imposes a number 

of requirements. First, the liquidity 

management plan of the banking entity 

must be limited to securities (in keeping 

with the liquidity management 

requirements proposed by the Federal 

banking agencies) and specifically 

contemplate and authorize the 

particular securities to be used for 

liquidity management purposes; 

describe the amount, types, and risks of 

securities that are consistent with the 

entity’s liquidity management; and the 

liquidity circumstances in which the 

particular securities may or must be 

used.245 Second, any purchase or sale of 

securities contemplated and authorized 

by the plan must be principally for the 

purpose of managing the liquidity of the 

banking entity, and not for the purpose 

of short-term resale, benefitting from 

actual or expected short-term price 

movements, realizing short-term 

arbitrage profits, or hedging a position 

taken for such short-term purposes. 

Third, the plan must require that any 

securities purchased or sold for 

liquidity management purposes be 

highly liquid and limited to instruments 

the market, credit and other risks of 

which the banking entity does not 

reasonably expect to give rise to 

appreciable profits or losses as a result 

of short-term price movements.246

Fourth, the plan must limit any 

securities purchased or sold for 

liquidity management purposes to an 

amount that is consistent with the 

banking entity’s near-term funding 

needs, including deviations from 

normal operations of the banking entity 

or any affiliate thereof, as estimated and 

documented pursuant to methods 

specified in the plan.247 Fifth, the 

banking entity must incorporate into its 

compliance program internal controls, 

analysis and independent testing 

designed to ensure that activities 

undertaken for liquidity management 

purposes are conducted in accordance 

with the requirements of the final rule 

and the entity’s liquidity management 

plan. Finally, the plan must be 

consistent with the supervisory 

requirements, guidance and 

expectations regarding liquidity 

management of the Agency responsible 

for regulating the banking entity. 

The final rule retains the provision 

that the financial instruments purchased 

and sold as part of a liquidity 

management plan be highly liquid and 

not reasonably expected to give rise to 

appreciable profits or losses as a result 

of short-term price movements. This 

requirement is consistent with the 

Agencies’ expectation for liquidity 

management plans in the supervisory 

context. It is not intended to prevent 

firms from recognizing profits (or losses) 

on instruments purchased and sold for 

liquidity management purposes. 

Instead, this requirement is intended to 

underscore that the purpose of these 

transactions must be liquidity 

management. Thus, the timing of 

purchases and sales, the types and 

duration of positions taken and the 

incentives provided to managers of 

these purchases and sales must all 

indicate that managing liquidity, and 

not taking short-term profits (or limiting 

short-term losses), is the purpose of 

these activities. 

The exclusion as adopted does not 

apply to activities undertaken with the 

stated purpose or effect of hedging 

aggregate risks incurred by the banking 

entity or its affiliates related to assetliability mismatches or other general 

market risks to which the entity or 

affiliates may be exposed. Further, the 

exclusion does not apply to any trading 

activities that expose banking entities to 

substantial risk from fluctuations in 

market values, unrelated to the 

management of near-term funding 

needs, regardless of the stated purpose 

of the activities.248

Overall, the Agencies do not believe 

that the final rule will stand as an 

obstacle to or otherwise impair the 

ability of banking entities to manage the 


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249See, e.g., ABA (Keating); BoA; CH/ABASA; 

JPMC. 

250See proposed rule § 75.3(b)(2)(iii)(D). 

251See Joint Proposal, 76 FR at 68863. 

252See Allen & Overy (Clearing); Goldman (Prop. 

Trading); SIFMA et al. (Prop. Trading) (Feb. 2012); 

State Street (Feb. 2012). 

253See IIB/EBF. 

254See Sens. Merkley & Levin (Feb. 2012). 

255 ‘‘Clearing agency’’ is defined in the final rule 

with reference to the definition of this term in the 

Exchange Act. See final rule § 75.3(e)(2). 

‘‘Derivatives clearing organization’’ is defined in the 

final rule as (i) a derivatives clearing organization 

registered under section 5b of the Commodity 

Exchange Act; (ii) a derivatives clearing 

organization that, pursuant to CFTC regulation, is 

exempt from the registration requirements under 

section 5b of the Commodity Exchange Act; or (iii) 

a foreign derivatives clearing organization that, 

pursuant to CFTC regulation, is permitted to clear 

for a foreign board of trade that is registered with 

the CFTC. 

256See IIB/EBF; BNY Mellon et al.; SIFMA et al. 

(Prop. Trading) (Feb. 2012); Allen & Overy 

(Clearing); Goldman (Prop. Trading). 

257See IIB/EBF; Allen & Overy (Clearing). 

258See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Allen & Overy (Clearing); Goldman (Prop. Trading); 

State Street (Feb. 2012). 

259See proposed rule § 75.3(b)(2)(iii)(D). 

260See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Allen & Overy (Clearing); Goldman (Prop. Trading); 

State Street (Feb. 2012). 

261See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Allen & Overy (Clearing); State Street (Feb. 2012). 

See also ISDA (Feb. 2012). 

262See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Allen & Overy (Clearing). 

263See Allen & Overy (Clearing). 

264See SIFMA et al. (Prop. Trading) (Feb. 2012). 

risks of their businesses and operate in 

a safe and sound manner. Banking 

entities engaging in bona fide liquidity 

management activities generally do not 

purchase or sell financial instruments 

for the purpose of short-term resale or 

to benefit from actual or expected shortterm price movements. The Agencies 

have determined, in contrast to certain 

commenters’ requests, not to expand 

this liquidity management provision to 

broadly allow asset-liability 

management, earnings management, or 

scenario hedging.249 To the extent these 

activities are for the purpose of profiting 

from short-term price movements or to 

hedge risks not related to short-term 

funding needs, they represent 

proprietary trading subject to section 13 

of the BHC Act and the final rule; the 

activity would then be permissible only 

if it meets all of the requirements for an 

exemption, such as the risk-mitigating 

hedging exemption, the exemption for 

trading in U.S. government securities, or 

another exemption. 

3. Transactions of Derivatives Clearing 

Organizations and Clearing Agencies 

A banking entity that is a central 

counterparty for clearing and settlement 

activities engages in the purchase and 

sale of financial instruments as an 

integral part of clearing and settling 

those instruments. The proposed 

definition of trading account excluded 

an account used to acquire or take one 

or more covered financial positions by 

a derivatives clearing organization 

registered under the Commodity 

Exchange Act or a clearing agency 

registered under the Securities 

Exchange Act of 1934 in connection 

with clearing derivatives or securities 

transactions.250 The preamble to the 

proposed rule noted that the purpose of 

these transactions is to provide a 

clearing service to third parties, not to 

profit from short-term resale or shortterm price movements.251

Several commenters supported the 

proposed exclusion for derivatives 

clearing organizations and urged the 

Agencies to expand the exclusion to 

cover a banking entity’s clearing-related 

activities, such as clearing a trade for a 

customer, trading with a clearinghouse, 

or accepting positions of a defaulting 

member, on grounds that these activities 

are not proprietary trades and reduce 

systemic risk.252 One commenter 

recommended expanding the exclusion 

to non-U.S. central counterparties 253 In 

contrast, one commenter argued that the 

exclusion for derivatives clearing 

organizations and clearing agencies had 

no statutory basis and should instead be 

a permitted activity under section 

13(d)(1)(J).254

After considering the comments 

received, the final rule retains the 

exclusion for purchases and sales of 

financial instruments by a banking 

entity that is a clearing agency or 

derivatives clearing organization in 

connection with its clearing 

activities.255 In response to 

comments,256 the Agencies have also 

incorporated two changes to the rule. 

First, the final rule applies the exclusion 

to the purchase and sale of financial 

instruments by a banking entity that is 

a clearing agency or derivatives clearing 

organization in connection with clearing 

financial instrument transactions. 

Second, in response to comments,257 the 

exclusion in the final rule is not limited 

to clearing agencies or derivatives 

clearing organizations that are subject to 

SEC or CFTC registration requirements 

and, instead, certain foreign clearing 

agencies and foreign derivatives clearing 

organizations will be permitted to rely 

on the exclusion if they are banking 

entities. 

The Agencies believe that clearing 

and settlement activity is not designed 

to create short-term trading profits. 

Moreover, excluding clearing and 

settlement activities prevents the final 

rule from inadvertently hindering the 

Dodd–Frank Act’s goal of promoting 

central clearing of financial 

transactions. The Agencies have 

narrowly tailored this exclusion by 

allowing only central counterparties to 

use it and only with respect to their 

clearing and settlement activity. 

4. Excluded Clearing-Related Activities 

of Clearinghouse Members 

In addition to the exclusion for 

trading activities of a derivatives 

clearing organization or clearing agency, 

some commenters requested an 

additional exclusion from the definition 

of ‘‘trading account’’ for clearing-related 

activities of members of these 

entities.258 These commenters noted 

that the proposed definition of ‘‘trading 

account’’ provides an exclusion for 

positions taken by registered derivatives 

clearing organizations and registered 

clearing agencie s259 and requested a 

corresponding exclusion for certain 

clearing-related activities of banking 

entities that are members of a clearing 

agency or members of a derivatives 

clearing organization (collectively, 

‘‘clearing members’’).260

Several commenters argued that 

certain aspects of the clearing process 

may require a clearing member to 

engage in principal transactions. For 

example, some commenters argued that 

a clearinghouse’s default management 

process may require clearing members 

to take positions in financial 

instruments upon default of another 

clearing member.261 According to 

commenters, default management 

processes can involve: (i) Collection of 

initial and variation margin from 

customers under an ‘‘agency model’’ of 

clearing; (ii) porting, where a defaulting 

clearing member’s customer positions 

and margin are transferred to another 

non-defaulting clearing member; 262 (iii) 

hedging, where the clearing house looks 

to clearing members and third parties to 

enter into risk-reducing transactions and 

to flatten the market risk associated with 

the defaulting clearing member’s house 

positions and non-ported customer 

positions; (iv) unwinding, where the 

defaulting member’s open positions may 

be allocated to other clearing members, 

affiliates, or third parties pursuant to a 

mandatory auction process or forced 

allocation; 263 and (v) imposing certain 

obligations on clearing members upon 

exhaustion of a guaranty fund.264

Commenters argued that, absent an 

exclusion from the definition of 

‘‘trading account,’’ some of these 

clearing-related activities could be 

considered prohibited proprietary 

trading under the proposal. Two 

commenters specifically contended that 


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265See SIFMA et al. (Prop. Trading) (Feb. 2012) 

(arguing that the SEC has suggested that entities 

that collect margins from customers for cleared 

swaps may be required to be registered as brokerdealers); State Street (Feb. 2012). 

266See Goldman (Prop. Trading); SIFMA et al. 

(Prop. Trading) (Feb. 2012); ISDA (Feb. 2012). 

267See SIFMA et al. (Prop. Trading) (Feb. 2012); 

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

Allen & Overy (Clearing). 

268See Allen & Overy (Clearing). 

269See Allen & Overy (Clearing); SIFMA et al. 

(Prop. Trading) (Feb. 2012). These commenters 

stated that, in order to ensure that a clearing 

member is providing accurate end-of-day prices for 

its open positions, a clearing house may require the 

member to provide firm bids for such positions, 

which may be tested through a ‘‘forced trade’’ with 

another member. See id.; see also ISDA (Feb. 2012). 

270For example, Title VII of the Dodd-Frank Act 

mandates the central clearing of swaps and 

security-based swaps, and requires that banking 

entities that are swap dealers, security-based swap 

dealers, major swap participants or major securitybased swap participants collect variation margin 

from many counterparties on a daily basis for their 

swap or security-based swap activity. See 7 U.S.C. 

2(h); 15 U.S.C. 78c–3; 7 U.S.C. 6s(e); 15 U.S.C. 78o– 

10(e); Margin Requirements for Uncleared Swaps 

for Swap Dealers and Major Swap Participants, 76 

FR 23732 (Apr. 28, 2011). Additionally, the SEC’s 

Rule 17Ad–22(d)(11) requires that each registered 

clearing agency establish, implement, maintain and 

enforce policies and procedures that set forth the 

clearing agency’s default management procedures. 

See 17 CFR 240.17Ad–22(d)(11). See also Exchange 

Act Release No. 68,080 (Oct. 12, 2012), 77 FR 

66220, 66,283 (Nov. 2, 2012). 

271Centralized clearing affects counterparty risk 

in three basic ways. First, it redistributes 

counterparty risk among members through 

mutualization of losses, reducing the likelihood of 

sequential counterparty failure and contagion. 

Second, margin requirements and monitoring 

reduce moral hazard, reducing counterparty risk. 

Finally, clearing may reallocate counterparty risk 

outside of the clearing agency because netting may 

implicitly subordinate outside creditors’ claims 

relative to other clearing member claims. 

272See Proposed Rule, Cross-Border SecurityBased Swap Activities, Exchange Act Release No. 

69490 (May 1, 2013), 78 FR 30968, 31,162–31,163 

(May 23, 2013). 

273See final rule § 75.3(d)(5). 

274See final rule § 75.3(e)(7). 

275A number of commenters discussed the 

default management process and requested an 

exclusion for such activities. See SIFMA et al. 

(Prop. Trading) (Feb. 2012); Allen & Overy 

(Clearing); State Street (Feb. 2012). See also ISDA 

(Feb. 2012). 

276See Allen & Overy (Clearing) (discussing rules 

that require unwinding self-referencing transactions 

through a mandatory auction (e.g., where a firm 

acquired CDS protection on itself as a result of a 

merger with another firm)). 

277See Allen & Overy (Clearing); SIFMA et al. 

(Prop. Trading) (Feb. 2012); see also ISDA (Feb. 

2012). 

278See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Goldman (Prop. Trading). 

the dealer prong of the definition of 

‘‘trading account’’ may cause certain of 

these activities to be considered 

proprietary trading.265 Some 

commenters suggested alternative 

avenues for permitting such clearingrelated activity under the rules.266

Commenters argued that such clearingrelated activities of banking entities 

should not be subject to the rule because 

they are risk-reducing, beneficial for the 

financial system, required by law under 

certain circumstances (e.g., central 

clearing requirements for swaps and 

security-based swaps under Title VII of 

the Dodd-Frank Act), and not used by 

banking entities to engage in proprietary 

trading.267

Commenters further argued that 

certain activities undertaken as part of 

a clearing house’s daily risk 

management process may be impacted 

by the rule, including unwinding selfreferencing transactions through a 

mandatory auction (e.g., where a firm 

acquired credit default swap (‘‘CDS’’) 

protection on itself as a result of a 

merger with another firm) 268 and trade 

crossing, a mechanism employed by 

certain clearing houses to ensure the 

accuracy of the price discovery process 

in the course of, among other things, 

calculating settlement prices and margin 

requirements.269

The Agencies do not believe that 

certain core clearing-related activities 

conducted by a clearing member, often 

as required by regulation or the rules 

and procedures of a clearing agency, 

derivatives clearing organization, or 

designated financial market utility, 

represent proprietary trading as 

contemplated by the statute. For 

example, the clearing and settlement 

activities discussed above are not 

conducted for the purpose of profiting 

from short-term price movements. The 

Agencies believe that these clearingrelated activities provide important 

benefits to the financial system.270 In 

particular, central clearing reduces 

counterparty credit risk,271 which can 

lead to a host of other benefits, 

including lower hedging costs, 

increased market participation, greater 

liquidity, more efficient risk sharing that 

promotes capital formation, and 

reduced operational risk.272

Accordingly, in response to 

comments, the final rule provides that 

proprietary trading does not include 

specified excluded clearing activities by 

a banking entity that is a member of a 

clearing agency, a member of a 

derivatives clearing organization, or a 

member of a designated financial market 

utility.273 ‘‘Excluded clearing activities’’ 

is defined in the rule to identify 

particular core clearing-related 

activities, many of which were raised by 

commenters.274 Specifically, the final 

rule will exclude the following activities 

by clearing members: (i) Any purchase 

or sale necessary to correct error trades 

made by or on behalf of customers with 

respect to customer transactions that are 

cleared, provided the purchase or sale is 

conducted in accordance with certain 

regulations, rules, or procedures; (ii) any 

purchase or sale related to the 

management of a default or threatened 

imminent default of a customer, subject 

to certain conditions, another clearing 

member, or the clearing agency, 

derivatives clearing organization, or 

designated financial market utility 

itself; 275 and (iii) any purchase or sale 

required by the rules or procedures of a 

clearing agency, derivatives clearing 

organization, or designated financial 

market utility that mitigates risk to such 

agency, organization, or utility that 

would result from the clearing by a 

clearing member of security-based 

swaps that references the member or an 

affiliate of the member.276

The Agencies are identifying specific 

activities in the rule to limit the 

potential for evasion that may arise from 

a more generalized approach. However, 

the relevant supervisory Agencies will 

be prepared to provide further guidance 

or relief, if appropriate, to ensure that 

the terms of the exclusion do not limit 

the ability of clearing agencies, 

derivatives clearing organizations, or 

designated financial market utilities to 

effectively manage their risks in 

accordance with their rules and 

procedures. In response to commenters 

requesting that the exclusion be 

available when a clearing member is 

required by rules of a clearing agency, 

derivatives clearing organization, or 

designated financial market utility to 

purchase or sell a financial instrument 

as part of establishing accurate prices to 

be used by the clearing agency, 

derivatives clearing organization, or 

designated financial market utility in its 

end of day settlement process,277 the 

Agencies note that whether this is an 

excluded clearing activity depends on 

the facts and circumstances. Similarly, 

the availability of other exemptions to 

the rule, such as the market-making 

exemption, depend on the facts and 

circumstances. This exclusion applies 

only to excluded clearing activities of 

clearing members. It does not permit a 

banking entity to engage in proprietary 

trading and claim protection for that 

activity because trades are cleared or 

settled through a central counterparty. 

5. Satisfying an Existing Delivery 

Obligation 

A few commenters requested 

additional or expanded exclusions from 

the definition of ‘‘trading account’’ for 

covering short sales or failures to 

deliver.278 These commenters alleged 

that a banking entity engages in this 

activity for purposes other than to 


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5830 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

279 In order to qualify for this exclusion, a 

banking entity’s principal trading activity that 

results in its own failure to deliver must have been 

conducted in compliance with these rules. 

280See, e.g., 17 CFR 242.204 (requiring, among 

other things, that a participant of a registered 

clearing agency or, upon reasonable allocation, a 

broker-dealer for which the participant clears trades 

or from which the participant receives trades for 

settlement, take action to close out a fail to deliver 

position in any equity security by borrowing or 

purchasing securities of like kind and quantity); 17 

CFR 240.15c3–3(m) (providing that, if a brokerdealer executes a sell order of a customer and does 

not obtain possession of the securities from the 

customer within 10 business days after settlement, 

the broker-dealer must immediately close the 

transaction with the customer by purchasing 

securities of like kind and quantity). 

281See, e.g., NSCC Rule 11, NASDAQ Rule 11810, 

FINRA Rule 11810. 

282See, e.g., 17 CFR 242.204 (requiring action to 

close out a fail to deliver position in an equity 

security within certain specified timeframes); 17 

CFR 240.15c3–3(m) (requiring a broker-dealer to 

‘‘immediately’’ close a transaction under certain 

circumstances). 

283For example, an administrative agency or SRO 

may require a broker-dealer to offer to buy 

securities back from customers where the agency or 

SRO finds the broker-dealer fraudulently sold 

securities to those customers. See, e.g., In re 

Raymond James & Assocs., Exchange Act Release 

No. 64767, 101 S.E.C. Docket 1749 (June 29, 2011); 

FINRA Dep’t of Enforcement v. Pinnacle Partners 

Fin. Corp., Disciplinary Proceeding No. 

2010021324501 (Apr. 25, 2012); FINRA Dep’t of 

Enforcement v. Fifth Third Sec., Inc., No. 

2005002244101 (Press Rel. Apr. 14, 2009). 

284For instance, section 29 of the Exchange Act 

may require a broker-dealer to rescind a contract 

with a customer that was made in violation of the 

Exchange Act. Such rescission relief may involve 

the broker-dealer’s repurchase of a financial 

instrument from a customer. See 15 U.S.C. 78cc; 

Reg’l Props., Inc. v. Fin. & Real Estate Consulting 

Co., 678 F.2d 552 (5th Cir. 1982); Freeman v. 

Marine Midland Bank N.Y., 419 F.Supp. 440 

(E.D.N.Y. 1976). 

285See proposed rule § 75.3(b)(1). 

286See Japanese Bankers Ass’n. 

287See 12 U.S.C. 1851(h)(4). A common or 

collective investment fund that is an investment 

company under section 3(c)(3) or 3(c)(11) will not 

be deemed to be acting as principal within the 

meaning of § 75.3(a) because the fund is performing 

a traditional trust activity and purchases and sells 

financial instruments solely on behalf of customers 

as trustee or in a similar fiduciary capacity, as 

evidenced by its regulation under 12 CFR part 9 

(Fiduciary Activities of National Banks) or similar 

state laws. 

288See Ass’n. of Institutional Investors (Nov. 

2012). 

benefit from short term price 

movements and that it is not proprietary 

trading as defined in the statute. In 

response to these comments, the final 

rule provides that a purchase or sale by 

a banking entity that satisfies an existing 

delivery obligation of the banking entity 

or its customers, including to prevent or 

close out a failure to deliver, in 

connection with delivery, clearing, or 

settlement activity is not proprietary 

trading. 

Among other things, this exclusion 

will allow a banking entity that is an 

SEC-registered broker-dealer to take 

action to address failures to deliver 

arising from its own trading activity or 

the trading activity of its customers.279

In certain circumstances, SEC-registered 

broker-dealers are required to take such 

action under SEC rules.280 In addition, 

buy-in procedures of a clearing agency, 

securities exchange, or national 

securities association may require a 

banking entity to deliver securities if a 

party with a fail to receive position 

takes certain action.281 When a banking 

entity purchases securities to meet an 

existing delivery obligation, it is 

engaging in activity that facilitates 

timely settlement of securities 

transactions and helps provide a 

purchaser of the securities with the 

benefits of ownership (e.g., voting and 

lending rights). In addition, a banking 

entity has limited discretion to 

determine when and how to take action 

to meet an existing delivery 

obligation.282 Providing a limited 

exclusion for this activity will avoid the 

potential for SEC-registered brokerdealers being subject to conflicting or 

inconsistent regulatory requirements 

with respect to activity required to meet 

the broker-dealer’s existing delivery 

obligations. 

6. Satisfying an Obligation in 

Connection With a Judicial, 

Administrative, Self-Regulatory 

Organization, or Arbitration Proceeding 

The Agencies recognize that, under 

certain circumstances, a banking entity 

may be required to purchase or sell a 

financial instrument at the direction of 

a judicial or regulatory body. For 

example, an administrative agency or 

self-regulatory organization (‘‘SRO’’) 

may require a banking entity to 

purchase or sell a financial instrument 

in the course of disciplinary 

proceedings against that banking 

entity.283 A banking entity may also be 

obligated to purchase or sell a financial 

instrument in connection with a judicial 

or arbitration proceeding.284 Such 

transactions do not represent trading for 

short-term profit or gain and do not 

constitute proprietary trading under the 

statute. 

Accordingly, the Agencies have 

determined to adopt a provision 

clarifying that a purchase or sale of one 

or more financial instruments that 

satisfies an obligation of the banking 

entity in connection with a judicial, 

administrative, self-regulatory 

organization, or arbitration proceeding 

is not proprietary trading for purposes 

of these rules. This clarification will 

avoid the potential for conflicting or 

inconsistent legal requirements for 

banking entities. 

7. Acting Solely as Agent, Broker, or 

Custodian 

The proposal clarified that proprietary 

trading did not include acting solely as 

agent, broker, or custodian for an 

unaffiliated third party.285 Commenters 

generally supported this aspect of the 

proposal. One commenter suggested that 

acting as agent, broker, or custodian for 

affiliates should be explicitly excluded 

from the definition of proprietary 

trading in the same manner as acting as 

agent, broker, or custodian for 

unaffiliated third parties.286

Like the proposal, the final rule 

expressly provides that the purchase or 

sale of one or more financial 

instruments by a banking entity acting 

solely as agent, broker, or custodian is 

not proprietary trading because acting in 

these types of capacities does not 

involve trading as principal, which is 

one of the requisite aspects of the 

statutory definition of proprietary 

trading.287 The final rule has been 

modified to include acting solely as 

agent, broker, or custodian on behalf of 

an affiliate. However, the affiliate must 

comply with section 13 of the BHC Act 

and the final implementing rule; and 

may not itself engage in prohibited 

proprietary trading. To the extent a 

banking entity acts in both a principal 

and agency capacity for a purchase or 

sale, it may only use this exclusion for 

the portion of the purchase or sale for 

which it is acting as agent. The banking 

entity must use a separate exemption or 

exclusion, if applicable, to the extent it 

is acting in a principal capacity. 

8. Purchases or Sales Through a 

Deferred Compensation or Similar Plan 

While the proposed rule provided that 

the prohibition on covered fund 

activities and investments did not apply 

to certain instances where the banking 

entity acted through or on behalf of a 

pension or similar deferred 

compensation plan, no such similar 

treatment was given for proprietary 

trading. One commenter argued that the 

proposal restricted a banking entity’s 

ability to engage in principal-based 

trading as an asset manager that serves 

the needs of the institutional investors, 

such as through ERISA pension and 

401(k) plans.288

To address these concerns, the final 

rule provides that proprietary trading 

does not include the purchase or sale of 

one or more financial instruments 

through a deferred compensation, stockbonus, profit-sharing, or pension plan of 

the banking entity that is established 


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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 5831 

289See LSTA (Feb. 2012); JPMC; Goldman (Prop. 

Trading); SIFMA et al. (Prop. Trading) (Feb. 2012). 

290See final rule § 75.3(d)(9). 291For example, if any margin call is not met in 

full within the time required by Regulation T, then 

Regulation T requires a broker-dealer to liquidate 

securities sufficient to meet the margin call or to 

eliminate any margin deficiency existing on the day 

such liquidation is required, whichever is less. See 

12 CFR 220.4(d). 292See SEC Proposed Rule, Capital, Margin, 

Segregation, Reporting and Recordkeeping 

Requirements for Security-Based Swap Dealers, 

Exchange Act Release No. 68071, 77 FR 70214 (Nov. 

23, 2012); CFTC Proposed Rule, Margin 

Requirements for Uncleared Swaps for Swap 

Dealers and Major Swap Participants, 76 FR 23732 

(Apr. 28, 2011); Banking Agencies’ Proposed Rule, 

Margin and Capital Requirements for Covered Swap 

Entities, 76 FR 27564 (May 11, 2011). 

293See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012) (transactions that are not based on expected 

or anticipated movements in asset prices, such as 

fully collateralized swap transactions that serve 

funding purposes); Norinchukin and Wells Fargo 

(Prop. Trading) (derivatives that qualify for hedge 

accounting); GE (Feb. 2012) (transactions related to 

commercial contracts); Citigroup (Feb. 2012) (FX 

swaps and FX forwards); SIFMA et al. (Prop. 

Trading) (Feb. 2012) (interaffiliate transactions); T. 

Rowe Price (purchase and sale of shares in 

sponsored mutual funds); RMA (cash collateral 

pools); Alfred Brock (arbitrage trading); ICBA 

(securities traded pursuant to 12 U.S.C. 1831a(f)). 

The Agencies are concerned that these exclusions 

could be used to conduct impermissible proprietary 

trading, and the Agencies believe some of these 

exclusions are more appropriately addressed by 

other provisions of the rule. For example, 

derivatives qualifying for hedge accounting may be 

permitted under the hedging exemption. 294 12 U.S.C. 1851(d)(1)(B). 

and administered in accordance with 

the laws of the United States or a foreign 

sovereign, if the purchase or sale is 

made directly or indirectly by the 

banking entity as trustee for the benefit 

of the employees of the banking entity 

or members of their immediate family. 

Banking entities often establish and act 

as trustee to pension or similar deferred 

compensation plans for their employees 

and, as part of managing these plans, 

may engage in trading activity. The 

Agencies believe that purchases or sales 

by a banking entity when acting through 

pension and similar deferred 

compensation plans generally occur on 

behalf of beneficiaries of the plan and 

consequently do not constitute the type 

of principal trading that is covered by 

the statute. 

The Agencies note that if a banking 

entity engages in trading activity for an 

unaffiliated pension or similar deferred 

compensation plan, the trading activity 

of the banking entity would not be 

proprietary trading under the final rule 

to the extent the banking entity was 

acting solely as agent, broker, or 

custodian. 

9. Collecting a Debt Previously 

Contracted 

Several commenters argued that the 

final rule should exclude collecting and 

disposing of collateral in satisfaction of 

debts previously contracted from the 

definition of proprietary trading.289

Commenters argued that acquiring and 

disposing of collateral in satisfaction of 

debt previously contracted does not 

involve trading with the intent of 

profiting from short-term price 

movements and, thus, should not be 

proprietary trading for purposes of this 

rule. Rather, this activity is a prudent 

and desirable part of lending and debt 

collection activities. 

The Agencies believe that the 

purchase and sale of a financial 

instrument in satisfaction of a debt 

previously contracted does not 

constitute proprietary trading. The 

Agencies believe an exclusion for 

purchases and sales in satisfaction of 

debts previously contracted is necessary 

for banking entities to continue to lend 

to customers, because it allows banking 

entities to continue lending activity 

with the knowledge that they will not be 

penalized for recouping losses should a 

customer default. Accordingly, the final 

rule provides that proprietary trading 

does not include the purchase or sale of 

one or more financial instruments in the 

ordinary course of collecting a debt 

previously contracted in good faith, 

provided that the banking entity divests 

the financial instrument as soon as 

practicable within the time period 

permitted or required by the appropriate 

financial supervisory agency.290

As a result of this exclusion, banking 

entities, including SEC-registered 

broker-dealers, will be able to continue 

providing margin loans to their 

customers and may take possession of 

margined collateral following a 

customer’s default or failure to meet a 

margin call under applicable regulatory 

requirements.291 Similarly, a banking 

entity that is a CFTC-registered swap 

dealer or SEC-registered security-based 

swap dealer may take, hold, and 

exchange any margin collateral as 

counterparty to a cleared or uncleared 

swap or security-based swap 

transaction, in accordance with the 

rules of the Agencies.292 This exclusion 

will allow banking entities to comply 

with existing regulatory requirements 

regarding the divestiture of collateral 

taken in satisfaction of a debt. 

10. Other Requested Exclusions 

Commenters requested a number of 

additional exclusions from the trading 

account and, in turn, the prohibition on 

proprietary trading. In order to avoid 

potential evasion of the final rule, the 

Agencies decline to adopt any 

exclusions from the trading account 

other than the exclusions described 

above.293 The Agencies believe that 

various modifications to the final rule, 

including in particular to the exemption 

for market-making related activities, 

address many of commenters’ concerns 

regarding unintended consequences of 

the prohibition on proprietary trading. 

2. Section 75.4(a): Underwriting 

Exemption 

a. Introduction 

After carefully considering comments 

on the proposed underwriting 

exemption, the Agencies are adopting 

the proposed underwriting exemption 

substantially as proposed, but with 

certain refinements and clarifications to 

the proposed approach to better reflect 

the range of securities offerings that an 

underwriter may help facilitate on 

behalf of an issuer or selling security 

holder and the types of activities an 

underwriter may undertake in 

connection with a distribution of 

securities to facilitate the distribution 

process and provide important benefits 

to issuers, selling security holders, or 

purchasers in the distribution. The 

Agencies are adopting such an approach 

because the statute specifically permits 

banking entities to continue providing 

these beneficial services to clients, 

customers, and counterparties. At the 

same time, to reduce the potential for 

evasion of the general prohibition on 

proprietary trading, the Agencies are 

requiring, among other things, that the 

trading desk make reasonable efforts to 

sell or otherwise reduce its 

underwriting position (accounting for 

the liquidity, maturity, and depth of the 

market for the relevant type of security) 

and be subject to a robust risk limit 

structure that is designed to prevent a 

trading desk from having an 

underwriting position that exceeds the 

reasonably expected near term demands 

of clients, customers, or counterparties. 

b. Overview 

1. Proposed Underwriting Exemption 

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

provides an exemption from the 

prohibition on proprietary trading for 

the purchase, sale, acquisition, or 

disposition of securities and certain 

other instruments in connection with 

underwriting activities, to the extent 

that such activities are designed not to 

exceed the reasonably expected near 

term demands of clients, customers, or 

counterparties.294

Section 75.4(a) of the proposed rule 

would have implemented this 

exemption by requiring that a banking 

entity’s underwriting activities comply 

with seven requirements. As discussed 


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5832 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

295See proposed rule § 75.4(a). 296See Joint Proposal, 76 FR at 68866; CFTC 

Proposal, 77 FR at 8352. 297See Barclays (stating that the proposed 

exemption generally effectuates the aims of the 

statute while largely avoiding undue interference, 

although the commenter also requested certain 

technical changes to the rule text); Alfred Brock. 

298See, e.g., Lord Abbett; BoA; Fidelity; Chamber 

(Feb. 2012). 

299See Sens. Merkley & Levin (Feb. 2012); BoA; 

Fidelity; Occupy; AFR et al. (Feb. 2012). 

300See Sens. Merkley & Levin (Feb. 2012) 

(suggesting a safe harbor for underwriting efforts 

that meet certain low-risk criteria, including that: 

The underwriting be in plain vanilla stock or bond 

offerings, including commercial paper, for 

established business and governments; and the 

distribution be completed within relevant time 

periods, as determined by asset classes, with 

relevant factors being the size of the issuer and the 

market served); Johnson & Prof. Stiglitz (expressing 

support for a narrow safe harbor for underwriting 

of basic stocks and bonds that raise capital for real 

economy firms). 

301See Sens. Merkley & Levin (Feb. 2012) 

(suggesting that, for example, the exemption plainly 

prevent high-risk, conflict ridden underwritings of 

securitizations and structured products and crossreference Section 621 of the Dodd-Frank Act, which 

prohibits certain material conflicts of interest in 

connection with asset-backed securities). 

302See AFR et al. (Feb. 2012) (recommending that 

the Agencies prohibit banking entities from acting 

as underwriter for assets classified as Level 3 under 

FAS 157, which would prohibit underwriting of 

illiquid and opaque securities without a genuine 

external market, and representing that such a 

restriction would be consistent with the statutory 

limitation on exposures to high-risk assets). 

303See Occupy. 

304See BoA (recommending that the Agencies 

establish a strong presumption that all of a banking 

entity’s activities related to underwriting are 

permitted under the rules as long as the banking 

entity has adequate compliance and risk 

management procedures). 

305See Fidelity (suggested that the rules be 

revised to ‘‘provide the broadest exemptions 

possible under the statute’’ for underwriting and 

certain other permitted activities). 

306See infra Part VI.A.2.c.1.c. 

307See infra Part VI.A.2.c.1.c. The term ‘‘trading 

desk’’ is defined in final rule § 75.3(e)(13) as ‘‘the 

smallest discrete unit of organization of a banking 

entity that purchases or sells financial instruments 

for the trading account of the banking entity or an 

affiliate thereof.’’ 

308See final rule §§ 75.4(a)(2)(i), 75.4(a)(3), 

75.4(a)(4); see also infra Part VI.A.2.c.1.c. 

309See final rule § 75.4(a)(2)(ii); see also infra Part 

VI.A.2.c.2.c. 

in more detail below, the proposed 

underwriting exemption required that: 

(i) A banking entity establish a 

compliance program under § 75.20; (ii) 

the covered financial position be a 

security; (iii) the purchase or sale be 

effected solely in connection with a 

distribution of securities for which the 

banking entity is acting as underwriter; 

(iv) the banking entity meet certain 

dealer registration requirements, where 

applicable; (v) the underwriting 

activities be designed not to exceed the 

reasonably expected near term demands 

of clients, customers, or counterparties; 

(vi) the underwriting activities be 

designed to generate revenues primarily 

from fees, commissions, underwriting 

spreads, or other income not attributable 

to appreciation in the value of covered 

financial positions or to hedging of 

covered financial positions; and (vii) the 

compensation arrangements of persons 

performing underwriting activities be 

designed not to reward proprietary risktaking.295 The proposal explained that 

these seven criteria were proposed so 

that any banking entity relying on the 

underwriting exemption would be 

engaged in bona fide underwriting 

activities and would conduct those 

activities in a way that would not be 

susceptible to abuse through the taking 

of speculative, proprietary positions as 

part of, or mischaracterized as, 

underwriting activity.296

2. Comments on Proposed Underwriting 

Exemption 

As a general matter, a few 

commenters expressed overall support 

for the proposed underwriting 

exemption.297 Some commenters 

indicated that the proposed exemption 

is too narrow and may negatively 

impact capital markets.298 As discussed 

in more detail below, many commenters 

expressed views on the effectiveness of 

specific requirements of the proposed 

exemption. Further, some commenters 

requested clarification or expansion of 

the proposed exemption for certain 

activities that may be conducted in the 

course of underwriting. 

Several commenters suggested 

alternative approaches to implementing 

the statutory exemption for 

underwriting activities.299 More 

specifically, commenters recommended 

that the Agencies: (i) Provide a safe 

harbor for low risk, standard 

underwritings; 300 (ii) better incorporate 

the statutory limitations on high-risk 

activity or conflicts of interest; 301 (iii) 

prohibit banking entities from 

underwriting illiquid securities; 302 (iv) 

prohibit banking entities from 

participating in private placements; 303

(v) place greater emphasis on adequate 

internal compliance and risk 

management procedures; 304 or (vi) 

make the exemption as broad as 

possible.305

3. Final Underwriting Exemption 

After considering the comments 

received, the Agencies are adopting the 

underwriting exemption substantially as 

proposed, but with important 

modifications to clarify provisions or to 

address commenters’ concerns. As 

discussed above, some commenters 

were generally supportive of the 

proposed approach to implementing the 

underwriting exemption, but noted 

certain areas of concern or uncertainty. 

The underwriting exemption the 

Agencies are adopting addresses these 

issues by further clarifying the scope of 

activities that qualify for the exemption. 

In particular, the Agencies are refining 

the proposed exemption to better 

capture the broad range of capitalraising activities facilitated by banking 

entities acting as underwriters on behalf 

of issuers and selling security holders. 

The final underwriting exemption 

includes the following components: 

• A framework that recognizes the 

differences in underwriting activities 

across markets and asset classes by 

establishing criteria that will be applied 

flexibly based on the liquidity, maturity, 

and depth of the market for the 

particular type of security. 

• A general focus on the 

‘‘underwriting position’’ held by a 

banking entity or its affiliate, and 

managed by a particular trading desk, in 

connection with the distribution of 

securities for which such banking entity 

or affiliate is acting as an 

underwriter.306

• A definition of the term ‘‘trading 

desk’’ that focuses on the functionality 

of the desk rather than its legal status, 

and requirements that apply at the 

trading desk level of organization within 

a banking entity or across two or more 

affiliates.307

• Five standards for determining 

whether a banking entity is engaged in 

permitted underwriting activities. Many 

of these criteria have similarities to 

those included in the proposed rule, but 

with important modifications in 

response to comments. These standards 

require that: 

Æ The banking entity act as an 

‘‘underwriter’’ for a ‘‘distribution’’ of 

securities and the trading desk’s 

underwriting position be related to such 

distribution. The final rule includes 

refined definitions of ‘‘distribution’’ and 

‘‘underwriter’’ to better capture the 

broad scope of securities offerings used 

by issuers and selling security holders 

and the range of roles that a banking 

entity may play as intermediary in such 

offerings.308

Æ The amount and types of securities 

in the trading desk’s underwriting 

position be designed not to exceed the 

reasonably expected near term demands 

of clients, customers, or counterparties, 

and reasonable efforts be made to sell or 

otherwise reduce the underwriting 

position within a reasonable period, 

taking into account the liquidity, 

maturity, and depth of the market for 

the relevant type of security.309


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310See final rule § 75.4(a)(2)(iii); see also infra 

Part VI.A.2.c.3.c. 

311See final rule § 75.4(a)(2)(iv); see also infra 

Part VI.A.2.c.4.c. 

312See final rule § 75.4(a)(2)(v); see also infra Part 

VI.A.2.c.5.c. 

313See Sens. Merkley & Levin (Feb. 2012); 

Johnson & Prof. Stiglitz. One of these commenters 

also suggested that the Agencies better incorporate 

the statutory limitations on material conflicts of 

interest and high-risk activities in the underwriting 

exemption by including additional provisions in 

the exemption to refer to these limitations. See 

Sens. Merkley & Levin (Feb. 2012). The Agencies 

note that these limitations are adopted in § 75.7 of 

the final rules, and this provision will apply to 

underwriting activities, as well as all other 

exempted activities. 

314See final rule § 75.4(a)(3). 

315See AFR et al. (Feb. 2012). 

316See Joint Proposal, 76 FR at 68859 n.101 

(explaining why the Agencies declined to 

incorporate certain accounting standards in the 

proposed rule); CFTC Proposal, 77 FR at 8344 

n.107. 

317See infra Part VI.A.2.c.2.c. 

318See BoA. 

319See Fidelity. 

320See, e.g., BoA (‘‘The underwriting activities of 

U.S. banking entities are essential to capital 

formation and, therefore, economic growth and job 

creation.’’); Goldman (Prop. Trading); Sens. Merkley 

& Levin (Feb. 2012). 

Æ The banking entity establish, 

implement, maintain, and enforce an 

internal compliance program that is 

reasonably designed to ensure the 

banking entity’s compliance with the 

requirements of the underwriting 

exemption, including reasonably 

designed written policies and 

procedures, internal controls, analysis, 

and independent testing identifying and 

addressing: 

D The products, instruments, or 

exposures each trading desk may 

purchase, sell, or manage as part of its 

underwriting activities; 

D Limits for each trading desk, based 

on the nature and amount of the trading 

desk’s underwriting activities, including 

the reasonably expected near term 

demands of clients, customers, or 

counterparties, on the amount, types, 

and risk of the trading desk’s 

underwriting position, level of 

exposures to relevant risk factors arising 

from the trading desk’s underwriting 

position, and period of time a security 

may be held; 

D Internal controls and ongoing 

monitoring and analysis of each trading 

desk’s compliance with its limits; and 

D Authorization procedures, 

including escalation procedures that 

require review and approval of any 

trade that would exceed a trading desk’s 

limit(s), demonstrable analysis of the 

basis for any temporary or permanent 

increase to a trading desk’s limit(s), and 

independent review of such 

demonstrable analysis and approval.310

Æ The compensation arrangements of 

persons performing the banking entity’s 

underwriting activities are designed not 

to reward or incentivize prohibited 

proprietary trading.311

Æ The banking entity is licensed or 

registered to engage in the activity 

described in the underwriting 

exemption in accordance with 

applicable law.312

After considering commenters’ 

suggested alternative approaches to 

implementing the statute’s underwriting 

exemption, the Agencies have 

determined to retain the general 

structure of the proposed underwriting 

exemption. For instance, two 

commenters suggested providing a safe 

harbor for ‘‘plain vanilla’’ or ‘‘basic’’ 

underwritings of stocks and bonds.313

The Agencies do not believe that a safe 

harbor is necessary to provide certainty 

that a banking entity may act as an 

underwriter in these particular types of 

offerings. This is because ‘‘plain 

vanilla’’ or ‘‘basic’’ underwriting 

activity should be able to meet the 

requirements of the final rule. For 

example, the final definition of 

‘‘distribution’’ includes any offering of 

securities made pursuant to an effective 

registration statement under the 

Securities Act.314

Further, in response to one 

commenter’s request that the final rule 

prohibit a banking entity from acting as 

an underwriter in illiquid assets that are 

determined to not have observable price 

inputs under accounting standards,315

the Agencies continue to believe that it 

would be inappropriate to incorporate 

accounting standards in the rule 

because accounting standards could 

change in the future without 

consideration of the potential impact on 

the final rule.316 Moreover, the Agencies 

do not believe it is necessary to 

differentiate between liquid and less 

liquid securities for purposes of 

determining whether a banking entity 

may underwrite a distribution of 

securities because, in either case, a 

banking entity must have a reasonable 

expectation of purchaser demand for the 

securities and must make reasonable 

efforts to sell or otherwise reduce its 

underwriting position within a 

reasonable period under the final 

rule.317

Another commenter suggested that 

the Agencies establish a strong 

presumption that all of a banking 

entity’s activities related to 

underwriting are permitted under the 

rule as long as the banking entity has 

adequate compliance and risk 

management procedures.318 While 

strong compliance and risk management 

procedures are important for banking 

entities’ permitted activities, the 

Agencies believe that an approach 

focused solely on the establishment of a 

compliance program would likely 

increase the potential for evasion of the 

general prohibition on proprietary 

trading. Similarly, the Agencies are not 

adopting an exemption that is 

unlimited, as requested by one 

commenter, because the Agencies 

believe controls are necessary to prevent 

potential evasion of the statute through, 

among other things, retaining an unsold 

allotment when there is sufficient 

customer interest for the securities and 

to limit the risks associated with these 

activities.319

Underwriters play an important role 

in facilitating issuers’ access to funding, 

and thus underwriters are important to 

the capital formation process and 

economic growth.320 Obtaining new 

financing can be expensive for an issuer 

because of the natural information 

advantage that less well-known issuers 

have over investors about the quality of 

their future investment opportunities. 

An underwriter can help reduce these 

costs by mitigating the information 

asymmetry between an issuer and its 

potential investors. The underwriter 

does this based in part on its familiarity 

with the issuer and other similar issuers 

as well as by collecting information 

about the issuer. This allows investors 

to look to the reputation and experience 

of the underwriter as well as its ability 

to provide information about the issuer 

and the underwriting. For these and 

other reasons, most U.S. issuers rely on 

the services of an underwriter when 

raising funds through public offerings. 

As recognized in the statute, the 

exemption is intended to permit 

banking entities to continue to perform 

the underwriting function, which 

contributes to capital formation and its 

positive economic effects. 

c. Detailed Explanation of the 

Underwriting Exemption 

1. Acting as an Underwriter for a 

Distribution of Securities 

a. Proposed Requirements That the 

Purchase or Sale Be Effected Solely in 

Connection With a Distribution of 

Securities for Which the Banking Entity 

Acts as an Underwriter and That the 

Covered Financial Position Be a 

Security 

Section 75.4(a)(2)(iii) of the proposed 

rule required that the purchase or sale 

be effected solely in connection with a 

distribution of securities for which a 

banking entity is acting as 


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5834 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

321See proposed rule § 75.4(a)(2)(iii). 322See proposed rule § 75.4(a)(2)(ii). 323See Joint Proposal, 76 FR at 68866–68867; 

CFTC Proposal, 77 FR at 8352; 17 CFR 242.101; 

proposed rule § 75.4(a)(3). 324See proposed rule § 75.4(a)(3). 325See Joint Proposal, 76 FR at 68867 (‘‘For 

example, the number of shares to be sold, the 

percentage of the outstanding shares, public float, 

and trading volume that those shares represent are 

all relevant to an assessment of magnitude. In 

addition, delivering a sales document, such as a 

prospectus, and conducting road shows are 

generally indicative of special selling efforts and 

selling methods. Another indicator of special 

selling efforts and selling methods is compensation 

that is greater than that for secondary trades but 

consistent with underwriting compensation for an 

offering.’’); CFTC Proposal, 77 FR at 8352; Review 

of Antimanipulation Regulation of Securities 

Offering, Exchange Act Release No. 33924 (Apr. 19, 

1994), 59 FR 21681, 21684–21685 (Apr. 26, 1994). 

326See Joint Proposal, 76 FR at 68867; CFTC 

Proposal, 77 FR at 8352. 

327See Joint Proposal, 76 FR at 68866–68867; 

CFTC Proposal, 77 FR at 8352; 17 CFR 242.101; 

proposed rule § 75.4(a)(4). 

328See proposed rule § 75.4(a)(4). As noted in the 

proposal, the proposed rule’s definition differed 

from the definition in Regulation M because the 

proposed rule’s definition would also include a 

person who has an agreement with another 

underwriter to engage in a distribution of securities 

for or on behalf of an issuer or selling security 

holder. See Joint Proposal, 76 FR at 68867; CFTC 

Proposal, 77 FR at 8352. 

329See Joint Proposal, 76 FR at 68867; CFTC 

Proposal, 77 FR at 8352. 

330See id. 

331See proposed rule § 75.4(a)(2)(ii). 

332See Joint Proposal, 76 FR at 68866; CFTC 

Proposal, 77 FR at 8352. 

333See Joint Proposal, 76 FR at 68866 n.132; 

CFTC Proposal, 77 FR at 8352 n.138. 

334See, e.g., Goldman (Prop. Trading); SIFMA et 

al. (Prop. Trading) (Feb. 2012). 

335See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Goldman (Prop. Trading); Wells Fargo (Prop. 

Trading); RBC. 

336See Occupy. 

underwriter.321 As discussed below, the 

Agencies proposed to define the terms 

‘‘distribution’’ and ‘‘underwriter’’ in the 

proposed rule. The proposed rule also 

required that the covered financial 

position being purchased or sold by the 

banking entity be a security.322

i. Proposed Definition of ‘‘Distribution’’ 

The proposed definition of 

‘‘distribution’’ mirrored the definition of 

this term used in the SEC’s Regulation 

M under the Exchange Act.323 More 

specifically, the proposed rule defined 

‘‘distribution’’ as ‘‘an offering of 

securities, whether or not subject to 

registration under the Securities Act, 

that is distinguished from ordinary 

trading transactions by the magnitude of 

the offering and the presence of special 

selling efforts and selling methods.’’ 324

The Agencies did not propose to define 

the terms ‘‘magnitude’’ and ‘‘special 

selling efforts and selling methods,’’ but 

stated that the Agencies would expect to 

rely on the same factors considered in 

Regulation M for assessing these 

elements.325 The Agencies noted that 

‘‘magnitude’’ does not imply that a 

distribution must be large and, 

therefore, this factor would not preclude 

small offerings or private placements 

from qualifying for the proposed 

underwriting exemption.326

ii. Proposed Definition of ‘‘Underwriter’’ 

Like the proposed definition of 

‘‘distribution,’’ the Agencies proposed 

to define ‘‘underwriter’’ in a manner 

similar to the definition of this term in 

the SEC’s Regulation M.327 The 

definition of ‘‘underwriter’’ in the 

proposed rule was: (i) Any person who 

has agreed with an issuer or selling 

security holder to: (a) Purchase 

securities for distribution; (b) engage in 

a distribution of securities for or on 

behalf of such issuer or selling security 

holder; or (c) manage a distribution of 

securities for or on behalf of such issuer 

or selling security holder; and (ii) a 

person who has an agreement with 

another person described in the 

preceding provisions to engage in a 

distribution of such securities for or on 

behalf of the issuer or selling security 

holder.328

In connection with this proposed 

requirement, the Agencies noted that 

the precise activities performed by an 

underwriter may vary depending on the 

liquidity of the securities being 

underwritten and the type of 

distribution being conducted. To 

determine whether a banking entity is 

acting as an underwriter as part of a 

distribution of securities, the Agencies 

proposed to take into consideration the 

extent to which a banking entity is 

engaged in the following activities: 

• Assisting an issuer in capitalraising; 

• Performing due diligence; 

• Advising the issuer on market 

conditions and assisting in the 

preparation of a registration statement 

or other offering document; 

• Purchasing securities from an 

issuer, a selling security holder, or an 

underwriter for resale to the public; 

• Participating in or organizing a 

syndicate of investment banks; 

• Marketing securities; and 

• Transacting to provide a postissuance secondary market and to 

facilitate price discovery.329

The proposal recognized that there may 

be circumstances in which an 

underwriter would hold securities that 

it could not sell in the distribution for 

investment purposes. The Agencies 

stated that if the unsold securities were 

acquired in connection with 

underwriting under the proposed 

exemption, then the underwriter would 

be able to dispose of such securities at 

a later time.330

iii. Proposed Requirement That the 

Covered Financial Position Be a 

Security 

Pursuant to § 75.4(a)(2)(ii) of the 

proposed exemption, a banking entity 

would be permitted to purchase or sell 

a covered financial position that is a 

security only in connection with its 

underwriting activities.331 The proposal 

stated that this requirement was meant 

to reflect the common usage and 

understanding of the term 

‘‘underwriting.’’ 332 It was noted, 

however, that a derivative or commodity 

future transaction may be otherwise 

permitted under another exemption 

(e.g., the exemptions for market makingrelated or risk-mitigating hedging 

activities).333

b. Comments on the Proposed 

Requirements That the Trade Be 

Effected Solely in Connection With a 

Distribution for Which the Banking 

Entity Is Acting as an Underwriter and 

That the Covered Financial Position Be 

a Security 

In response to the proposed 

requirement that a purchase or sale be 

‘‘effected solely in connection with a 

distribution of securities’’ for which the 

‘‘banking entity is acting as 

underwriter,’’ commenters generally 

focused on the proposed definitions of 

‘‘distribution’’ and ‘‘underwriter’’ and 

the types of activities that should be 

permitted under the ‘‘in connection 

with’’ standard. Commenters did not 

directly address the requirement in 

§ 75.4(a)(2)(ii) of the proposed rule, 

which provided that the covered 

financial position purchased or sold 

under the exemption must be a security. 

A number of commenters expressed 

general concern that the proposed 

underwriting exemption’s references to 

a ‘‘purchase or sale of a covered 

financial position’’ could be interpreted 

to require compliance with the 

proposed rule on a transaction-bytransaction basis. These commenters 

indicated that such an approach would 

be overly burdensome.334

i. Definition of ‘‘Distribution’’ 

Several commenters stated that the 

proposed definition of ‘‘distribution’’ is 

too narrow,335 while one commenter 

stated that the proposed definition is too 

broad.336 Commenters who viewed the 

proposed definition as too narrow stated 

that it may exclude important capitalraising and financing transactions that 

do not appear to involve ‘‘special selling 


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337See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Goldman (Prop. Trading); Wells Fargo (Prop. 

Trading); RBC. 

338See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Goldman (Prop. Trading); Wells Fargo (Prop. 

Trading). In addition, one commenter expressed 

general concern that the proposed rule would cause 

a reduction in underwriting services with respect to 

commercial paper, which would reduce liquidity in 

commercial paper markets and raise the costs of 

capital in already tight credit markets. See Chamber 

(Feb. 2012). 

339See Goldman (Prop. Trading); Wells Fargo 

(Prop. Trading); RBC; LSTA (Feb. 2012). 

340See Goldman (Prop. Trading). 

341See SIFMA et al. (Prop. Trading) (Feb. 2012). 

342See SIFMA et al. (Prop. Trading) (Feb. 2012). 

343See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Goldman (Prop. Trading); Wells Fargo (Prop. 

Trading). 

344See RBC. 

345See Goldman (Prop. Trading); SIFMA et al. 

(Prop. Trading) (Feb. 2012); RBC. 

346See Goldman (Prop. Trading) (stating that this 

would capture, among other things, commercial 

paper issuances, issuer ‘‘dribble out’’ programs, and 

small private offerings, which involve the purchase 

of securities directly from an issuer with a view 

toward resale, but may not always be clearly 

distinguished by ‘‘special selling efforts and selling 

methods’’ or by ‘‘magnitude’’); SIFMA et al. (Prop. 

Trading) (Feb. 2012). 

347See SIFMA et al. (Prop. Trading) (Feb. 2012). 

This commenter indicated that expanding the 

definition of ‘‘distribution’’ to include both 

offerings of securities by an issuer and offerings by 

a selling security holder that are registered under 

the Securities Act or that involve an offering 

document prepared by the issuer would ‘‘include, 

for example, an offering of securities by an issuer 

or a selling security holder where securities are sold 

through an automated order execution system, 

offerings in response to reverse inquiries and 

commercial paper issuances.’’ Id. 

348See RBC. 

349See Goldman (Prop. Trading); RBC. In 

addition, one commenter requested the Agencies 

clarify that permitted underwriting activities 

include the acquisition and resale of securities 

issued in lieu of or to refinance bridge loan 

facilities, irrespective of whether such activities 

qualify as ‘‘distributions’’ under the proposal. See 

LSTA (Feb. 2012). 

350See Goldman (Prop. Trading). 

351See Occupy. 

352See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Goldman (Prop. Trading); Wells Fargo (Prop. 

Trading). 

353See AFR et al. (Feb. 2012); Public Citizen; 

Occupy (suggesting that the Agencies exceeded 

their statutory authority by incorporating the 

Regulation M definition of ‘‘underwriter,’’ rather 

than the Securities Act definition of ‘‘underwriter’’). 

354See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Goldman (Prop. Trading); Wells Fargo (Prop. 

Trading). The term ‘‘distribution participant’’ is 

defined in Rule 100 of Regulation M as ‘‘an 

underwriter, prospective underwriter, broker, 

dealer, or other person who has agreed to 

participate or is participating in a distribution.’’ 17 

CFR 242.100. 

355See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Goldman (Prop. Trading); Wells Fargo (Prop. 

Trading). 

356See Goldman (Prop. Trading). 

357See SIFMA et al. (Prop. Trading) (Feb. 2012). 

This commenter also requested a technical 

amendment to proposed rule § 75.4(a)(4)(ii) to 

clarify that the person is ‘‘participating’’ in a 

distribution, not ‘‘engaging’’ in a distribution. See 

id. 

358See AFR et al. (Feb. 2012); Public Citizen. 

efforts and selling methods’’ or 

‘‘magnitude.’’337 In particular, these 

commenters stated that the proposed 

definition of ‘‘distribution’’ may 

preclude a banking entity from 

participating in commercial paper 

issuances,338 bridge loans,339 ‘‘at-themarket’’ offerings or ‘‘dribble out’’ 

programs conducted off issuer shelf 

registrations,340 offerings in response to 

reverse inquiries,341 offerings through 

an automated execution system,342

small private offerings,343 or selling 

security holders’ sales of securities of 

issuers with large market capitalizations 

that are executed as underwriting 

transactions in the normal course.344

Several commenters suggested that 

the proposed definition be modified to 

include some or all of these types of 

offerings.345 For example, two 

commenters requested that the 

definition explicitly include all 

offerings of securities by an issuer.346

One of these commenters further 

requested a broader definition that 

would include any offering by a selling 

security holder that is registered under 

the Securities Act or that involves an 

offering document prepared by the 

issuer.347 Another commenter suggested 

that the rule explicitly authorize certain 

forms of offerings, such as offerings 

under Rule 144A, Regulation S, Rule 

101(b)(10) of Regulation M, or the socalled ‘‘section 4(11⁄2)’’ of the Securities 

Act, as well as transactions on behalf of 

selling security holders.348 Two 

commenters proposed approaches that 

would include the resale of notes or 

other debt securities received by a 

banking entity from a borrower to 

replace or refinance a bridge loan.349

One of these commenters stated that 

permitting a banking entity to receive 

and resell notes or other debt securities 

from a borrower to replace or refinance 

a bridge loan would preserve the ability 

of a banking entity to extend credit and 

offer customers a range of financing 

options. This commenter further 

represented that such an approach 

would be consistent with the exclusion 

of loans from the proposed definition of 

‘‘covered financial position’’ and the 

commenter’s recommended exclusion 

from the definition of ‘‘trading account’’ 

for collecting debts previously 

contracted.350

One commenter, however, stated that 

the proposed definition of 

‘‘distribution’’ is too broad. This 

commenter suggested that the 

underwriting exemption should only be 

available for registered offerings, and 

the rule should preclude a banking 

entity from participating in a private 

placement. According to the 

commenter, permitting a banking entity 

to participate in a private placement 

may facilitate evasion of the prohibition 

on proprietary trading.351

ii. Definition of ‘‘Underwriter’’ 

Several commenters stated that the 

proposed definition of ‘‘underwriter’’ is 

too narrow.352 Other commenters, 

however, stated that the proposed 

definition is too broad, particularly due 

to the proposed inclusion of selling 

group members.353

Commenters requesting a broader 

definition generally stated that the 

Agencies should instead use the 

Regulation M definition of ‘‘distribution 

participant’’ or otherwise revise the 

definition of ‘‘underwriter’’ to 

incorporate the concept of a 

‘‘distribution participant,’’ as defined 

under Regulation M.354 According to 

these commenters, using the term 

‘‘distribution participant’’ would better 

reflect current market practice and 

would include dealers that participate 

in an offering but that do not deal 

directly with the issuer or selling 

security holder and do not have a 

written agreement with the 

underwriter.355 One commenter further 

represented that the proposed provision 

for selling group members may be less 

inclusive than the Agencies intended 

because individual selling dealers or 

dealer groups may or may not have 

written agreements with an underwriter 

in privity of contract with the issuer.356

Another commenter requested that, if 

the ‘‘distribution participant’’ concept is 

not incorporated into the rule, the 

proposed definition of ‘‘underwriter’’ be 

modified to include a person who has 

an agreement with an affiliate of an 

issuer or selling security holder (e.g., an 

agreement with a parent company to 

distribute the issuer’s securities).357

Other commenters opposed the 

inclusion of selling group members in 

the proposed definition of 

‘‘underwriter.’’ These commenters 

stated that because selling group 

members do not provide a price 

guarantee to an issuer, they do not 

provide services to a customer and their 

activities should not qualify for the 

underwriting exemption.358

A number of commenters stated that 

it is unclear whether the proposed 

underwriting exemption would permit a 

banking entity to act as an authorized 

participant (‘‘AP’’) to an ETF issuer, 

particularly with respect to the creation 

and redemption of ETF shares or 

‘‘seeding’’ an ETF for a short period of 


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359See BoA; ICI Global; Vanguard; ICI (Feb. 

2012); SSgA (Feb. 2012). As one commenter 

explained, an AP may ‘‘seed’’ an ETF for a short 

period of time at its inception by entering into 

several initial creation transactions with the ETF 

issuer and refraining from selling those shares to 

investors or redeeming them for a period of time to 

facilitate the ETF achieving its liquidity launch 

goals. See BoA. 

360See ICI Global; ICI (Feb. 2012); Vanguard. 

361See SSgA (Feb. 2012). 

362See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Goldman (Prop. Trading); BoA; Wells Fargo (Prop. 

Trading); Comm. on Capital Markets Regulation. 

363See Goldman (Prop. Trading). 

364See Goldman (Prop. Trading); Wells Fargo 

(Prop. Trading); SIFMA et al. (Prop. Trading) (Feb. 

2012). 

365See Goldman (Prop. Trading). 

366See SIFMA et al. (Prop. Trading) (Feb. 2012). 

367See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Goldman (Prop. Trading); Wells Fargo (Prop. 

Trading); RBC. 

368See SIFMA et al. (Prop. Trading) (Feb. 2012) 

(‘‘The reason for creating the short positions 

(covered and naked) is to facilitate an orderly 

aftermarket and to reduce price volatility of newly 

offered securities. This provides significant value to 

issuers and selling security holders, as well as to 

investors, by giving the syndicate buying power that 

helps protect against immediate volatility in the 

aftermarket.’’); RBC; Goldman (Prop. Trading). 

369See SIFMA et al. (Prop. Trading) (Feb. 2012) 

(‘‘Underwriters may also engage in stabilization 

activities under Regulation M by creating a 

stabilizing bid to prevent or slow a decline in the 

market price of a security. These activities should 

be encouraged rather than restricted by the Volcker 

Rule because they reduce price volatility and 

facilitate the orderly pricing and aftermarket trading 

of underwritten securities, thereby contributing to 

capital formation.’’). 

370See RBC. 

371See Goldman (Prop. Trading). 

372See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Goldman (Prop. Trading) (stating that the call 

spread arrangement ‘‘may make a wider range of 

financing options feasible for the issuer of the 

convertible debt’’ and ‘‘can help it to raise more 

capital at more attractive prices’’). 

373See Wells Fargo (Prop. Trading). The 

commenter further stated that the need to purchase 

the issuer’s other debt securities from investors may 

arise if an investor has limited risk tolerance to the 

issuer’s credit or has portfolio restrictions. 

According to the commenter, the underwriter 

would typically sell the debt securities it purchased 

from existing investors to new investors. See id. 

374See Wells Fargo (Prop. Trading). 

375See Goldman (Prop. Trading). 

376See ASF (Feb. 2012) (stating that, for example, 

a banking entity may respond to customer or 

general market demand for highly-rated mortgage 

paper by accumulating residential mortgage-backed 

securities over time and holding such securities in 

inventory until the transaction can be organized 

and assembled). 

377See ICI (Feb. 2012) (stating that the sale of 

assets to an intermediate asset-backed commercial 

paper or tender option bond program should be 

permitted under the underwriting exemption if the 

sale is part of the creation of a structured security). 

See also AFR et al. (Feb. 2012) (stating that the 

treatment of a sale to an intermediate entity should 

depend on whether the banking entity or an 

external client is the driver of the demand and, if 

the banking entity is the driver of the demand, then 

the near term demand requirement should not be 

met). Two commenters stated that the underwriting 

exemption should not permit a banking entity to 

sell a security to an intermediate entity in the 

course of creating a structured product. See 

Occupy; Alfred Brock. These commenters were 

generally responding to a question on this issue in 

the proposal. See Joint Proposal, 76 FR at 68868– 

68869 (question 78); CFTC Proposal, 77 FR at 8354 

(question 78). 

378Final rule § 75.4(a)(2)(i). The terms 

‘‘distribution’’ and ‘‘underwriter’’ are defined in 

final rule § 75.4(a)(3) and § 75.4(a)(4), respectively. 

379Proposed rule § 75.4(a)(2)(iii) required that 

‘‘[t]he purchase or sale is effected solely in 

connection with a distribution of securities for 

which the covered banking entity is acting as 

underwriter.’’ 

time when it is initially launched.359

For example, a few commenters noted 

that APs typically do not perform some 

or all of the activities that the Agencies 

proposed to consider to help determine 

whether a banking entity is acting as an 

underwriter in connection with a 

distribution of securities, including due 

diligence, advising an issuer on market 

conditions and assisting in preparation 

of a registration statement or offering 

documents, and participating in or 

organizing a syndicate of investment 

banks.360

However, one commenter appeared to 

oppose applying the underwriting 

exemption to certain AP activities. 

According to this commenter, APs are 

generally reluctant to concede that they 

are statutory underwriters because they 

do not perform all the activities 

associated with the underwriting of an 

operating company’s securities. Further, 

this commenter expressed concern that, 

if an AP had to rely on the proposed 

underwriting exemption, the AP could 

be subject to heightened risk of 

incurring underwriting liability on the 

issuance of ETF shares traded by the 

AP. As a result of these considerations, 

the commenter believed that a banking 

entity may be less willing to act as an 

AP for an ETF issuer if it were required 

to rely on the underwriting 

exemption.361

iii. ‘‘Solely in Connection With’’ 

Standard 

To qualify for the underwriting 

exemption, the proposed rule required a 

purchase or sale of a covered financial 

position to be effected ‘‘solely in 

connection with’’ a distribution of 

securities for which the banking entity 

is acting as underwriter. Several 

commenters expressed concern that the 

word ‘‘solely’’ in this provision may 

result in an overly narrow interpretation 

of permissible activities. In particular, 

these commenters indicated that the 

‘‘solely in connection with’’ standard 

creates uncertainty about certain 

activities that are currently conducted 

in the course of an underwriting, such 

as customary underwriting syndicate 

activities.362 One commenter 

represented that such activities are 

traditionally undertaken to: Support the 

success of a distribution; mitigate risk to 

issuers, investors, and underwriters; and 

facilitate an orderly aftermarket.363 A 

few commenters further stated that 

requiring a trade to be ‘‘solely’’ in 

connection with a distribution by an 

underwriter would be inconsistent with 

the statute,364 may reduce future 

innovation in the capital-raising 

process,365 and could create market 

disruptions.366

A number of commenters stated that 

it is unclear whether certain activities 

would qualify for the proposed 

underwriting exemption and requested 

that the Agencies adopt an exemption 

that is broad enough to permit such 

activities.367 Commenters stated that 

there are a number of activities that 

should be permitted under the 

underwriting exemption, including: (i) 

Creating a naked or covered syndicate 

short position in connection with an 

offering;368 (ii) creating a stabilizing 

bid;369 (iii) acquiring positions via 

overallotments370 or trading in the 

market to close out short positions in 

connection with an overallotment 

option or in connection with other 

stabilization activities;371 (iv) using call 

spread options in a convertible debt 

offering to mitigate dilution of existing 

shareholders;372 (v) repurchasing 

existing debt securities of an issuer in 

the course of underwriting a new series 

of debt securities in order to stimulate 

demand for the new issuance;373 (vi) 

purchasing debt securities of 

comparable issuers as a price discovery 

mechanism in connection with 

underwriting a new debt security;374

(vii) hedging the underwriter’s exposure 

to a derivative strategy engaged in with 

an issuer;375 (viii) organizing and 

assembling a resecuritized product, 

including, for example, sourcing bond 

collateral over a period of time in 

anticipation of issuing new 

securities;376 and (ix) selling a security 

to an intermediate entity as part of the 

creation of certain structured 

products.377

c. Final Requirement That the Banking 

Entity Act as an Underwriter for a 

Distribution of Securities and the 

Trading Desk’s Underwriting Position 

Be Related to Such Distribution 

The final rule requires that the 

banking entity act as an underwriter for 

a distribution of securities and the 

trading desk’s underwriting position be 

related to such distribution.378 This 

requirement is substantially similar to 

the proposed rule,379 but with five key 

refinements. First, to address 

commenters’ confusion about whether 


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380See, e.g., Goldman (Prop. Trading); SIFMA et 

al. (Prop. Trading) (Feb. 2012). 

381See infra Part VI.A.3.c. (discussing the final 

market-making exemption). 

382See supra note 307 and accompanying text. 

383Final rule § 75.4(a)(3). 

the underwriting exemption applies on 

a transaction-by-transaction basis, the 

phrase ‘‘purchase or sale’’ has been 

modified to instead refer to the trading 

desk’s ‘‘underwriting position.’’ Second, 

to balance this more aggregated 

position-based approach, the final rule 

specifies that the trading desk is the 

organizational level of a banking entity 

(or across one or more affiliated banking 

entities) at which the requirements of 

the underwriting exemption will be 

assessed. Third, the Agencies have 

made important modifications to the 

definition of ‘‘distribution’’ to better 

capture the various types of private and 

registered offerings a banking entity may 

be asked to underwrite by an issuer or 

selling security holder. Fourth, the 

definition of ‘‘underwriter’’ has been 

refined to clarify that both members of 

the underwriting syndicate and selling 

group members may qualify as 

underwriters for purposes of this 

exemption. Finally, the word ‘‘solely’’ 

has been removed to clarify that a 

broader scope of activities conducted in 

connection with underwriting (e.g., 

stabilization activities) are permitted 

under this exemption. These issues are 

discussed in turn below. 

i. Definition of ‘‘Underwriting Position’’ 

In response to commenters’ concerns 

about transaction-by-transaction 

analyses,380 the Agencies are modifying 

the exemption to clarify the level at 

which compliance with certain 

provisions will be assessed. The 

proposal was not intended to impose a 

transaction-by-transaction approach, 

and the final rule’s requirements 

generally focus on the long or short 

positions in one or more securities held 

by a banking entity or its affiliate, and 

managed by a particular trading desk, in 

connection with a particular 

distribution of securities for which such 

banking entity or its affiliate is acting as 

an underwriter. Like § 75.4(a)(2)(ii) of 

the proposed rule, the definition of 

‘‘underwriting position’’ is limited to 

positions in securities because the 

common usage and understanding of the 

term ‘‘underwriting’’ is limited to 

activities in securities. 

A trading desk’s underwriting 

position constitutes the securities 

positions that are acquired in 

connection with a single distribution for 

which the relevant banking entity is 

acting as an underwriter. A trading desk 

may not aggregate securities positions 

acquired in connection with two or 

more distributions to determine its 

‘‘underwriting position.’’ A trading desk 

may, however, have more than one 

‘‘underwriting position’’ at a particular 

point in time if the banking entity is 

acting as an underwriter for more than 

one distribution. As a result, the 

underwriting exemption’s requirements 

pertaining to a trading desk’s 

underwriting position will apply on a 

distribution-by-distribution basis. 

A trading desk’s underwriting 

position can include positions in 

securities held at different affiliated 

legal entities, provided the banking 

entity is able to provide supervisors or 

examiners of any Agency that has 

regulatory authority over the banking 

entity pursuant to section 13(b)(2)(B) of 

the BHC Act with records, promptly 

upon request, that identify any related 

positions held at an affiliated entity that 

are being included in the trading desk’s 

underwriting position for purposes of 

the underwriting exemption. Banking 

entities should be prepared to provide 

all records that identify all of the 

positions included in a trading desk’s 

underwriting position and where such 

positions are held. 

The Agencies believe that a 

distribution-by-distribution approach is 

appropriate due to the relatively distinct 

nature of underwriting activities for a 

single distribution on behalf of an issuer 

or selling security holder. The Agencies 

do not believe that a narrower 

transaction-by-transaction analysis is 

necessary to determine whether a 

banking entity is engaged in permitted 

underwriting activities. The Agencies 

also decline to take a broader approach, 

which would allow a banking entity to 

aggregate positions from multiple 

distributions for which it is acting as an 

underwriter, because it would be more 

difficult for the banking entity’s internal 

compliance personnel and Agency 

supervisors and examiners to review the 

trading desk’s positions to assess the 

desk’s compliance with the 

underwriting exemption. A more 

aggregated approach would increase the 

number of positions in different types of 

securities that could be included in the 

underwriting position, which would 

make it more difficult to determine that 

an individual position is related to a 

particular distribution of securities for 

which the banking entity is acting as an 

underwriter and, in turn, increase the 

potential for evasion of the general 

prohibition on proprietary trading. 

ii. Definition of ‘‘Trading Desk’’ 

The proposed underwriting 

exemption would have applied certain 

requirements across an entire banking 

entity. To promote consistency with the 

market-making exemption and address 

potential evasion concerns, the final 

rule applies the requirements of the 

underwriting exemption at the trading 

desk level of organization.381 This 

approach will result in the requirements 

of the underwriting exemption applying 

to the aggregate trading activities of a 

relatively limited group of employees on 

a single desk. Applying requirements at 

the trading desk level should facilitate 

banking entity and Agency monitoring 

and review of compliance with the 

exemption by limiting the location 

where underwriting activity may occur 

and allowing better identification of the 

aggregate trading volume that must be 

reviewed to determine whether the 

desk’s activities are being conducted in 

a manner that is consistent with the 

underwriting exemption, while also 

allowing adequate consideration of the 

particular facts and circumstances of the 

desk’s trading activities. 

The trading desk should be managed 

and operated as an individual unit and 

should reflect the level at which the 

profit and loss of employees engaged in 

underwriting activities is attributed. The 

term ‘‘trading desk’’ in the underwriting 

context is intended to encompass what 

is commonly thought of as an 

underwriting desk. A trading desk 

engaged in underwriting activities 

would not necessarily be an active 

market participant that engages in 

frequent trading activities. 

A trading desk may manage an 

underwriting position that includes 

positions held by different affiliated 

legal entities.382 Similarly, a trading 

desk may include employees working 

on behalf of multiple affiliated legal 

entities or booking trades in multiple 

affiliated entities. The geographic 

location of individual traders is not 

dispositive for purposes of determining 

whether the employees are engaged in 

activities for a single trading desk. 

iii. Definition of ‘‘Distribution’’ 

The term ‘‘distribution’’ is defined in 

the final rule as: (i) An offering of 

securities, whether or not subject to 

registration under the Securities Act, 

that is distinguished from ordinary 

trading transactions by the presence of 

special selling efforts and selling 

methods; or (ii) an offering of securities 

made pursuant to an effective 

registration statement under the 

Securities Act.383 In response to 

comments, the proposed definition has 

been revised to eliminate the need to 

consider the ‘‘magnitude’’ of an offering 

and instead supplements the definition 


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384Proposed rule § 75.4(a)(3) defined 

‘‘distribution’’ as ‘‘an offering of securities, whether 

or not subject to registration under the Securities 

Act, that is distinguished from ordinary trading 

transactions by the magnitude of the offering and 

the presence of special selling efforts and selling 

methods.’’ 

385The policy goals of this rule differ from those 

of the SEC’s Regulation M, which is an antimanipulation rule. The focus on magnitude is 

appropriate for that regulation because it helps 

identify offerings that can give rise to an incentive 

to condition the market for the offered security. To 

the contrary, this rule is intended to allow banking 

entities to continue to provide client-oriented 

financial services, including underwriting services. 

The SEC emphasizes that this rule does not have 

any impact on Regulation M. 

386See Joint Proposal, 76 FR at 68867; CFTC 

Proposal, 77 FR at 8352. 

387See Joint Proposal, 76 FR at 68867; CFTC 

Proposal, 77 FR at 8352; Review of 

Antimanipulation Regulation of Securities Offering, 

Exchange Act Release No. 33924 (Apr. 19, 1994), 59 

FR 21681, 21684–21685 (Apr. 26, 1994). 

388The final rule does not provide safe harbors 

for particular distribution techniques. A safe 

harbor-based approach would provide certainty for 

specific types of offerings, but may not account for 

evolving market practices and distribution 

techniques that could technically satisfy a safe 

harbor but that might implicate the concerns that 

led Congress to enact section 13 of the BHC Act. 

See RBC. 

389This clarification is intended to address 

commenters’ concern regarding potential 

limitations on banking entities’ ability to facilitate 

commercial paper offerings under the proposed 

underwriting exemption. See supra Part 

VI.A.2.c.1.b.i. 

390See, e.g., Form S–1 (17 CFR 239.11); Form S– 

3 (17 CFR 239.13); Form S–8 (17 CFR 239.16b); 

Form F–1 (17 CFR 239.31); Form F–3 (17 CFR 

239.33). 

391Although the Agencies are providing an 

additional prong to the definition of ‘‘distribution’’ 

for registered offerings, the final rule does not limit 

the availability of the underwriting exemption to 

registered offerings, as suggested by one 

commenter. The statute does not include such an 

express limitation, and the Agencies decline to 

construe the statute to require such an approach. In 

response to the commenter stating that permitting 

a banking entity to participate in a private 

placement may facilitate evasion of the prohibition 

on proprietary trading, the Agencies believe this 

concern is addressed by the provision in the final 

rule requiring that a trading desk have a reasonable 

expectation of demand from other market 

participants for the amount and type of securities 

to be acquired from an issuer or selling security 

holder for distribution and make reasonable efforts 

to sell its underwriting position within a reasonable 

period. As discussed below, the Agencies believe 

this requirement in the final rule appropriately 

addresses evasion concerns that a banking entity 

may retain an unsold allotment for purely 

speculative purposes. Further, the Agencies believe 

that preventing a banking entity from facilitating a 

private offering could unnecessarily hinder capitalraising without providing commensurate benefits 

because issuers use private offerings to raise capital 

in a variety of situations and the underwriting 

exemption’s requirements limit the potential for 

evasion for both registered and private offerings, as 

noted above. 

392See Securities Offering Reform, Securities Act 

Release No. 8591 (July 19, 2005), 70 FR 44722 (Aug. 

3, 2005); 17 CFR 230.405 (defining ‘‘automatic shelf 

registration statement’’ as a registration statement 

filed on Form S–3 (17 CFR 239.13) or Form F–3 (17 

CFR 239.33) by a well-known seasoned issuer 

pursuant to General Instruction I.D. or I.C. of such 

forms, respectively); 17 CFR 230.415. 

393A bought deal is a distribution technique 

whereby an underwriter makes a bid for securities 

without engaging in a preselling effort, such as book 

building or distribution of a preliminary 

prospectus. See, e.g., Delayed or Continuous 

Offering and Sale of Securities, Securities Act 

Release No. 6470 (June 9, 1983), n.5. 

394See, e.g., 17 CFR 230.415(a)(4) (defining ‘‘at 

the market offering’’ as ‘‘an offering of equity 

securities into an existing trading market for 

outstanding shares of the same class at other than 

a fixed price’’). At the market offerings may also be 

referred to as ‘‘dribble out’’ programs. 

395Under the ‘‘reverse inquiry’’ process, an 

investor may be allowed to purchase securities from 

the issuer through an underwriter that is not 

designated in the prospectus as the issuer’s agent 

by having such underwriter approach the issuer 

with an interest from the investor. See Joseph 

McLaughlin and Charles J. Johnson, Jr., ‘‘Corporate 

Finance and the Securities Laws’’ (4th ed. 2006, 

supplemented 2012). 

396See SIFMA et al. (Prop. Trading) (Feb. 2012). 

with an alternative prong for registered 

offerings under the Securities Act.384

The proposed definition’s reference to 

magnitude caused some commenter 

concern with respect to whether it could 

be interpreted to preclude a banking 

entity from intermediating a small 

private placement. After considering 

comments, the Agencies have 

determined that the requirement to have 

special selling efforts and selling 

methods is sufficient to distinguish 

between permissible securities offerings 

and prohibited proprietary trading, and 

the additional magnitude factor is not 

needed to further this objective.385 As 

proposed, the Agencies will rely on the 

same factors considered under 

Regulation M to analyze the presence of 

special selling efforts and selling 

methods.386 Indicators of special selling 

efforts and selling methods include 

delivering a sales document (e.g., a 

prospectus), conducting road shows, 

and receiving compensation that is 

greater than that for secondary trades 

but consistent with underwriting 

compensation.387 For purposes of the 

final rule, each of these factors need not 

be present under all circumstances. 

Offerings that qualify as distributions 

under this prong of the definition 

include, among others, private 

placements in which resales may be 

made in reliance on the SEC’s Rule 

144A or other available exemptions 388

and, to the extent the commercial paper 

being offered is a security, commercial 

paper offerings that involve the 

underwriter receiving special 

compensation.389

The Agencies are also adopting a 

second prong to this definition, which 

will independently capture all offerings 

of securities that are made pursuant to 

an effective registration statement under 

the Securities Act.390 The registration 

prong of the definition is intended to 

provide another avenue by which an 

offering of securities may be conducted 

under the exemption, absent other 

special selling efforts and selling 

methods or a determination of whether 

such efforts and methods are being 

conducted. The Agencies believe this 

prong reduces potential administrative 

burdens by providing a bright-line test 

for what constitutes a distribution for 

purposes of the final rule. In addition, 

this prong is consistent with the 

purpose and goals of the statute because 

it reflects a common type of securities 

offering and does not raise evasion 

concerns as it is unlikely that an entity 

would go through the registration 

process solely to facilitate or engage in 

speculative proprietary trading.391 This 

prong would include, among other 

things, the following types of registered 

securities offerings: Offerings made 

pursuant to a shelf registration 

statement (whether on a continuous or 

delayed basis),392 bought deals,393 at the 

market offerings,394 debt offerings, assetbacked security offerings, initial public 

offerings, and other registered offerings. 

An offering can be a distribution for 

purposes of either § 75.4(a)(3)(i) or 

§ 75.4(a)(3)(ii) of the final rule regardless 

of whether the offering is issuer driven, 

selling security holder driven, or arises 

as a result of a reverse inquiry.395

Provided the definition of distribution is 

met, an offering can be a distribution for 

purposes of this rule regardless of how 

it is conducted, whether by direct 

communication, exchange transactions, 

or automated execution system.396

As discussed above, some 

commenters expressed concern that the 

proposed definition of ‘‘distribution’’ 

would prevent a banking entity from 

acquiring and reselling securities issued 

in lieu of or to refinance bridge loan 

facilities in reliance on the underwriting 

exemption. Bridge financing 

arrangements can be structured in many 

different ways, depending on the 

context and the specific objectives of the 

parties involved. As a result, the 

treatment of securities acquired in lieu 

of or to refinance a bridge loan and the 

subsequent sale of such securities under 

the final rule depends on the facts and 

circumstances. A banking entity may 

meet the terms of the underwriting 

exemption for its bridge loan activity, or 

it may be able to rely on the marketmaking exemption. If the banking 

entity’s bridge loan activity does not 

qualify for an exemption under the rule, 

then it would not be permitted to engage 

in such activity. 


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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 5839 

397See final rule § 75.4(a)(4). 398The basic documents in firm commitment 

underwritten securities offerings generally are: (i) 

The agreement among underwriters, which 

establishes the relationship among the managing 

underwriter, any co-managers, and the other 

members of the underwriting syndicate; (ii) the 

underwriting (or ‘‘purchase’’) agreement, in which 

the underwriters commit to purchase the securities 

from the issuer or selling security holder; and (iii) 

the selected dealers agreement, in which selling 

group members agree to certain provisions relating 

to the distribution. See Joseph McLaughlin and 

Charles J. Johnson, Jr., ‘‘Corporate Finance and the 

Securities Laws’’ (4th ed. 2006, supplemented 

2012), Ch. 2. The Agencies understand that two 

firms may enter into a master agreement that 

governs all offerings in which both firms participate 

as members of the underwriting syndicate or as a 

member of the syndicate and a selling group 

member. See, e.g., SIFMA Master Selected Dealers 

Agreement (June 10, 2011), available at 

www.sifma.org. 

399See AFR et al. (Feb. 2012); Public Citizen. 

400See Joint Proposal, 76 FR at 68867; CFTC 

Proposal, 77 FR at 8352. Post-issuance secondary 

market activity is expected to be conducted in 

accordance with the market-making exemption. 

401See infra Part VI.A.3. 

402See final rule § 75.3(e)(9) (defining the term 

‘‘issuer’’ for purposes of the proprietary trading 

provisions in subpart B of the final rule). Under 

section 2(a)(4) of the Securities Act, ‘‘issuer’’ is 

defined as ‘‘every person who issues or proposes to 

issue any security; except that with respect to 

certificates of deposit, voting-trust certificates, or 

collateral-trust certificates, or with respect to 

certificates of interest or shares in an 

unincorporated investment trust not having a board 

of directors (or persons performing similar 

functions) or of the fixed, restricted management, or 

unit type, the term ‘issuer’ means the person or 

persons performing the acts and assuming the 

duties of depositor or manager pursuant to the 

provisions of the trust or other agreement or 

instrument under which such securities are issued; 

except that in the case of an unincorporated 

association which provides by its articles for 

limited liability of any or all of its members, or in 

the case of a trust, committee, or other legal entity, 

the trustees or members thereof shall not be 

individually liable as issuers of any security issued 

by the association, trust, committee, or other legal 

entity; except that with respect to equipment-trust 

certificates or like securities, the term ‘issuer’ 

means the person by whom the equipment or 

property is or is to be used; and except that with 

respect to fractional undivided interests in oil, gas, 

or other mineral rights, the term ‘issuer’ means the 

owner of any such right or of any interest in such 

right (whether whole or fractional) who creates 

fractional interests therein for the purpose of public 

offering.’’ 15 U.S.C. 77b(a)(4). 

403Final rule § 75.4(a)(5). 

iv. Definition of ‘‘Underwriter’’ 

In response to comments, the 

Agencies are adopting certain 

modifications to the proposed definition 

of ‘‘underwriter’’ to better capture 

selling group members and to more 

closely resemble the definition of 

‘‘distribution participant’’ in Regulation 

M. In particular, the Agencies are 

defining ‘‘underwriter’’ as: (i) A person 

who has agreed with an issuer or selling 

security holder to: (A) Purchase 

Securities from the issuer or selling 

security holder for distribution; (B) 

engage in a distribution of securities for 

or on behalf of the issuer or selling 

security holder; or (C) manage a 

distribution of securities for or on behalf 

of the issuer or selling security holder; 

or (ii) a person who has agreed to 

participate or is participating in a 

distribution of such securities for or on 

behalf of the issuer or selling security 

holder.397

A number of commenters requested 

that the Agencies broaden the 

underwriting exemption to permit 

activities in connection with a 

distribution of securities by any 

distribution participant. A few of these 

commenters interpreted the proposed 

definition of ‘‘underwriter’’ as requiring 

a selling group member to have a 

written agreement with the underwriter 

to participate in the distribution.398

These commenters noted that such a 

written agreement may not exist under 

all circumstances. The Agencies did not 

intend to require that members of the 

underwriting syndicate or the lead 

underwriter have a written agreement 

with all selling group members for each 

offering or that they be in privity of 

contract with the issuer or selling 

security holder. To provide clarity on 

this issue, the Agencies have modified 

the language of subparagraph (ii) of the 

definition to include firms that, while 

not members of the underwriting 

syndicate, have agreed to participate or 

are participating in a distribution of 

securities for or on behalf of the issuer 

or selling security holder. 

The final rule does not adopt a 

narrower definition of ‘‘underwriter,’’ as 

suggested by two commenters.399

Although selling group members do not 

have a direct relationship with the 

issuer or selling security holder, they do 

help facilitate the successful 

distribution of securities to a wider 

variety of purchasers, such as regional 

or retail purchasers that members of the 

underwriting syndicate may not be able 

to access as easily. Thus, the Agencies 

believe it is consistent with the purpose 

of the statutory underwriting exemption 

and beneficial to recognize and allow 

the current market practice of an 

underwriting syndicate and selling 

group members collectively facilitating 

a distribution of securities. The 

Agencies note that because banking 

entities that are selling group members 

will be underwriters under the final 

rule, they will be subject to all the 

requirements of the underwriting 

exemption. 

As provided in the preamble to the 

proposed rule, engaging in the following 

activities may indicate that a banking 

entity is acting as an underwriter under 

§ 75.4(a)(4) as part of a distribution of 

securities: 

• Assisting an issuer in capitalraising; 

• Performing due diligence; 

• Advising the issuer on market 

conditions and assisting in the 

preparation of a registration statement 

or other offering document; 

• Purchasing securities from an 

issuer, a selling security holder, or an 

underwriter for resale to the public; 

• Participating in or organizing a 

syndicate of investment banks; 

• Marketing securities; and 

• Transacting to provide a postissuance secondary market and to 

facilitate price discovery.400

The Agencies continue to take the view 

that the precise activities performed by 

an underwriter will vary depending on 

the liquidity of the securities being 

underwritten and the type of 

distribution being conducted. A banking 

entity is not required to engage in each 

of the above-noted activities to be 

considered an underwriter for purposes 

of this rule. In addition, the Agencies 

note that, to the extent a banking entity 

does not meet the definition of 

‘‘underwriter’’ in the final rule, it may 

be able to rely on the market-making 

exemption in the final rule for its 

trading activity. In response to 

comments noting that APs for ETFs do 

not engage in certain of these activities 

and inquiring whether an AP would be 

able to qualify for the underwriting 

exemption for certain of its activities, 

the Agencies believe that many AP 

activities, such as conducting general 

creations and redemptions of ETF 

shares, are better suited for analysis 

under the market-making exemption 

because they are driven by the demands 

of other market participants rather than 

the issuer, the ETF.401 Whether an AP 

may rely on the underwriting exemption 

for its activities in an ETF will depend 

on the facts and circumstances, 

including, among other things, whether 

the AP meets the definition of 

‘‘underwriter’’ and the offering of ETF 

shares qualifies as a ‘‘distribution.’’ 

To provide further clarity about the 

scope of the definition of ‘‘underwriter,’’ 

the Agencies are defining the terms 

‘‘selling security holder’’ and ‘‘issuer’’ 

in the final rule. The Agencies are using 

the definition of ‘‘issuer’’ from the 

Securities Act because this definition is 

commonly used in the context of 

securities offerings and is well 

understood by market participants.402 A 

‘‘selling security holder’’ is defined as 

‘‘any person, other than an issuer, on 

whose behalf a distribution is made.’’403

This definition is consistent with the 


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5840 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

404See 17 CFR 242.100(b). 

405See supra Part VI.A.2.c.1.b.iii. 

406See supra notes 362, 363, 368–77 and 

accompanying text. 

407See SIFMA et al. (Prop. Trading) (Feb. 2012). 

See Anti-Manipulation Rules Concerning Securities 

Offerings, Exchange Act Release No. 38067 (Dec. 20, 

1996), 62 FR 520, 535 (Jan. 3, 1997) (‘‘Although 

stabilization is price-influencing activity intended 

to induce others to purchase the offered security, 

when appropriately regulated it is an effective 

mechanism for fostering an orderly distribution of 

securities and promotes the interests of 

shareholders, underwriters, and issuers.’’). 

408See SIFMA et al. (Prop. Trading) (Feb. 2012); 

RBC; Goldman (Prop. Trading). See Proposed 

Amendments to Regulation M: Anti-Manipulation 

Rules Concerning Securities Offerings, Exchange 

Act Release No. 50831 (Dec. 9, 2004), 69 FR 75774, 

75780 (Dec. 17, 2004) (‘‘In the typical offering, the 

syndicate agreement allows the managing 

underwriter to ‘oversell’ the offering, i.e., establish 

a short position beyond the number of shares to 

which the underwriting commitment relates. The 

underwriting agreement with the issuer often 

provides for an ‘overallotment option’ whereby the 

syndicate can purchase additional shares from the 

issuer or selling shareholders in order to cover its 

short position. To the extent that the syndicate 

short position is in excess of the overallotment 

option, the syndicate is said to have taken an 

‘uncovered’ short position. The syndicate short 

position, up to the amount of the overallotment 

option, may be covered by exercising the option or 

by purchasing shares in the market once secondary 

trading begins.’’). 

409See SIFMA et al. (Prop. Trading) (Feb. 2012); 

RBC; BoA; BDA (Feb. 2012). 

410See SIFMA et al. (Prop. Trading) (Feb. 2012); 

RBC; Goldman (Prop. Trading). 

411See final rule § 75.4(a)(2)(ii); infra Part 

VI.A.2.c.2.c. (discussing the requirement to make 

reasonable efforts to sell or otherwise reduce the 

underwriting position). 

412See final rule § 75.4(a)(2)(iii)(B); infra Part 

VI.A.2.c.3.c. (discussing the required limits for 

trading desks engaged in underwriting activity). 

413See Wells Fargo (Prop. Trading). The Agencies 

do not believe this activity is consistent with 

underwriting activity because it could result in an 

underwriting desk holding a variety of positions 

over time that are not directly related to a 

distribution of securities the desk is conducting on 

behalf of an issuer or selling security holder. 

Further, the Agencies believe this activity may be 

more appropriately analyzed under the marketmaking exemption because market makers generally 

purchase or sell a financial instrument at the 

request of customers and otherwise routinely stand 

ready to purchase and sell a variety of related 

financial instruments. 

414See id. The Agencies view this activity as 

inconsistent with underwriting because 

underwriters typically engage in other activities, 

such as book-building and other marketing efforts, 

to determine the appropriate price for a security 

and these activities do not involve taking positions 

that are unrelated to the securities subject to 

distribution. See infra VI.A.2.c.2. 

415Although one commenter suggested that an 

underwriter’s hedging activity be permitted under 

the underwriting exemption, we do not believe the 

requirements in the proposed hedging exemption 

would be unworkable or overly burdensome in the 

context of an underwriter’s hedging activity. See 

Goldman (Prop. Trading). As noted above, 

underwriting activity is of a relatively distinct 

nature, which is substantially different from 

market-making activity, which is more dynamic and 

involves more frequent trading activity giving rise 

to a variety of positions that may naturally hedge 

the risks of certain other positions. The Agencies 

believe it is appropriate to require that a trading 

desk comply with the requirements of the hedging 

exemption when it is hedging the risks of its 

underwriting position, while allowing a trading 

desk’s market making-related hedging under the 

market-making exemption. 

definition of ‘‘selling security holder’’ 

found in the SEC’s Regulation M.404

v. Activities Conducted ‘‘in Connection 

With’’ a Distribution 

As discussed above, several 

commenters expressed concern that the 

proposed underwriting exemption 

would not allow a banking entity to 

engage in certain auxiliary activities that 

may be conducted in connection with 

acting as an underwriter for a 

distribution of securities in the normal 

course. These commenters’ concerns 

generally arose from the use of the word 

‘‘solely’’ in § 75.4(a)(2)(iii) of the 

proposed rule, which commenters noted 

was not included in the statute’s 

underwriting exemption.405 In addition, 

a number of commenters discussed 

particular activities they believed 

should be permitted under the 

underwriting exemption and indicated 

the term ‘‘solely’’ created uncertainty 

about whether such activities would be 

permitted.406

To reduce uncertainty in response to 

comments, the final rule requires a 

trading desk’s underwriting position to 

be ‘‘held . . . and managed . . . in 

connection with’’ a single distribution 

for which the relevant banking entity is 

acting as an underwriter, rather than 

requiring that a purchase or sale be 

‘‘effected solely in connection with’’ 

such a distribution. Importantly, for 

purposes of establishing an 

underwriting position in reliance on the 

underwriting exemption, a trading desk 

may only engage in activities that are 

related to a particular distribution of 

securities for which the banking entity 

is acting as an underwriter. Activities 

that may be permitted under the 

underwriting exemption include 

stabilization activities,407 syndicate 

shorting and aftermarket short 

covering,408 holding an unsold 

allotment when market conditions may 

make it impracticable to sell the entire 

allotment at a reasonable price at the 

time of the distribution and selling such 

position when it is reasonable to do 

so,409 and helping the issuer mitigate its 

risk exposure arising from the 

distribution of its securities (e.g., 

entering into a call-spread option with 

an issuer as part of a convertible debt 

offering to mitigate dilution to existing 

shareholders).410 Such activities should 

be intended to effectuate the 

distribution process and provide 

benefits to issuers, selling security 

holders, or purchasers in the 

distribution. Existing laws, regulations, 

and self-regulatory organization rules 

limit or place certain requirements 

around many of these activities. For 

example, an underwriter’s subsequent 

sale of an unsold allotment must 

comply with applicable provisions of 

the Federal securities laws and the rules 

thereunder. Moreover, any position 

resulting from these activities must be 

included in the trading desk’s 

underwriting position, which is subject 

to a number of restrictions in the final 

rule. Specifically, as discussed in more 

detail below, the trading desk must 

make reasonable efforts to sell or 

otherwise reduce its underwriting 

position within a reasonable period,411

and each trading desk must have robust 

limits on, among other things, the 

amount, types, and risks of its 

underwriting position and the period of 

time a security may be held.412 Thus, in 

general, the underwriting exemption 

would not permit a trading desk, for 

example, to acquire a position as part of 

its stabilization activities and hold that 

position for an extended period. 

This approach does not mean that any 

activity that is arguably connected to a 

distribution of securities is permitted 

under the underwriting exemption. 

Certain activities noted by commenters 

are not core to the underwriting 

function and, thus, are not permitted 

under the final underwriting exemption. 

However, a banking entity may be able 

to rely on another exemption for such 

activities (e.g., the market-making or 

hedging exemptions), if applicable. For 

example, a trading desk would not be 

able to use the underwriting exemption 

to purchase a financial instrument from 

a customer to facilitate the customer’s 

ability to buy securities in the 

distribution.413 Further, purchasing 

another financial instrument to help 

determine how to price the securities 

that are subject to a distribution would 

not be permitted under the underwriting 

exemption.414 These two activities may 

be permitted under the market-making 

exemption, depending on the facts and 

circumstances. In response to one 

commenter’s suggestion that hedging 

the underwriter’s risk exposure be 

permissible under this exemption, the 

Agencies emphasize that hedging the 

underwriter’s risk exposure is not 

permitted under the underwriting 

exemption.415 A banking entity must 

comply with the hedging exemption for 

such activity. 

In response to comments about the 

sale of a security to an intermediate 

entity in connection with a structured 


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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 5841 

416See ICI (Feb. 2012); AFR et al. (Feb. 2012); 

Occupy; Alfred Brock. 417A banking entity may accumulate loans in 

anticipation of securitization because loans are not 

financial instruments under the final rule. See 

supra Part VI.A.1.c. 418See proposed rule § 75.4(a)(2)(v); Joint 

Proposal, 76 FR at 68867; CFTC Proposal, 77 FR at 

8353. 419See supra Part VI.A.2.c.2.a. 420See SIFMA et al. (Prop. Trading) (Feb. 2012); 

BoA; BDA (Feb. 2012); RBC. Another commenter 

requested that this requirement be eliminated or 

changed to ‘‘underwriting activities of the banking 

entity with respect to the covered financial position 

must be designed to meet the near-term demands 

of clients, customers, or counterparties.’’ See 

Japanese Bankers Ass’n. 

421See RBC (stating that the Board has found 

acceptable the retention of assets acquired in 

connection with underwriting activities for a period 

of 90 to 180 days and has further permitted holding 

periods of up to a year in certain circumstances, 

such as for less liquid securities). 

422See AFR et al. (Feb. 2012); Sens. Merkley & 

Levin (Feb. 2012). 

423See SIFMA et al. (Prop. Trading) (Feb. 2012); 

BoA; BDA (Feb. 2012); RBC. 

424See SIFMA et al. (Prop. Trading) (Feb. 2012); 

BoA; RBC. These commenters generally stated that 

an underwriter for a ‘‘bought deal’’ may end up 

with an unsold allotment because, pursuant to this 

type of offering, an underwriter makes a 

commitment to purchase securities from an issuer 

or selling security holder, without pre-commitment 

marketing to gauge customer interest, in order to 

provide greater speed and certainty of execution. 

See SIFMA et al. (Prop. Trading) (Feb. 2012); RBC. 

425See SIFMA et al. (Prop. Trading) (Feb. 2012) 

(representing that because an underwriter generally 

backstops a rights offering by committing to 

exercise any rights not exercised by shareholders, 

the underwriter may end up holding a residual 

portion of the offering if investors do not exercise 

all of the rights). 

426See BDA (Feb. 2012). This commenter stated 

that underwriters frequently underwrite bonds in 

the fixed-income market knowing that they may 

need to retain unsold allotments in their inventory. 

The commenter indicated that this scenario arises 

because the fixed-income market is not as deep as 

other markets, so underwriters frequently cannot 

sell bonds when they go to market; instead, the 

underwriters will retain the bonds until a sufficient 

amount of liquidity is available in the market. See 

id. 

427See SIFMA et al. (Prop. Trading) (Feb. 2012); 

BoA. 

428See BoA; RBC; LSTA (Feb. 2012). One of these 

commenters stated that, in the case of securities 

issued in lieu of or to refinance bridge loan 

facilities, market conditions or investor demand 

may change during the period of time between 

extension of the bridge commitment and when the 

bridge loan is required to be funded or such 

securities are required to be issued. As a result, this 

commenter requested that the near term demands 

of clients, customers, or counterparties be measured 

at the time of the initial extension of the bridge 

commitment. See LSTA (Feb. 2012). 

429See SIFMA et al. (Prop. Trading) (Feb. 2012); 

RBC. 

430See AFR et al. (Feb. 2012); CalPERS; Occupy; 

Public Citizen; Goldman (Prop. Trading); Fidelity; 

Japanese Bankers Ass’n.; Sens. Merkley & Levin 

(Feb. 2012); Alfred Brock. 

431See AFR et al. (Feb. 2012); CalPERS; Occupy; 

Public Citizen; Alfred Brock. 

432See AFR et al. (Feb. 2012) (recognizing, 

however, that a small portion of an underwriting 

may occasionally be ‘‘hung’’); CalPERS; Occupy 

(stating that a banking entity’s retention of unsold 

allotments may result in potential conflicts of 

interest). 

433See AFR et al. (Feb. 2012). 

434See Occupy (stating that the meaning of the 

term ‘‘substantial’’ would depend on the 

circumstances of the particular offering). 

finance product,416 the Agencies have 

not modified the underwriting 

exemption. Underwriting is distinct 

from product development. Thus, 

parties must adjust activities associated 

with developing structured finance 

products or meet the terms of other 

available exemptions. Similarly, the 

accumulation of securities or other 

assets in anticipation of a securitization 

or resecuritization is not an activity 

conducted ‘‘in connection with’’ 

underwriting for purposes of the 

exemption.417 This activity is typically 

engaged in by an issuer or sponsor of a 

securitized product in that capacity, 

rather than in the capacity of an 

underwriter. The underwriting 

exemption only permits a banking 

entity’s activities when it is acting as an 

underwriter. 

2. Near Term Customer Demand 

Requirement 

a. Proposed Near Term Customer 

Demand Requirement 

Like the statute, § 75.4(a)(2)(v) of the 

proposed rule required that the 

underwriting activities of the banking 

entity with respect to the covered 

financial position be designed not to 

exceed the reasonably expected near 

term demands of clients, customers, or 

counterparties.418

b. Comments Regarding the Proposed 

Near Term Customer Demand 

Requirement 

Both the statute and the proposed rule 

require a banking entity’s underwriting 

activity to be ‘‘designed not to exceed 

the reasonably expected near term 

demands of clients, customers, or 

counterparties.’’ 419 Several commenters 

requested that this standard be 

interpreted in a flexible manner to allow 

a banking entity to participate in an 

offering that may require it to retain an 

unsold allotment for a period of time.420

In addition, one commenter stated that 

the final rule should provide flexibility 

in this standard by recognizing that the 

concept of ‘‘near term’’ differs between 

asset classes and depends on the 

liquidity of the market.421 Two 

commenters expressed views on how 

the near term customer demand 

requirement should work in the context 

of a securitization or creating what the 

commenters characterized as 

‘‘structured products’’ or ‘‘structured 

instruments.’’422

Many commenters expressed concern 

that the proposed requirement, if 

narrowly interpreted, could prevent an 

underwriter from holding a residual 

position for which there is no 

immediate demand from clients, 

customers, or counterparties.423

Commenters noted that there are a 

variety of offerings that present some 

risk of an underwriter having to hold a 

residual position that cannot be sold in 

the initial distribution, including 

‘‘bought deals,’’ 424 rights offerings,425

and fixed-income offerings.426 A few 

commenters noted that similar scenarios 

can arise in the case of an AP creating 

more shares of an ETF than it can sell427

and bridge loans.428 Two commenters 

indicated that if the rule does not 

provide greater clarity and flexibility 

with respect to the near term customer 

demand requirement, a banking entity 

may be less inclined to participate in a 

distribution where there is the potential 

risk of an unsold allotment, may price 

such risk into the fees charged to 

underwriting clients, or may be forced 

into a ‘‘fire sale’’ of the unsold 

allotment.429

Several other commenters provided 

views on whether a banking entity 

should be able to hold a residual 

position from an offering pursuant to 

the underwriting exemption, although 

they did not generally link their 

comments to the proposed near term 

demand requirement.430 Many of these 

commenters expressed concern about 

permitting a banking entity to retain a 

portion of an underwriting and noted 

potential risks that may arise from such 

activity.431 For example, some of these 

commenters stated that retention or 

warehousing of underwritten securities 

can be an indication of impermissible 

proprietary trading intent (particularly if 

systematic), or may otherwise result in 

high-risk exposures or conflicts of 

interests.432 One of these commenters 

recommended the Agencies use a metric 

to monitor the size of residual positions 

retained by an underwriter,433 while 

another commenter suggested adding a 

requirement to the proposed exemption 

to provide that a ‘‘substantial’’ unsold or 

retained allotment would be an 

indication of prohibited proprietary 

trading.434 Similarly, one commenter 

recommended that the Agencies 

consider whether there are sufficient 

provisions in the proposed rule to 

reduce the risks posed by banking 

entities retaining or warehousing 

underwritten instruments, such as 

subprime mortgages, collateralized debt 

obligation tranches, and high yield debt 

of leveraged buyout issuers, which 


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435See CalPERS. 

436See Goldman (Prop. Trading); Fidelity 

(expressing concern that this may result in a more 

concentrated supply of securities and, thus, 

decrease the opportunity for diversification in the 

portfolios of shareholders’ funds). 

437See Goldman (Prop. Trading). 

438See Japanese Bankers Ass’n. 

439See Sens. Merkley & Levin (Feb. 2012). 

440See AFR et al. (Feb. 2012); Sens. Merkley & 

Levin (Feb. 2012). 

441See AFR et al. (Feb. 2012). 

442See Sens. Merkley & Levin (Feb. 2012). 

443See Banco de Me ́xico. 

444See SIFMA et al. (Prop. Trading) (Feb. 2012); 

IIB/EBF. One of these commenters represented that 

many banking entities serve as primary dealers in 

jurisdictions in which they operate, and primary 

dealers often: (i) Are subject to minimum purchase 

and other obligations in the jurisdiction’s foreign 

sovereign debt; (ii) play important roles in 

underwriting and market making in State, 

provincial, and municipal debt issuances; and (iii) 

act as intermediaries through which a government’s 

financial and monetary policies operate. This 

commenter stated that, due to these considerations, 

restrictions on the ability of banking entities to act 

as primary dealer are likely to harm the 

governments they serve. See IIB/EBF. 

445Final rule § 75.4(a)(2)(ii). 

446The proposed rule required the underwriting 

activities of the banking entity with respect to the 

covered financial position to be designed not to 

exceed the reasonably expected near term demands 

of clients, customers, or counterparties. See 

proposed rule § 75.4(a)(2)(v). 

447See supra Part VI.A.2.c.2.b. (discussing 

commenters’ concerns that the proposed near term 

customer demand requirement may limit a banking 

entity’s ability to retain an unsold allotment). 

448A banking entity may not structure a complex 

instrument on its own initiative using the 

underwriting exemption. It may use the 

underwriting exemption only with respect to 

distributions of securities that comply with the final 

rule. The Agencies believe this requirement 

addresses one commenter’s concern that a banking 

entity could rely on the underwriting exemption 

without regard to anticipated customer demand. 

See AFR et al. (Feb. 2012) In addition, a trading 

desk hedging the risks of an underwriting position 

in a complex, novel instrument must comply with 

the hedging exemption in the final rule. 

449An issuer or selling security holder for 

purposes of this rule may include, among others, 

corporate issuers, sovereign issuers for which the 

banking entity acts as primary dealer (or functional 

equivalent), or any other person that is an issuer, 

as defined in final rule § 75.3(e)(9), or a selling 

security holder, as defined in final rule § 75.4(a)(5). 

The Agencies believe that the underwriting 

exemption in the final rule should generally allow 

a primary dealer (or functional equivalent) to act as 

an underwriter for a sovereign government’s 

issuance of its debt because, similar to other 

underwriting activities, this involves a banking 

entity agreeing to distribute securities for an issuer 

(in this case, the foreign sovereign) and engaging in 

a distribution of such securities. See SIFMA et al. 

poses heightened financial risk at the 

top of economic cycles.435

Other commenters indicated that 

undue restrictions on an underwriter’s 

ability to retain a portion of an offering 

may result in certain harms to the 

capital-raising process. These 

commenters represented that unclear or 

negative treatment of residual positions 

will make banking entities averse to the 

risk of an unsold allotment, which may 

result in banking entities underwriting 

smaller offerings, less capital generation 

for issuers, or higher underwriting 

discounts, which would increase the 

cost of raising capital for businesses.436

One of these commenters suggested that 

a banking entity be permitted to hold a 

residual position under the 

underwriting exemption as long as it 

continues to take reasonable steps to 

attempt to dispose of the residual 

position in light of existing market 

conditions.437

In addition, in response to a question 

in the proposal, one commenter 

expressed the view that the rule should 

not require documentation with respect 

to residual positions held by an 

underwriter.438 In the case of 

securitizations, one commenter stated 

that if the underwriter wishes to retain 

some of the securities or bonds in its 

longer-term investment book, such 

decisions should be made by a separate 

officer, subject to different standards 

and compensation.439

Two commenters discussed how the 

near term customer demand 

requirement should apply in the context 

of a banking entity acting as an 

underwriter for a securitization or 

structured product.440 One of these 

commenters indicated that the near term 

demand requirement should be 

interpreted to require that a distribution 

of securities facilitate pre-existing client 

demand. This commenter stated that a 

banking entity should not be considered 

to meet the terms of the proposed 

requirement if, on the firm’s own 

initiative, it designs and structures a 

complex, novel instrument and then 

seeks customers for the instrument, 

while retaining part of the issuance on 

its own book. The commenter further 

emphasized that underwriting should 

involve two-way demand—clients who 

want assistance in marketing their 

securities and customers who may wish 

to purchase the securities—with the 

banking entity serving as an 

intermediary.441 Another commenter 

indicated that an underwriting should 

likely be seen as a distribution of all, or 

nearly all, of the securities related to a 

securitization (excluding any amount 

required for credit risk retention 

purposes) along a time line designed not 

to exceed reasonably expected near term 

demands of clients, customers, or 

counterparties. According to the 

commenter, this approach would serve 

to minimize the arbitrage and risk 

concentration possibilities that can arise 

through the securitization and sale of 

some tranches and the retention of other 

tranches.442

One commenter expressed concern 

that the proposed near term customer 

demand requirement may impact a 

banking entity’s ability to act as primary 

dealer because some primary dealers are 

obligated to bid on each issuance of a 

government’s sovereign debt, without 

regard to expected customer demand.443

Two other commenters expressed 

general concern that the proposed 

underwriting exemption may be too 

narrow to permit banking entities that 

act as primary dealers in or for foreign 

jurisdictions to continue to meet the 

relevant jurisdiction’s primary dealer 

requirements.444

c. Final Near Term Customer Demand 

Requirement 

The final rule requires that the 

amount and types of the securities in 

the trading desk’s underwriting position 

be designed not to exceed the 

reasonably expected near term demands 

of clients, customers, or counterparties, 

and reasonable efforts be made to sell or 

otherwise reduce the underwriting 

position within a reasonable period, 

taking into account the liquidity, 

maturity, and depth of the market for 

the relevant type of security.445 As 

noted above, the near term demand 

standard originates from section 

13(d)(1)(B) of the BHC Act, and a similar 

requirement was included in the 

proposed rule.446 The Agencies are 

making certain modifications to the 

proposed approach in response to 

comments. 

In particular, the Agencies are 

clarifying the operation of this 

requirement, particularly with respect to 

unsold allotments.447 Under this 

requirement, a trading desk must have 

a reasonable expectation of demand 

from other market participants for the 

amount and type of securities to be 

acquired from an issuer or selling 

security holder for distribution.448 Such 

reasonable expectation may be based on 

factors such as current market 

conditions and prior experience with 

similar offerings of securities. A banking 

entity is not required to engage in bookbuilding or similar marketing efforts to 

determine investor demand for the 

securities pursuant to this requirement, 

although such efforts may form the basis 

for the trading desk’s reasonable 

expectation of demand. While an issuer 

or selling security holder can be 

considered to be a client, customer, or 

counterparty of a banking entity acting 

as an underwriter for its distribution of 

securities, this requirement cannot be 

met by accounting solely for the issuer’s 

or selling security holder’s desire to sell 

the securities.449 However, the 


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(Prop. Trading) (Feb. 2012); IIB/EBF; Banco de 

Me ́xico. A banking entity acting as primary dealer 

(or functional equivalent) may also be able to rely 

on the market-making exemption or other 

exemptions for some of its activities. See infra Part 

VI.A.3.c.2.c. The final rule defines ‘‘client, 

customer, or counterparty’’ for purposes of the 

underwriting exemption as ‘‘market participants 

that may transact with the banking entity in 

connection with a particular distribution for which 

the banking entity is acting as underwriter.’’ Final 

rule § 75.4(a)(7). 

450One commenter stated that, in the case of a 

securitization, an underwriting should be seen as a 

distribution of all, or nearly all, of the securities 

related to a securitization (excluding the amount 

required for credit risk retention purposes) along a 

time line designed not to exceed the reasonably 

expected near term demands of clients, customers, 

or counterparties. See Sens. Merkley & Levin (Feb. 

2012). The final rule’s near term customer demand 

requirement considers the liquidity, maturity, and 

depth of the market for the type of security and 

recognizes that the amount of time a trading desk 

may need to hold an underwriting position may 

vary based on these factors. The final rule does not, 

however, adopt a standard that applies differently 

based solely on the particular type of security being 

distributed (e.g., an asset-backed security versus an 

equity security) or that precludes certain types of 

securities from being distributed by a banking entity 

acting as an underwriter in accordance with the 

requirements of this exemption because the 

Agencies believe the statute is best read to permit 

a banking entity to engage in underwriting activity 

to facilitate distributions of securities by issuers and 

selling security holders, regardless of type, to 

provide client-oriented financial services. That 

reading is consistent with the statute’s language and 

finds support in the legislative history. See 156 

Cong. Rec. S5895–S5896 (daily ed. July 15, 2010) 

(statement of Sen. Merkley) (stating that the 

underwriting exemption permits ‘‘transactions that 

are technically trading for the account of the firm 

but, in fact, facilitate the provision of near-term 

client-oriented financial services’’). In addition, 

with respect to this commenter’s statement 

regarding credit risk retention requirements, the 

Agencies note that compliance with the credit risk 

retention requirements of Section 15G of the 

Exchange Act would not impact the availability of 

the underwriting exemption in the final rule. 

451This approach should help address 

commenters’ concerns that an inflexible 

interpretation of the near term demand requirement 

could result in fire sales, higher fees for 

underwriting services, or reluctance to act as an 

underwriter for certain types of distributions that 

present a greater risk of unsold allotments. See 

SIFMA et al. (Prop. Trading) (Feb. 2012); RBC. 

Further, the Agencies believe this should reduce 

commenters’ concerns that, to the extent a delayed 

distribution of securities, which are acquired as a 

result of an outstanding bridge loan, is able to 

qualify for the underwriting exemption, a stringent 

interpretation of the near term demand requirement 

could prevent a banking entity from retaining such 

securities if market conditions are suboptimal or 

marketing efforts are not entirely successful. See 

RBC; BoA; LSTA (Feb. 2012). In response to one 

commenter’s request that the Agencies allow a 

banking entity to assess near term demand at the 

time of the initial extension of the bridge 

commitment, the Agencies believe it could be 

appropriate to determine whether the banking 

entity has a reasonable expectation of demand from 

other market participants for the amount and type 

of securities to be acquired at that time, but note 

that the trading desk would continue to be subject 

to the requirement to make reasonable efforts to sell 

the resulting underwriting position at the time of 

the initial distribution and for the remaining time 

the securities are in its inventory. See LSTA (Feb. 

2012). 

452The Agencies believe that requiring a trading 

desk to make reasonable efforts to sell or otherwise 

reduce its underwriting position addresses 

commenters’ concerns about the risks associated 

with unsold allotments or the retention of 

underwritten instruments because this requirement 

is designed to prevent a trading desk from retaining 

an unsold allotment for speculative purposes when 

there is customer buying interest for the relevant 

security at commercially reasonable prices. Thus, 

the Agencies believe this obviates the need for 

certain additional requirements suggested by 

commenters. See, e.g., Occupy; AFR et al. (Feb. 

2012); CalPERS. The final rule strikes an 

appropriate balance between the concerns raised by 

these commenters and those noted by other 

commenters regarding the potential market impacts 

of strict requirements against holding an unsold 

allotment, such as higher fees to underwriting 

clients, fire sales of unsold allotments, or general 

reluctance to participate in any distribution that 

presents a risk of an unsold allotment. The 

requirement to make reasonable efforts to sell or 

otherwise reduce the underwriting position should 

not cause the market impacts predicted by these 

commenters because it does not prevent an 

underwriter from retaining an unsold allotment for 

a reasonable period or impose strict holding period 

limits on unsold allotments. See SIFMA et al. (Prop. 

Trading) (Feb. 2012); RBC; Goldman (Prop. 

Trading); Fidelity. 

453This approach is generally consistent with one 

commenter’s suggested approach to addressing the 

issue of unsold allotments. See, e.g., Goldman 

(Prop. Trading) (suggesting that a banking entity be 

permitted to hold a residual position under the 

underwriting exemption as long as it continues to 

take reasonable steps to attempt to dispose of the 

residual position in light of existing market 

conditions). In addition, allowing an underwriter to 

retain an unsold allotment under certain 

circumstances is consistent with the proposal. See 

Joint Proposal, 76 FR at 68867 (‘‘There may be 

circumstances in which an underwriter would hold 

securities that it could not sell in the distribution 

for investment purposes. If the acquisition of such 

unsold securities were in connection with the 

underwriting pursuant to the permitted 

underwriting activities exemption, the underwriter 

would also be able to dispose of such securities at 

a later time.’’); CFTC Proposal, 77 FR at 8352. A 

number of commenters raised questions about 

whether the rule would permit retaining an unsold 

allotment. See Goldman (Prop. Trading); Fidelity; 

SIFMA et al. (Prop. Trading) (Feb. 2012); BoA; RBC; 

AFR et al. (Feb. 2012); CalPERS; Occupy; Public 

Citizen; Alfred Brock. 

454See Goldman (Prop. Trading); Fidelity. 

455See SIFMA et al. (Prop. Trading) (Feb. 2012); 

BoA; RBC. 

456See AFR et al. (Feb. 2012); CalPERS; Occupy; 

Public Citizen; Alfred Brock. 

457To the extent that an AP for an ETF is able 

to meet the terms of the underwriting exemption for 

its activity, it may be able to retain ETF shares that 

it created if it had a reasonable expectation of 

buying interest in the ETF shares and engages in 

reasonable efforts to sell the ETF shares. See SIFMA 

et al. (Prop. Trading) (Feb. 2012); BoA. 

458See Goldman (Prop. Trading); Fidelity; SIFMA 

et al. (Prop. Trading) (Feb. 2012); RBC. 

expectation of demand does not require 

a belief that the securities will be placed 

immediately. The time it takes to carry 

out a distribution may differ based on 

the liquidity, maturity, and depth of the 

market for the type of security.450

This requirement is not intended to 

prevent a trading desk from distributing 

an offering over a reasonable time 

consistent with market conditions or 

from retaining an unsold allotment of 

the securities acquired from an issuer or 

selling security holder where holding 

such securities is necessary due to 

circumstances such as less-thanexpected purchaser demand at a given 

price.451 An unsold allotment is, 

however, subject to the requirement to 

make reasonable efforts to sell or 

otherwise reduce the underwriting 

position.452 The definition of 

‘‘underwriting position’’ includes, 

among other things, any residual 

position from the distribution that is 

managed by the trading desk. The final 

rule includes the requirement to make 

reasonable efforts to sell or otherwise 

reduce the trading desk’s underwriting 

position in order to respond to 

comments on the issue of when a 

banking entity may retain an unsold 

allotment when it is acting as an 

underwriter, as discussed in more detail 

below, and ensure that the exemption is 

available only for activities that involve 

underwriting activities, and not 

prohibited proprietary trading.453

As a general matter, commenters 

expressed differing views on whether an 

underwriter should be permitted to hold 

an unsold allotment for a certain period 

of time after the initial distribution. For 

example, a few commenters suggested 

that limitations on retaining an unsold 

allotment would increase the cost of 

raising capital 454 or would negatively 

impact certain types of securities 

offerings (e.g., bought deals, rights 

offerings, and fixed-income 

offerings).455 Other commenters, 

however, expressed concern that the 

proposed exemption would allow a 

banking entity to retain a portion of a 

distribution for speculative purposes.456

The Agencies believe the requirement 

to make reasonable efforts to sell or 

otherwise reduce the underwriting 

position appropriately addresses both 

sets of comments. More specifically, this 

standard clarifies that an underwriter 

generally may retain an unsold 

allotment that it was unable to sell to 

purchasers as part of the initial 

distribution of securities, provided it 

had a reasonable expectation of buying 

interest and engaged in reasonable 

selling efforts.457 This should reduce the 

potential for the negative impacts of a 

more stringent approach predicted by 

commenters, such as increased fees for 

underwriting, greater costs to businesses 

for raising capital, and potential fire 

sales of unsold allotments.458 However, 

to address concerns that a banking 

entity may retain an unsold allotment 

for purely speculative purposes, the 

Agencies are requiring that reasonable 

efforts be made to sell or otherwise 


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459See AFR et al. (Feb. 2012); CalPERS; Occupy. 

460The trading desk’s retention and sale of the 

unsold allotment must comply with the Federal 

securities laws and regulations, but is otherwise 

permitted under the underwriting exemption. 

461See supra note 408. 

462For example, some commenters suggested that 

the proposed underwriting exemption could have a 

chilling effect on banking entities’ willingness to 

engage in underwriting activities. See, e.g., Lord 

Abbett; Fidelity. Further, some commenters 

expressed concern that the proposed near term 

customer demand requirement might negatively 

impact certain forms of capital-raising if the 

requirement is interpreted narrowly or inflexibly. 

See SIFMA et al. (Prop. Trading) (Feb. 2012); BoA; 

BDA (Feb. 2012); RBC. 

463See proposed rule § 75.4(a)(2)(i). 

464See Joint Proposal, 76 FR at 68866; CFTC 

Proposal, 77 FR at 8352. 

465The independent testing standard is discussed 

in more detail in Part VI.C., which discusses the 

compliance program requirement in § 75.20 of the 

final rule. 

466See final rule § 75.4(a)(2)(iii)(A). 

467See final rule § 75.4(a)(2)(iii)(B). A trading 

desk must have limits on the amount, types, and 

risk of the securities in its underwriting position, 

level of exposures to relevant risk factors arising 

from its underwriting position, and period of time 

a security may be held. See id. 

468See final rule § 75.4(a)(2)(iii)(C). 

reduce the underwriting position, which 

includes any unsold allotment, within a 

reasonable period. The Agencies agree 

with these commenters that systematic 

retention of an underwriting position, 

without engaging in efforts to sell the 

position and without regard to whether 

the trading desk is able to sell the 

securities at a commercially reasonable 

price, would be indicative of 

impermissible proprietary trading 

intent.459 The Agencies recognize that 

the meaning of ‘‘reasonable period’’ may 

differ based on the liquidity, maturity, 

and depth of the market for the relevant 

type of securities. For example, an 

underwriter may be more likely to retain 

an unsold allotment in a bond offering 

because liquidity in the fixed-income 

market is generally not as deep as that 

in the equity market. If a trading desk 

retains an underwriting position for a 

period of time after the distribution, the 

trading desk must manage the risk of its 

underwriting position in accordance 

with its inventory and risk limits and 

authorization procedures. As discussed 

above, hedging transactions undertaken 

in connection with such risk 

management activities must be 

conducted in compliance with the 

hedging exemption in § 75.5 of the final 

rule. 

The Agencies emphasize that the 

requirement to make reasonable efforts 

to sell or otherwise reduce the 

underwriting position applies to the 

entirety of the trading desk’s 

underwriting position. As a result, this 

requirement applies to a number of 

different scenarios in which an 

underwriter may hold a long or short 

position in the securities that are the 

subject of a distribution for a period of 

time. For example, if an underwriter is 

facilitating a distribution of securities 

for which there is sufficient investor 

demand to purchase the securities at the 

offering price, this requirement would 

prevent the underwriter from retaining 

a portion of the allotment for its own 

account instead of selling the securities 

to interested investors. If instead there 

was insufficient investor demand at the 

time of the initial offering, this 

requirement would recognize that it 

may be appropriate for the underwriter 

to hold an unsold allotment for a 

reasonable period of time. Under these 

circumstances, the underwriter would 

need to make reasonable efforts to sell 

the unsold allotment when there is 

sufficient market demand for the 

securities.460 This requirement would 

also apply in situations where the 

underwriters sell securities in excess of 

the number of securities to which the 

underwriting commitment relates, 

resulting in a syndicate short position in 

the same class of securities that were the 

subject of the distribution.461 This 

provision of the final exemption would 

require reasonable efforts to reduce any 

portion of the syndicate short position 

attributable to the banking entity that is 

acting as an underwriter. Such 

reduction could be accomplished if, for 

example, the managing underwriter 

exercises an overallotment option or 

shares are purchased in the secondary 

market to cover the short position. 

The near term demand requirement, 

including the requirement to make 

reasonable efforts to reduce the 

underwriting position, represents a new 

regulatory requirement for banking 

entities engaged in underwriting. At the 

margins, this requirement could alter 

the participation decision for some 

banking entities with respect to certain 

types of distributions, such as 

distributions that are more likely to 

result in the banking entity retaining an 

underwriting position for a period of 

time.462 However, the Agencies 

recognize that liquidity, maturity, and 

depth of the market vary across types of 

securities, and the Agencies expect that 

the express recognition of these 

differences in the rule should help 

mitigate any incentive to exit the 

underwriting business for certain types 

of securities or types of distributions. 

3. Compliance Program Requirement 

a. Proposed Compliance Program 

Requirement 

Section 75.4(a)(2)(i) of the proposed 

exemption required a banking entity to 

establish an internal compliance 

program, as required by § 75.20 of the 

proposed rule, that is designed to ensure 

the banking entity’s compliance with 

the requirements of the underwriting 

exemption, including reasonably 

designed written policies and 

procedures, internal controls, and 

independent testing.463 This 

requirement was proposed so that any 

banking entity relying on the 

underwriting exemption would have 

reasonably designed written policies 

and procedures, internal controls, and 

independent testing in place to support 

its compliance with the terms of the 

exemption.464

b. Comments on the Proposed 

Compliance Program Requirement 

Commenters did not directly address 

the proposed compliance program 

requirement in the underwriting 

exemption. Comments on the proposed 

compliance program requirement of 

§ 75.20 of the proposed rule are 

discussed in Part VI.C., below. 

c. Final Compliance Program 

Requirement 

The final rule includes a compliance 

program requirement that is similar to 

the proposed requirement, but the 

Agencies are making certain 

enhancements to emphasize the 

importance of a strong internal 

compliance program. More specifically, 

the final rule requires that a banking 

entity’s compliance program specifically 

include reasonably designed written 

policies and procedures, internal 

controls, analysis and independent 

testing 465 identifying and addressing: (i) 

The products, instruments or exposures 

each trading desk may purchase, sell, or 

manage as part of its underwriting 

activities; 466 (ii) limits for each trading 

desk, based on the nature and amount 

of the trading desk’s underwriting 

activities, including the reasonably 

expected near term demands of clients, 

customers, or counterparties; 467 (iii) 

internal controls and ongoing 

monitoring and analysis of each trading 

desk’s compliance with its limits; 468

and (iv) authorization procedures, 

including escalation procedures that 

require review and approval of any 

trade that would exceed one or more of 

a trading desk’s limits, demonstrable 

analysis of the basis for any temporary 

or permanent increase to one or more of 

a trading desk’s limits, and independent 

review (i.e., by risk managers and 

compliance officers at the appropriate 

level independent of the trading desk) of 


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469See final rule § 75.4(a)(2)(iii)(D). 

470See Joint Proposal, 76 FR at 68963–68967 

(requiring certain banking entities to establish, 

maintain, and enforce compliance programs with, 

among other things: (i) Written policies and 

procedures that describe a trading unit’s authorized 

instruments and products; (ii) internal controls for 

each trading unit, including risk limits for each 

trading unit and surveillance procedures; and (iii) 

a management framework, including management 

procedures for overseeing compliance with the 

proposed rule). 

471See final rule §§ 75.4(a)(2)(iii), 75.4(b)(2)(iii). 

472See final rule § 75.5. 

473See final rule § 75.4(a)(2)(iii)(C). 

474See final rule § 75.4(a)(2)(iii)(D). 

475See Part VI.C. (discussing the compliance 

program requirement in § 75.20 of the final rule). 

476See proposed rule § 75.4(a)(2)(vii); Joint 

Proposal, 76 FR at 68868; CFTC Proposal, 77 FR at 

8353. 

477See id. 

478See Occupy; AFR et al. (Feb. 2012); Better 

Markets (Feb. 2012). 

such demonstrable analysis and 

approval.469

As noted above, the proposed 

compliance program requirement did 

not include the four specific elements 

listed above in the proposed 

underwriting exemption, although each 

of these provisions was included in 

some form in the detailed compliance 

program requirement under Appendix C 

of the proposed rule.470 The Agencies 

are moving these particular 

requirements, with certain 

enhancements, into the underwriting 

exemption because the Agencies believe 

these are core elements of a program to 

ensure compliance with the 

underwriting exemption. These 

compliance procedures must be 

established, implemented, maintained, 

and enforced for each trading desk 

engaged in underwriting activity under 

§ 75.4(a) of the final rule. Each of the 

requirements in paragraphs (a)(2)(iii)(A) 

through (D) must be appropriately 

tailored to the individual trading 

activities and strategies of each trading 

desk. 

The compliance program requirement 

in the underwriting exemption is 

substantially similar to the compliance 

program requirement in the marketmaking exemption, except that the 

Agencies are requiring more detailed 

risk management procedures in the 

market-making exemption due to the 

nature of that activity.471 The Agencies 

believe including similar compliance 

program requirements in the 

underwriting and market-making 

exemptions may reduce burdens 

associated with building and 

maintaining compliance programs for 

each trading desk. 

Identifying in the compliance 

program the relevant products, 

instruments, and exposures in which a 

trading desk is permitted to trade will 

facilitate monitoring and oversight of 

compliance with the underwriting 

exemption. For example, this 

requirement should prevent an 

individual trader on an underwriting 

desk from establishing positions in 

instruments that are unrelated to the 

desk’s underwriting function. Further, 

the identification of permissible 

products, instruments, and exposures 

will help form the basis for the specific 

types of position and risk limits that the 

banking entity must establish and is 

relevant to considerations throughout 

the exemption regarding the liquidity, 

maturity, and depth of the market for 

the relevant type of security. 

A trading desk must have limits on 

the amount, types, and risk of the 

securities in its underwriting position, 

level of exposures to relevant risk 

factors arising from its underwriting 

position, and period of time a security 

may be held. Limits established under 

this provision, and any modifications to 

these limits made through the required 

escalation procedures, must account for 

the nature and amount of the trading 

desk’s underwriting activities, including 

the reasonably expected near term 

demands of clients, customers, or 

counterparties. Among other things, 

these limits should be designed to 

prevent a trading desk from 

systematically retaining unsold 

allotments even when there is customer 

demand for the positions that remain in 

the trading desk’s inventory. The 

Agencies recognize that trading desks’ 

limits may differ across types of 

securities and acknowledge that trading 

desks engaged in underwriting activities 

in less liquid securities, such as 

corporate bonds, may require different 

inventory, risk exposure, and holding 

period limits than trading desks engaged 

in underwriting activities in more liquid 

securities, such as certain equity 

securities. A trading desk hedging the 

risks of an underwriting position must 

comply with the hedging exemption, 

which provides for compliance 

procedures regarding risk 

management.472

Furthermore, a banking entity must 

establish internal controls and ongoing 

monitoring and analysis of each trading 

desk’s compliance with its limits, 

including the frequency, nature, and 

extent of a trading desk exceeding its 

limits.473 This may include the use of 

management and exception reports. 

Moreover, the compliance program must 

set forth a process for determining the 

circumstances under which a trading 

desk’s limits may be modified on a 

temporary or permanent basis (e.g., due 

to market changes). 

As noted above, a banking entity’s 

compliance program for trading desks 

engaged in underwriting activity must 

also include escalation procedures that 

require review and approval of any 

trade that would exceed one or more of 

a trading desk’s limits, demonstrable 

analysis that the basis for any temporary 

or permanent increase to one or more of 

a trading desk’s limits is consistent with 

the near term customer demand 

requirement, and independent review of 

such demonstrable analysis and 

approval.474 Thus, to increase a limit of 

a trading desk, there must be an analysis 

of why such increase would be 

appropriate based on the reasonably 

expected near term demands of clients, 

customers, or counterparties, which 

must be independently reviewed. A 

banking entity also must maintain 

documentation and records with respect 

to these elements, consistent with the 

requirement of § 75.20(b)(6). 

As discussed in more detail in Part 

VI.C., the Agencies recognize that the 

compliance program requirements in 

the final rule will impose certain costs 

on banking entities but, on balance, the 

Agencies believe such requirements are 

necessary to facilitate compliance with 

the statute and the final rule and to 

reduce the risk of evasion.475

4. Compensation Requirement 

a. Proposed Compensation Requirement 

Another provision of the proposed 

underwriting exemption required that 

the compensation arrangements of 

persons performing underwriting 

activities at the banking entity must be 

designed not to encourage proprietary 

risk-taking.476 In connection with this 

requirement, the proposal clarified that 

although a banking entity relying on the 

underwriting exemption may 

appropriately take into account 

revenues resulting from movements in 

the price of securities that the banking 

entity underwrites to the extent that 

such revenues reflect the effectiveness 

with which personnel have managed 

underwriting risk, the banking entity 

should provide compensation 

incentives that primarily reward client 

revenues and effective client service, 

not proprietary risk-taking.477

b. Comments on the Proposed 

Compensation Requirement 

A few commenters expressed general 

support for the proposed requirement, 

but suggested certain modifications that 

they believed would enhance the 

requirement and make it more 

effective.478 Specifically, one 


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479See AFR et al. (Feb. 2012). 

480See Occupy. 

481See final rule § 75.4(a)(2)(iv); proposed rule 

§ 75.4(a)(2)(vii). This is consistent with the final 

compensation requirements in the market-making 

and hedging exemptions. See final rule 

§ 75.4(b)(2)(v); final rule § 75.5(b)(3). 

482See AFR et al. (Feb. 2012); supra Part 

VI.A.2.c.2.c. (discussing the requirement to make 

reasonable efforts to sell or otherwise reduce the 

underwriting position). 

483See AFR et al. (Feb. 2012). 

484See Occupy. 

485See proposed rule § 75.4(a)(2)(iv); Joint 

Proposal, 76 FR at 68867; CFTC Proposal, 77 FR at 

8353. The proposal clarified that, in the case of a 

financial institution that is a government securities 

dealer, such institution must have filed notice of 

that status as required by section 15C(a)(1)(B) of the 

Exchange Act. See Joint Proposal, 76 FR at 68867; 

CFTC Proposal, 77 FR at 8353. 

486See Part VI.A.3.c.6. (discussing the registration 

requirement in the market-making exemption). 

487For example, if a banking entity is a bank 

engaged in underwriting asset-backed securities for 

which it would be required to register as a 

securities dealer but for the exclusion contained in 

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

rule would not require the banking entity to be a 

registered securities dealer to underwrite the assetbacked securities. See 15 U.S.C. 78c(a)(5)(C)(iii). 

commenter suggested tailoring the 

requirement to underwriting activity by, 

for example, ensuring that personnel 

involved in underwriting are given 

compensation incentives for the 

successful distribution of securities off 

the firm’s balance sheet and are not 

rewarded for profits associated with 

securities that are not successfully 

distributed (although losses from such 

positions should be taken into 

consideration in determining the 

employee’s compensation). This 

commenter further recommended that 

bonus compensation for a deal be 

withheld until all or a high percentage 

of the relevant securities are 

distributed.479 Finally, one commenter 

suggested that the term ‘‘designed’’ 

should be removed from this 

provision.480

c. Final Compensation Requirement 

Similar to the proposed rule, the 

underwriting exemption in the final rule 

requires that the compensation 

arrangements of persons performing the 

banking entity’s underwriting activities, 

as described in the exemption, be 

designed not to reward or incentivize 

prohibited proprietary trading.481 The 

Agencies do not intend to preclude an 

employee of an underwriting desk from 

being compensated for successful 

underwriting, which involves some risktaking. 

Consistent with the proposal, 

activities for which a banking entity has 

established a compensation incentive 

structure that rewards speculation in, 

and appreciation of, the market value of 

securities underwritten by the banking 

entity are inconsistent with the 

underwriting exemption. A banking 

entity may, however, take into account 

revenues resulting from movements in 

the price of securities that the banking 

entity underwrites to the extent that 

such revenues reflect the effectiveness 

with which personnel have managed 

underwriting risk. The banking entity 

should provide compensation 

incentives that primarily reward client 

revenues and effective client services, 

not prohibited proprietary trading. For 

example, a compensation plan based 

purely on net profit and loss with no 

consideration for inventory control or 

risk undertaken to achieve those profits 

would not be consistent with the 

underwriting exemption. 

The Agencies are not adopting an 

approach that prevents an employee 

from receiving any compensation 

related to profits arising from an unsold 

allotment, as suggested by one 

commenter, because the Agencies 

believe the final rule already includes 

sufficient controls to prevent a trading 

desk from intentionally retaining an 

unsold allotment to make a speculative 

profit when such allotment could be 

sold to customers.482 The Agencies also 

are not requiring compensation to be 

vested for a period of time, as 

recommended by one commenter to 

reduce traders’ incentives for undue 

risk-taking. The Agencies believe the 

final rule includes sufficient controls 

around risk-taking activity without a 

compensation vesting requirement 

because a banking entity must establish 

limits for a trading desk’s underwriting 

position and the trading desk must 

make reasonable efforts to sell or 

otherwise reduce the underwriting 

position within a reasonable period.483

The Agencies continue to believe it is 

appropriate to focus on the design of a 

banking entity’s compensation 

structure, so the Agencies are not 

removing the term ‘‘designed’’ from this 

provision.484 This retains an objective 

focus on actions that the banking entity 

can control—the design of its incentive 

compensation program—and avoids a 

subjective focus on whether an 

employee feels incentivized by 

compensation, which may be more 

difficult to assess. In addition, the 

framework of the final compensation 

requirement will allow banking entities 

to better plan and control the design of 

their compensation arrangements, 

which should reduce costs and 

uncertainty and enhance monitoring, 

than an approach focused solely on 

individual outcomes. 

5. Registration Requirement 

a. Proposed Registration Requirement 

Section 75.4(a)(2)(iv) of the proposed 

rule would have required that a banking 

entity have the appropriate dealer 

registration or be exempt from 

registration or excluded from regulation 

as a dealer to the extent that, in order 

to underwrite the security at issue, a 

person must generally be a registered 

securities dealer, municipal securities 

dealer, or government securities 

dealer.485 Further, if the banking entity 

was engaged in the business of a dealer 

outside the United States in a manner 

for which no U.S. registration is 

required, the proposed rule would have 

required the banking entity to be subject 

to substantive regulation of its dealing 

business in the jurisdiction in which the 

business is located. 

b. Comments on Proposed Registration 

Requirement 

Commenters generally did not address 

the proposed dealer requirement in the 

underwriting exemption. However, as 

discussed below in Part VI.A.3.c.2.b., a 

number of commenters addressed a 

similar requirement in the proposed 

market-making exemption. 

c. Final Registration Requirement 

The requirement in § 75.4(a)(2)(vi) of 

the underwriting exemption, which 

provides that the banking entity must be 

licensed or registered to engage in 

underwriting activity in accordance 

with applicable law, is substantively 

similar to the proposed dealer 

registration requirement in 

§ 75.4(a)(2)(iv) of the proposed rule. The 

primary difference between the 

proposed requirement and the final 

requirement is that the Agencies have 

simplified the language of the rule. The 

Agencies have also made conforming 

changes to the corresponding 

requirement in the market-making 

exemption to promote consistency 

across the exemptions, where 

appropriate.486

As was proposed, this provision will 

require a U.S. banking entity to be an 

SEC-registered dealer in order to rely on 

the underwriting exemption in 

connection with a distribution of 

securities—other than exempted 

securities, security-based swaps, 

commercial paper, bankers acceptances 

or commercial bills—unless the banking 

entity is exempt from registration or 

excluded from regulation as a dealer.487

To the extent that a banking entity relies 

on the underwriting exemption in 


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488See infra Part VI.A.3.c.6.c. (discussing 

comments on this issue with respect to the 

proposed dealer registration requirement in the 

market-making exemption). 489See proposed rule § 75.4(a)(2)(vi); Joint 

Proposal, 76 FR at 68867–68868; CFTC Proposal, 77 

FR at 8353. 

490See Joint Proposal, 76 FR at 68867–68868 

n.142; CFTC Proposal, 77 FR at 8353 n.148. 

491See Joint Proposal, 76 FR at 68867–68868; 

CFTC Proposal, 77 FR at 8353. 

492See Goldman (Prop. Trading); Occupy; Sens. 

Merkley & Levin (Feb. 2012). 

493See Banco de Me ́xico (stating that primary 

dealers need to profit from resulting proprietary 

positions in foreign sovereign debt, including by 

holding significant positions in anticipation of 

future price movements, in order to make the 

primary dealer business financially attractive); IIB/ 

EBF (noting that primary dealers may actively seek 

to profit from price and interest rate movements of 

their holdings, which the relevant sovereign entity 

supports because such activity provides muchneeded liquidity for securities that are otherwise 

largely purchased pursuant to buy-and-hold 

strategies by institutional investors and other 

entities seeking safe returns and liquidity buffers); 

Japanese Bankers Ass’n. 

494See Goldman (Prop. Trading). 

495See Sens. Merkley & Levin (Feb. 2012). 

496See Occupy (requesting that the rule require 

automatic disgorgement of any profits arising from 

appreciation in the value of positions in connection 

with underwriting activities). 

497See AFR et al. (Feb. 2012); Public Citizen. 

498See Goldman (Prop. Trading). 

499See Banco de Me ́xico; IIB/EBF; Japanese 

Bankers Ass’n. 

connection with a distribution of 

municipal securities or government 

securities, rather than the exemption in 

§ 75.6(a) of the final rule, this provision 

may require the banking entity to be 

registered or licensed as a municipal 

securities dealer or government 

securities dealer, if required by 

applicable law. However, this provision 

does not require a banking entity to 

register in order to qualify for the 

underwriting exemption if the banking 

entity is not otherwise required to 

register by applicable law. 

The Agencies have determined that, 

for purposes of the underwriting 

exemption, rather than require a 

banking entity engaged in the business 

of a securities dealer outside the United 

States to be subject to substantive 

regulation of its dealing business in the 

jurisdiction in which the business is 

located, a banking entity’s dealing 

activity outside the U.S. should only be 

subject to licensing or registration 

provisions if required under applicable 

foreign law (provided no U.S. 

registration or licensing requirements 

apply to the banking entity’s activities). 

In response to comments, the final rule 

recognizes that certain foreign 

jurisdictions may not provide for 

substantive regulation of dealing 

businesses.488 The Agencies do not 

believe it is necessary to preclude 

banking entities from engaging in 

underwriting activities in such foreign 

jurisdictions to achieve the goals of 

section 13 of the BHC Act because these 

banking entities would continue to be 

subject to the other requirements of the 

underwriting exemption. 

6. Source of Revenue Requirement 

a. Proposed Source of Revenue 

Requirement 

Under § 75.4(a)(2)(vi) of the proposed 

rule, the underwriting activities of a 

banking entity would have been 

required to be designed to generate 

revenues primarily from fees, 

commissions, underwriting spreads, or 

other income not attributable to 

appreciation in the value of covered 

financial positions or hedging of 

covered financial positions.489 The 

proposal clarified that underwriting 

spreads would include any ‘‘gross 

spread’’ (i.e., the difference between the 

price an underwriter sells securities to 

the public and the price it purchases 

them from the issuer) designed to 

compensate the underwriter for its 

services.490 This requirement provided 

that activities conducted in reliance on 

the underwriting exemption should 

demonstrate patterns of revenue 

generation and profitability consistent 

with, and related to, the services an 

underwriter provides to its customers in 

bringing securities to market, rather 

than changes in the market value of the 

underwritten securities.491

b. Comments on the Proposed Source of 

Revenue Requirement 

A few commenters requested certain 

modifications to the proposed source of 

revenue requirement. These 

commenters’ suggested revisions were 

generally intended either to refine the 

standard to better account for certain 

activities or to make it more 

stringent.492 Three commenters 

expressed concern that the proposed 

source of revenue requirement would 

negatively impact a banking entity’s 

ability to act as a primary dealer or in 

a similar capacity.493

With respect to suggested 

modifications, one commenter 

recommended that ‘‘customer revenue’’ 

include revenues attributable to 

syndicate activities, hedging activities, 

and profits and losses from sales of 

residual positions, as long as the 

underwriter makes a reasonable effort to 

dispose of any residual position in light 

of existing market conditions.494

Another commenter indicated that the 

rule would better address securitization 

if it required compensation to be linked 

in part to risk minimization for the 

securitizer and in part to serving 

customers. This commenter suggested 

that such a framework would be 

preferable because, in the context of 

securitizations, fee-based compensation 

structures did not previously prevent 

banking entities from accumulating 

large and risky positions with 

significant market exposure.495

To strengthen the proposed 

requirement, one commenter requested 

that the terms ‘‘designed’’ and 

‘‘primarily’’ be removed and replaced by 

the word ‘‘solely.’’ 496 Two other 

commenters requested that this 

requirement be interpreted to prevent a 

banking entity from acting as an 

underwriter for a distribution of 

securities if such securities lack a 

discernible and sufficiently liquid preexisting market and a foreseeable market 

price.497

c. Final Rule’s Approach To Assessing 

Source of Revenue 

The Agencies believe the final rule 

includes sufficient controls around an 

underwriter’s source of revenue and 

have determined not to adopt the 

additional requirement included in 

proposed rule § 75.4(a)(2)(vi). The 

Agencies believe that removing this 

requirement addresses commenters’ 

concerns that the proposed requirement 

did not appropriately reflect certain 

revenue sources from underwriting 

activity 498 or may impact primary 

dealer activities.499 At the same time, 

the final rule continues to include 

provisions that focus on whether an 

underwriter is generating underwritingrelated revenue and that should limit an 

underwriter’s ability to generate 

revenues purely from price 

appreciation. In particular, the 

requirement to make reasonable efforts 

to sell or otherwise reduce the 

underwriting position within a 

reasonable period, which was not 

included in the proposed rule, should 

limit an underwriter’s ability to gain 

revenues purely from price appreciation 

related to its underwriter position. 

Similarly, the determination of whether 

an underwriter receives special 

compensation for purposes of the 

definition of ‘‘distribution’’ takes into 

account whether a banking entity is 

generating underwriting-related 

revenue. 

The final rule does not adopt a 

requirement that prevents an 

underwriter from generating any 

revenue from price appreciation out of 

concern that such a requirement could 

prevent an underwriter from retaining 

an unsold allotment under any 


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500See Occupy; supra Part VI.A.2.c.2. (discussing 

comments on unsold allotments and the 

requirement in the final rule to make reasonable 

efforts to sell or otherwise reduce the underwriting 

position). 

501See AFR et al. (Feb. 2012); Public Citizen. 

502See supra Part VI.A.2.c.2. 

503See Sens. Merkley & Levin (Feb. 2012). 

504See final rule § 75.4(a)(2)(ii). Further, as noted 

above, this exemption does not permit the 

accumulation of assets for securitization. See supra 

Part VI.A.2.c.1.c.v. 

505As discussed in Part VI.A.3.c.2.c.i., infra, the 

terms ‘‘client,’’ ‘‘customer,’’ and ‘‘counterparty’’ are 

defined in the same manner in the final rule. Thus, 

the Agencies use these terms synonymously 

throughout this discussion and sometimes use the 

term ‘‘customer’’ to refer to all entities that meet the 

definition of ‘‘client, customer, and counterparty’’ 

in the final rule’s market-making exemption. 

506 12 U.S.C. 1851(d)(1)(B). 

507See Joint Proposal, 76 FR at 68869; CFTC 

Proposal, 77 FR at 8354–8355. 

508See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012) (stating that the proposed exemption ‘‘seems 

to view market making based on a liquid, exchangetraded equity model in which market makers are 

simple intermediaries akin to agents’’ and that 

‘‘[t]his view does not fit market making even in 

equity markets and widely misses the mark for the 

vast majority of markets and asset classes’’); SIFMA 

(Asset Mgmt.) (Feb. 2012); Credit Suisse (Seidel); 

ICI (Feb. 2012); BoA; Columbia Mgmt.; Comm. on 

Capital Markets Regulation; Invesco; ASF (Feb. 

2012) (‘‘The seven criteria in the proposed rule, and 

circumstances, which would be 

inconsistent with other provisions of the 

exemption.500 Similarly, the Agencies 

are not adopting a source of revenue 

requirement that would prevent a 

banking entity from acting as 

underwriter for a distribution of 

securities if such securities lack a 

discernible and sufficiently liquid preexisting market and a foreseeable market 

price, as suggested by two 

commenters.501 The Agencies believe 

these commenters’ concern is mitigated 

by the near term demand requirement, 

which requires a trading desk to have a 

reasonable expectation of demand from 

other market participants for the amount 

and type of securities to be acquired 

from an issuer or selling security holder 

for distribution.502 Further, one 

commenter recommended a revenue 

requirement directed at securitization 

activities to prevent banking entities 

from accumulating large and risky 

positions with significant market 

exposure.503 The Agencies believe the 

requirement to make reasonable efforts 

to sell or otherwise reduce the 

underwriting position should achieve 

this stated goal and, thus, the Agencies 

do not believe an additional revenue 

requirement for securitization activity is 

needed.504

3. Section 75.4(b): Market-Making 

Exemption 

a. Introduction 

In adopting the final rule, the 

Agencies are striving to balance two 

goals of section 13 of the BHC Act: To 

allow market making, which is 

important to well-functioning markets 

as well as to the economy, and 

simultaneously to prohibit proprietary 

trading, unrelated to market making or 

other permitted activities, that poses 

significant risks to banking entities and 

the financial system. In response to 

comments on the proposed marketmaking exemption, the Agencies are 

adopting certain modifications to the 

proposed exemption to better account 

for the varying characteristics of market 

making-related activities across markets 

and asset classes, while requiring that 

banking entities maintain a robust set of 

risk controls for their market makingrelated activities. A flexible approach to 

this exemption is appropriate because 

the activities a market maker undertakes 

to provide important intermediation and 

liquidity services will differ based on 

the liquidity, maturity, and depth of the 

market for a given type of financial 

instrument. The statute specifically 

permits banking entities to continue to 

provide these beneficial services to their 

clients, customers, and 

counterparties.505 Thus, the Agencies 

are adopting an approach that 

recognizes the full scope of market 

making-related activities banking 

entities currently undertake and 

requires that these activities be subject 

to clearly defined, verifiable, and 

monitored risk parameters. 

b. Overview 

1. Proposed Market-Making Exemption 

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

provides an exemption from the 

prohibition on proprietary trading for 

the purchase, sale, acquisition, or 

disposition of securities, derivatives, 

contracts of sale of a commodity for 

future delivery, and options on any of 

the foregoing in connection with market 

making-related activities, to the extent 

that such activities are designed not to 

exceed the reasonably expected near 

term demands of clients, customers, or 

counterparties.506

Section 75.4(b) of the proposed rule 

would have implemented this statutory 

exemption by requiring that a banking 

entity’s market making-related activities 

comply with seven standards. As 

discussed in the proposal, these 

standards were designed to ensure that 

any banking entity relying on the 

exemption would be engaged in bona 

fide market making-related activities 

and, further, would conduct such 

activities in a way that was not 

susceptible to abuse through the taking 

of speculative, proprietary positions as 

a part of, or mischaracterized as, market 

making-related activities. The Agencies 

proposed to use additional regulatory 

and supervisory tools in conjunction 

with the proposed market-making 

exemption, including quantitative 

measurements for banking entities 

engaged in significant covered trading 

activity in proposed Appendix A, 

commentary on how the Agencies 

proposed to distinguish between 

permitted market making-related 

activity and prohibited proprietary 

trading in proposed Appendix B, and a 

compliance regime in proposed § 75.20 

and, where applicable, Appendix C of 

the proposal. This multi-faceted 

approach was intended to address the 

complexities of differentiating permitted 

market making-related activities from 

prohibited proprietary trading.507

2. Comments on the Proposed MarketMaking Exemption 

The Agencies received significant 

comment regarding the proposed 

market-making exemption. In this Part, 

the Agencies highlight the main issues, 

concerns, and suggestions raised by 

commenters with respect to the 

proposed market-making exemption. As 

discussed in greater detail below, 

commenters’ views on the effectiveness 

of the proposed exemption varied. 

Commenters discussed a broad range of 

topics related to the proposed marketmaking exemption including, among 

others: The overall scope of the 

proposed exemption and potential 

restrictions on market making in certain 

markets or asset classes; the potential 

market impact of the proposed marketmaking exemption; the appropriate level 

of analysis for compliance with the 

proposed exemption; the effectiveness 

of the individual requirements of the 

proposed exemption; and specific 

activities that should or should not be 

considered permitted market makingrelated activity under the rule. 

a. Comments on the Overall Scope of 

the Proposed Exemption 

With respect to the general scope of 

the exemption, a number of commenters 

expressed concern that the proposed 

approach to implementing the marketmaking exemption is too narrow or 

restrictive, particularly with respect to 

less liquid markets. These commenters 

expressed concern that the proposed 

exemption would not be workable in 

many markets and asset classes and 

does not take into account how marketmaking services are provided in those 

markets and asset classes.508 Some 


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the related criterion for identifying permitted 

hedging, are overly restrictive and will make it 

impractical for dealers to continue making markets 

in most securitized products.’’); Chamber (Feb. 

2012) (expressing particular concern about the 

commercial paper market). 

509Several commenters stated that the proposed 

rule would limit a market maker’s ability to 

maintain inventory. See, e.g., NASP; Oliver Wyman 

(Dec. 2011); Wellington; Prof. Duffie; Standish 

Mellon; MetLife; Lord Abbett; NYSE Euronext; 

CIEBA; British Columbia; SIFMA et al. (Prop. 

Trading) (Feb. 2012); Shadow Fin. Regulatory 

Comm.; Credit Suisse (Seidel); Morgan Stanley; 

Goldman (Prop. Trading); BoA; STANY; SIFMA 

(Asset Mgmt.) (Feb. 2012); Chamber (Feb. 2012); 

IRSG; Abbott Labs et al. (Feb. 14, 2012); Abbott Labs 

et al. (Feb. 21, 2012); Australian Bankers Ass’n. 

(Feb. 2012); FEI; ASF (Feb. 2012); RBC; PUC Texas; 

Columbia Mgmt.; SSgA (Feb. 2012); PNC et al.; 

Fidelity; ICI (Feb. 2012); British Bankers’ Ass’n.; 

Comm. on Capital Markets Regulation; IHS; Oliver 

Wyman (Feb. 2012); Thakor Study (stating that by 

artificially constraining the security holdings that a 

banking entity can have in its inventory for market 

making or proprietary trading purposes, section 13 

of the BHC Act will make bank risk management 

less efficient and may adversely impact the 

diversified financial services business model of 

banks). However, some commenters stated that 

market makers should seek to minimize their 

inventory or should not need large inventories. See, 

e.g., AFR et al. (Feb. 2012); Public Citizen; Johnson 

& Prof. Stiglitz. Other commenters expressed 

concern that the proposed rule could limit 

interdealer trading. See, e.g., Prof. Duffie; Credit 

Suisse (Seidel); JPMC; Morgan Stanley; Goldman 

(Prop. Trading); Chamber (Feb. 2012); Oliver 

Wyman (Dec. 2011). 510See, e.g., BlackRock; Putnam; Fixed Income 

Forum/Credit Roundtable; ACLI (Feb. 2012); 

MetLife; IAA; Wells Fargo (Prop. Trading); T. Rowe 

Price; Sen. Bennet; Sen. Corker; PUC Texas; 

Fidelity; ICI (Feb. 2012); Invesco. 

511See, e.g., Wellington; Prof. Duffie; Standish 

Mellon; Commissioner Barnier; NYSE Euronext; 

BoA; Citigroup (Feb. 2012); STANY; ICE; Chamber 

(Feb. 2012); BDA (Feb. 2012); Putnam; FTN; Fixed 

Income Forum/Credit Roundtable; ACLI (Feb. 

2012); IAA; CME Group; Capital Group; PUC Texas; 

Columbia Mgmt.; SSgA (Feb. 2012); Eaton Vance; 

ICI (Feb. 2012); Invesco; Comm. on Capital Markets 

Regulation; Oliver Wyman (Feb. 2012); SIFMA 

(Asset Mgmt.) (Feb. 2012); Thakor Study. 

512For example, some commenters stated that 

market makers may revert to an agency or ‘‘special 

order’’ model. See, e.g., Barclays; Goldman (Prop. 

Trading); ACLI (Feb. 2012); Vanguard; RBC. In 

addition, some commenters stated that new systems 

will be developed, such as alternative market 

matching networks, but these commenters 

disagreed about whether such changes would 

happen in the near term. See, e.g., CalPERS; 

BlackRock; Stuyvesant; Comm. on Capital Markets 

Regulation. Other commenters stated that it is 

unlikely that new systems will be developed. See, 

e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); Oliver 

Wyman (Feb. 2012). One commenter stated that the 

proposed rule may cause a banking organization 

that engages in significant market-making activity to 

give up its banking charter or spin off its marketmaking operations to avoid compliance with the 

proposed exemption. See Prof. Duffie. 

513See, e.g., NASP; Wellington; JPMC; Morgan 

Stanley; Credit Suisse (Seidel); BoA; Goldman 

(Prop. Trading); Citigroup (Feb. 2012); STANY; 

SIFMA (Asset Mgmt.) (Feb. 2012); Chamber (Feb. 

2012); Putnam; ICI (Feb. 2012); Wells Fargo (Prop. 

Trading); NYSE Euronext; Sen. Corker; Invesco. 

514See, e.g., Better Markets (Feb. 2012); Sens. 

Merkley & Levin (Feb. 2012); Occupy; AFR et al. 

(Feb. 2012); Public Citizen; Johnson & Prof. Stiglitz. 

515See, e.g., Johnson & Prof. Stiglitz; Sens. 

Merkley & Levin (Feb. 2012); Occupy; AFR et al. 

(Feb. 2012); Public Citizen. 

516See Occupy (‘‘[I]t is unclear that this rule, as 

written, will markedly alter the current customerserving business. Indeed, this rule has gone to 

excessive lengths to protect the covered banking 

entities’ ability to maintain responsible customerfacing business.’’); Alfred Brock. 

517See, e.g., Rep. Bachus et al.; IIF; Morgan 

Stanley (stating that beyond walled-off proprietary 

trading, the line is hard to draw, particularly 

because both require principal risk-taking and the 

features of market making vary across markets and 

asset classes and become more pronounced in times 

of market stress); CFA Inst. (representing that the 

distinction is particularly difficult in the fixedincome market); ICFR; Prof. Duffie; WR Hambrecht. 

518See, e.g., Chamber (Feb. 2012) (citing an article 

by Stephen Breyer stating that society should not 

expend disproportionate resources trying to reduce 

or eliminate ‘‘the last 10 percent’’ of the risks of a 

certain problem); JPMC; RBC; ICFR; Sen. Hagan. 

One of these commenters indicated that any 

concerns that banking entities would engage in 

speculative trading as a result of an expansive 

market-making exemption would be addressed by 

other reform initiatives (e.g., Basel III 

implementation will provide laddered disincentives 

to holding positions as principal as a result of 

capital and liquidity requirements). See RBC. 

519See Wellington; Paul Volcker; Better Markets 

(Feb. 2012); Occupy. 520See Wellington. 521See Paul Volcker. 522See Wellington; SIFMA et al. (Prop. Trading) 

(Feb. 2012); Barclays; Goldman (Prop. Trading); 

HSBC; Fixed Income Forum/Credit Roundtable; 

ACLI (Feb. 2012); PUC Texas; ERCOT; Invesco. See 

also IAA (stating that it is unclear whether the 

requirements must be applied on a transaction-bytransaction basis or if compliance with the 

requirements is based on overall activities). This 

issue is addressed in Part VI.A.3.c.1.c., infra. 

523See, e.g., Barclays; SIFMA et al. (Prop. 

Trading) (Feb. 2012). As explained above, the term 

‘‘covered financial position’’ from the proposal has 

been replaced by the term ‘‘financial instrument’’ in 

the final rule. Because the types of instruments 

included in both definitions are identical, the term 

‘‘financial instrument’’ is used throughout this Part. 

524See, e.g., Goldman (Prop. Trading); 

Wellington. 

commenters expressed particular 

concern that the proposed exemption 

may restrict or limit certain activities 

currently conducted by market makers 

(e.g., holding inventory or interdealer 

trading).509 Several commenters stated 

that the proposed exemption would 

create too much uncertainty regarding 

compliance 510 and, further, may have a 

chilling effect on banking entities’ 

market making-related activities.511 Due 

to the perceived restrictions and 

burdens of the proposed exemption, 

many commenters indicated that the 

rule may change the way in which 

market-making services are provided.512

A number of commenters expressed the 

view that the proposed exemption is 

inconsistent with Congressional intent 

because it would restrict and reduce 

banking entities’ current market makingrelated activities.513

Other commenters, however, stated 

that the proposed exemption was too 

broad and recommended that the rule 

place greater restrictions on market 

making, particularly in illiquid, 

nontransparent markets.514 Many of 

these commenters suggested that the 

exemption should only be available for 

traditional market-making activity in 

relatively safe, ‘‘plain vanilla’’ 

instruments.515 Two commenters 

represented that the proposed 

exemption would have little to no 

impact on banking entities’ current 

market making-related services.516

Commenters expressed differing 

views regarding the ease or difficulty of 

distinguishing permitted market 

making-related activity from prohibited 

proprietary trading. A number of 

commenters represented that it is 

difficult or impossible to distinguish 

prohibited proprietary trading from 

permitted market making-related 

activity.517 With regard to this issue, 

several commenters recommended that 

the Agencies not try to remove all 

aspects of proprietary trading from 

market making-related activity because 

doing so would likely restrict certain 

legitimate market-making activity.518

Other commenters were of the view 

that it is possible to differentiate 

between prohibited proprietary trading 

and permitted market making-related 

activity.519 For example, one commenter 

stated that, while the analysis may 

involve subtle distinctions, the 

fundamental difference between a 

banking entity’s market-making 

activities and proprietary trading 

activities is the emphasis in market 

making on seeking to meet customer 

needs on a consistent and reliable basis 

throughout a market cycle.520 According 

to another commenter, holding 

substantial securities in a trading book 

for an extended period of time assumes 

the character of a proprietary position 

and, while there may be occasions when 

a customer-oriented purchase and 

subsequent sale extend over days and 

cannot be more quickly executed or 

hedged, substantial holdings of this 

character should be relatively rare and 

limited to less liquid markets.521

Several commenters expressed 

general concern that the proposed 

exemption may be applied on a 

transaction-by-transaction basis and 

explained the burdens that may result 

from such an approach.522 Commenters 

appeared to attribute these concerns to 

language in the proposed exemption 

referring to a ‘‘purchase or sale of a 

[financial instrument]’’ 523 or to 

language in Appendix B indicating that 

the Agencies may assess certain factors 

and criteria at different levels, including 

a ‘‘single significant transaction.’’ 524

With respect to the burdens of a 

transaction-by-transaction analysis, 


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525See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); Barclays (stating that ‘‘hundreds or 

thousands of trades can occur in a single day in a 

single trading unit’’). 

526See, e.g., ICI (Feb. 2012); Barclays; Goldman 

(Prop. Trading). 

527See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); Goldman (Prop. Trading). 

528SIFMA et al. (Prop. Trading) (Feb. 2012). 

529See id. (suggesting that the Agencies ‘‘give full 

effect to the statutory intent to allow market making 

by viewing the permitted activity on a holistic 

basis’’). 

530See ACLI (Feb. 2012); Fixed Income Forum/

Credit Roundtable. 

531See Wellington; Morgan Stanley; SIFMA et al. 

(Prop. Trading) (Feb. 2012); ACLI (Feb. 2012); Fixed 

Income Forum/Credit Roundtable. The Agencies 

address this topic in Part VI.A.3.c.1.c., infra. 

532See Wellington. This commenter did not 

provide greater specificity about how it would 

define ‘‘trading desk’’ or ‘‘aggregation unit.’’ See id. 

533See Morgan Stanley (stating that ‘‘trading 

unit’’ should be defined as ‘‘each organizational 

unit that is used to structure and control the 

aggregate risk-taking activities and employees that 

are engaged in the coordinated implementation of 

a customer-facing revenue generation strategy and 

that participate in the execution of any covered 

trading activity’’); SIFMA et al. (Prop. Trading) 

(Feb. 2012). One of these commenters discussed its 

suggested definition of ‘‘trading unit’’ in the context 

of the proposed requirement to record and report 

certain quantitative measurements, but it is unclear 

that the commenter was also suggesting that this 

definition be used for purposes of the marketmaking exemption. For example, this commenter 

expressed support for a multi-level approach to 

defining ‘‘trading unit,’’ and it is not clear how a 

definition that captures multiple organizational 

levels across a banking organization would work in 

the context of the market-making exemption. See 

SIFMA et al. (Prop. Trading) (Feb. 2012) (suggested 

that ‘‘trading unit’’ be defined ‘‘at a level that 

presents its activities in the context of the whole’’ 

and noting that the appropriate level may differ 

depending on the structure of the banking entity). 

534See, e.g., Wellington; Japanese Bankers Ass’n.; 

Prof. Duffie; IR&M; G2 FinTech; MetLife; NYSE 

Euronext; Anthony Flynn and Koral Fusselman; IIF; 

CalPERS; SIFMA et al. (Prop. Trading) (Feb. 2012); 

Sens. Merkley & Levin (Feb. 2012); Shadow Fin. 

Regulatory Comm.; John Reed; Prof. Richardson; 

Credit Suisse (Seidel); JPMC; Morgan Stanley; 

Barclays; Goldman (Prop. Trading); BoA; Citigroup 

(Feb. 2012); STANY; ICE; BlackRock; Johnson & 

Prof. Stiglitz; Fixed Income Forum/Credit 

Roundtable; ACLI (Feb. 2012); Wells Fargo (Prop. 

Trading); WR Hambrecht; Vanguard; Capital Group; 

PUC Texas; SSgA (Feb. 2012); PNC et al.; Fidelity; 

Occupy; AFR et al. (Feb. 2012); Invesco; ISDA (Feb. 

2012); Stephen Roach; Oliver Wyman (Feb. 2012). 

The Agencies respond to these comments in Part 

VI.A.3.b.3., infra. 

535See, e.g., Sens. Merkley & Levin (Feb. 2012); 

John Reed; Prof. Richardson; Johnson & Prof. 

Stiglitz; Capital Group; Invesco; BDA (Feb. 2012) 

(Oct. 2012) (suggesting a safe harbor for any trading 

desk that effects more than 50 percent of its 

transactions through sales representatives). 

536See, e.g., Flynn & Fusselman; Prof. Colesanti 

et al. 

537See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); IIF; NYSE Euronext; Credit Suisse (Seidel); 

JPMC; Barclays; BoA; Wells Fargo (Prop. Trading) 

(suggesting that the rule: (i) Provide a general grant 

of authority to engage in any transactions entered 

into as part of a banking entity’s market-making 

business, where ‘‘market making’’ is defined as ‘‘the 

business of being willing to facilitate customer 

purchases and sales of [financial instruments] as an 

intermediary over time and in size, including by 

holding positions in inventory;’’ and (ii) allow 

banking entities to monitor compliance with this 

exemption internally through their compliance and 

risk management infrastructure); PNC et al.; Oliver 

Wyman (Feb. 2012). 

538See, e.g., Goldman (Prop. Trading); Morgan 

Stanley; Barclays; Wellington; CalPERS; BlackRock; 

SSgA (Feb. 2012); Invesco. 

539See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012) (suggesting that this guidance could be 

incorporated in banking entities’ policies and 

procedures for purposes of complying with the rule, 

in addition to the establishment of risk limits, 

controls, and metrics); JPMC; BoA; PUC Texas; 

SSgA (Feb. 2012); PNC et al.; Wells Fargo (Prop. 

Trading). 

540See, e.g., Japanese Bankers Ass’n.; Citigroup 

(Feb. 2012). 

541See, e.g., Morgan Stanley; Stephen Roach. 

542See, e.g., Prof. Duffie; CalPERS; STANY; ICE; 

Vanguard; Capital Group. 

543See MetLife; Fixed Income Forum/Credit 

Roundtable; ACLI (Feb. 2012). 

544See, e.g., Prof. Duffie; Shadow Fin. Regulatory 

Comm. See also Wedbush. 

545See WR Hambrecht. 

546See G2 FinTech. 

547See ISDA (Feb. 2012); ISDA (Apr. 2012). 

548See Sens. Merkley & Levin (Feb. 2012) (stating 

that the exemption should expressly mention the 

conflicts provision and provide examples to warn 

against particular conflicts, such as recommending 

clients buy poorly performing assets in order to 

remove them from the banking entity’s book or 

attempting to move market prices in favor of trading 

positions a banking entity has built up in order to 

make a profit); Stephen Roach (suggesting that the 

exemption integrate the limitations on permitted 

activities). 

549See Fidelity (stating that the exemption needs 

to be as broad as possible to account for customerfacing principal trades, block trades, and market 

making in OTC derivatives). See also STANY 

(stating that it is better to make the exemption too 

broad than too narrow). 

some commenters noted that banking 

entities can engage in a large volume of 

market-making transactions daily, 

which would make it burdensome to 

apply the exemption to each trade.525 A 

few commenters indicated that, even if 

the Agencies did not intend to require 

transaction-by-transaction analysis, the 

proposed rule’s language can be read to 

imply such a requirement. These 

commenters indicated that ambiguity on 

this issue could have a chilling effect on 

market making or could allow some 

examiners to rigidly apply the 

requirements of the exemption on a 

trade-by-trade basis.526 Other 

commenters indicated that it would be 

difficult to determine whether a 

particular trade was or was not a 

market-making trade without 

consideration of the relevant unit’s 

overall activities.527 One commenter 

elaborated on this point by stating that 

‘‘an analysis that seeks to characterize 

specific transactions as either market 

making . . . or prohibited activity does 

not accord with the way in which 

modern trading units operate, which 

generally view individual positions as a 

bundle of characteristics that contribute 

to their complete portfolio.’’ 528 This 

commenter noted that a position entered 

into as part of market making-related 

activities may serve multiple functions 

at one time, such as responding to 

customer demand, hedging a risk, and 

building inventory. The commenter also 

expressed concern that individual 

transactions or positions may not be 

severable or separately identifiable as 

serving a market-making purpose.529

Two commenters suggested that the 

requirements in the market-making 

exemption be applied at the portfolio 

level rather than the trade level.530

Moreover, commenters also set forth 

their views on the organizational level 

at which the requirements of the 

proposed market-making exemption 

should apply.531 The proposed 

exemption generally applied 

requirements to a ‘‘trading desk or other 

organizational unit’’ of a banking entity. 

In response to this proposed approach, 

commenters stated that compliance 

should be assessed at each trading desk 

or aggregation unit532 or at each trading 

unit.533

Several commenters suggested 

alternative or additive means of 

implementing the statutory exemption 

for market making-related activity.534

Commenters’ recommended approaches 

varied, but a number of commenters 

requested approaches involving one or 

more of the following elements: (i) Safe 

harbors,535 bright lines,536 or 

presumptions of compliance with the 

exemption based on the existence of 

certain factors (e.g., compliance 

program, metrics, general customer 

focus or orientation, providing liquidity, 

and/or exchange registration as a market 

maker); 537 (ii) a focus on metrics or 

other objective factors; 538 (iii) guidance 

on permitted market making-related 

activity, rather than rule 

requirements; 539 (iv) risk management 

structures and/or risk limits; 540 (v) 

adding a new customer-facing criterion 

or focusing on client-related 

activities; 541 (vi) capital and liquidity 

requirements; 542 (vii) development of 

individualized plans for each banking 

entity, in coordination with 

regulators; 543 (viii) ring fencing 

affiliates engaged in market makingrelated activity; 544 (ix) margin 

requirements; 545 (x) a compensationfocused approach; 546 (xi) permitting all 

swap dealing activity; 547 (xii) additional 

provisions regarding material conflicts 

of interest and high-risk assets and 

trading strategies; 548 and/or (xiii) 

making the exemption as broad as 

possible under the statute.549


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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 5851 

550See, e.g., AllianceBernstein; Rep. Bachus et al. 

(Dec. 2011); EMTA; NASP; Wellington; Japanese 

Bankers Ass’n.; Sen. Hagan; Prof. Duffie; Investure; 

Standish Mellon; IR&M; MetLife; Lord Abbett; 

Commissioner Barnier; Quebec; IIF; Sumitomo 

Trust; Liberty Global; NYSE Euronext; CIEBA; 

EFAMA; SIFMA et al. (Prop. Trading) (Feb. 2012); 

Credit Suisse (Seidel); JPMC; Morgan Stanley; 

Barclays; Goldman (Prop. Trading); BoA; Citigroup 

(Feb. 2012); STANY; ICE; BlackRock; SIFMA (Asset 

Mgmt.) (Feb. 2012); BDA (Feb. 2012); Putnam; 

Fixed Income Forum/Credit Roundtable; Western 

Asset Mgmt.; ACLI (Feb. 2012); IAA; CME Group; 

Wells Fargo (Prop. Trading); Abbott Labs et al. (Feb. 

14, 2012); Abbott Labs et al. (Feb. 21, 2012); T. 

Rowe Price; Australian Bankers Ass’n. (Feb. 2012); 

FEI; AFMA; Sen. Carper et al.; PUC Texas; ERCOT; 

IHS; Columbia Mgmt.; SSgA (Feb. 2012); PNC et al.; 

Eaton Vance; Fidelity; ICI (Feb. 2012); British 

Bankers’ Ass’n.; Comm. on Capital Markets 

Regulation; Union Asset; Sen. Casey; Oliver Wyman 

(Dec. 2011); Oliver Wyman (Feb. 2012) (providing 

estimated impacts on asset valuation, borrowing 

costs, and transaction costs in the corporate bond 

market based on hypothetical liquidity reduction 

scenarios); Thakor Study. The Agencies respond to 

comments regarding the potential market impact of 

the rule in Part VI.A.3.b.3., infra. 

551See, e.g., AllianceBernstein; Wellington; 

Investure; Standish Mellon; MetLife; Lord Abbett; 

Barclays; Goldman (Prop. Trading); Citigroup (Feb. 

2012); BlackRock; Putnam; ACLI (Feb. 2012); 

Abbott Labs et al. (Feb. 14, 2012); Abbott Labs et 

al. (Feb. 21, 2012); T. Rowe Price; Sen. Carper et 

al.; IHS; Columbia Mgmt.; ICI (Feb. 2012) British 

Bankers’ Ass’n.; Comm. on Capital Markets 

Regulation; Thakor Study (stating that section 13 of 

the BHC Act will likely result in higher bid-ask 

spreads by causing at least some retrenchment of 

banks from market making, resulting in fewer 

market makers and less competition). 

552See, e.g., Wellington; Prof. Duffie; Standish 

Mellon; Lord Abbett; IIF; SIFMA et al. (Prop. 

Trading) (Feb. 2012); Barclays; Goldman (Prop. 

Trading); BDA (Feb. 2012); IHS; FTN; IAA; Wells 

Fargo (Prop. Trading); T. Rowe Price; Columbia 

Mgmt.; SSgA (Feb. 2012); Eaton Vance; British 

Bankers’ Ass’n.; Comm. on Capital Markets 

Regulation. 

553See, e.g., Prof. Duffie (arguing that, for 

example, ‘‘during the financial crisis of 2007–2009, 

the reduced market making capacity of major dealer 

banks caused by their insufficient capital levels 

resulted in dramatic downward distortions in 

corporate bond prices’’); IIF; Barclays; IAA; 

Vanguard; Wellington; FTN. 

554See, e.g., AllianceBernstein; Chamber (Dec. 

2011); Members of Congress (Dec. 2011); 

Wellington; Sen. Hagan; Prof. Duffie; IR&M; 

MetLife; Lord Abbett; Liberty Global; NYSE 

Euronext; SIFMA et al. (Prop. Trading) (Feb. 2012); 

NCSHA; ASF (Feb. 2012) (stating that ‘‘[f]ailure to 

permit the activities necessary for banking entities 

to act in [a] market-making capacity [in assetbacked securities] would have a dramatic adverse 

effect on the ability of securitizers to access the 

asset-backed securities markets and thus to obtain 

the debt financing necessary to ensure a vibrant 

U.S. economy’’); Credit Suisse (Seidel); JPMC; 

Morgan Stanley; Barclays; Goldman (Prop. Trading); 

BoA; Citigroup (Feb. 2012); STANY; BlackRock; 

Chamber (Feb. 2012); IHS; BDA (Feb. 2012); Fixed 

Income Forum/Credit Roundtable; ACLI (Feb. 

2012); Wells Fargo (Prop. Trading); Abbott Labs et 

al. (Feb. 14, 2012); Abbott Labs et al. (Feb. 21, 

2012); T. Rowe Price; FEI; AFMA; SSgA (Feb. 2012); 

PNC et al.; ICI (Feb. 2012); British Bankers’ Ass’n.; 

Oliver Wyman (Dec. 2011); Oliver Wyman (Feb. 

2012); GE (Feb. 2012); Thakor Study (stating that 

when a firm’s cost of capital goes up, it invests 

less—resulting in lower economic growth and lower 

employment—and citing supporting data indicating 

that a 1 percent increase in the cost of capital would 

lead to a $55 to $82.5 billion decline in aggregate 

annual capital spending by U.S. nonfarm firms and 

job losses between 550,000 and 1.1 million per year 

in the nonfarm sector). One commenter further 

noted that a higher cost of capital can lead a firm 

to make riskier, short-term investments. See Thakor 

Study. 

555See, e.g., Wellington; Standish Mellon; IR&M; 

MetLife; Lord Abbett; NYSE Euronext; CIEBA; 

Barclays; Goldman (Prop. Trading); BoA; Citigroup 

(Feb. 2012); STANY; ICE; BlackRock; Fixed Income 

Forum/Credit Roundtable; ACLI (Feb. 2012); IAA; 

Abbott Labs et al. (Feb. 14, 2012); Abbott Labs et 

al. (Feb. 21, 2012); T. Rowe Price; Vanguard; 

Australian Bankers Ass’n. (Feb. 2012); FEI; Sen. 

Carper et al.; Columbia Mgmt.; SSgA (Feb. 2012); 

ICI (Feb. 2012); Comm. on Capital Markets 

Regulation; TMA Hong Kong; Sen. Casey; IHS; 

Oliver Wyman (Dec. 2011); Oliver Wyman (Feb. 

2012); Thakor Study. 

556See, e.g., Barclays; FTN; Abbott Labs et al. 

(Feb. 14, 2012); Abbott Labs et al. (Feb. 21, 2012). 

557See, e.g., AllianceBernstein (stating that, to the 

extent the rule reduces liquidity provided by 

market makers, open end mutual funds that are 

largely driven by the need to respond to both 

redemptions and subscriptions will be immediately 

impacted in terms of higher trading costs); 

Wellington (indicating that periods of extreme 

market stress are likely to exacerbate costs and 

challenges, which could force investors such as 

mutual funds and pension funds to accept 

distressed prices to fund redemptions or pay 

current benefits); Lord Abbett (stating that certain 

factors, such as reduced bank capital to support 

market-making businesses and economic 

uncertainty, have already reduced liquidity and 

caused asset managers to have an increased 

preference for highly liquid credits and expressing 

concern that, if section 13 of the BHC Act further 

reduces liquidity, then: (i) asset managers’ 

increased preference for highly liquid credit could 

lead to unhealthy portfolio concentrations, and (ii) 

asset managers will maintain a larger cash cushion 

in portfolios that may be subject to redemption, 

which will likely result in investors getting poorer 

returns); EFAMA; BlackRock (stating that 

investment decisions are heavily dependent on a 

liquidity factor input, so as liquidity dissipates, 

investment strategies become more limited and 

returns to investors are diminished by wider 

spreads and higher transaction costs); CFA Inst. 

(noting that a mutual fund that tries to liquidate 

holdings to meet redemptions may have difficulty 

selling at acceptable prices, thus impairing the 

fund’s NAV for both redeeming investors and for 

those that remain in the fund); Putnam; Fixed 

Income Forum/Credit Roundtable; ACLI; T. Rowe 

Price; Vanguard; IAA; FEI; Sen. Carper et al.; 

Columbia Mgmt.; ICI (Feb. 2012); Invesco; Union 

Asset; Standish Mellon; Morgan Stanley; SIFMA 

(Asset Mgmt.) (Feb. 2012). 

558See, e.g., CIEBA (stating that for smaller 

issuers in particular, market makers need to have 

incentives to make markets, and the proposal 

removes important incentives); ACLI (indicating 

that lower liquidity will most likely result in higher 

costs for issuers of debt and, for lesser known or 

lower quality issuers, this cost may be significant 

and in some cases prohibitive because the cost will 

vary depending on the credit quality of the issuer, 

the amount of debt it has in the market, and the 

maturity of the security); PNC et al. (expressing 

concern that a regional bank’s market-making 

activity for small and middle market customers is 

more likely to be inappropriately characterized as 

impermissible proprietary trading due to lower 

trading volume involving less liquid securities); 

Morgan Stanley; Chamber (Feb. 2012); Abbott Labs 

et al. (Feb. 14, 2012); Abbott Labs et al. (Feb. 21, 

2012); FEI; ICI (Feb. 2012); TMA Hong Kong; Sen. 

Casey. 

559See SIFMA et al. (Prop. Trading) (Feb. 2012); 

JPMC; RBC; NYSE Euronext; Credit Suisse (Seidel). 

560See, e.g., Paul Volcker; AFR et al. (Feb. 2012); 

Public Citizen; Prof. Richardson; Johnson & Prof. 

Stiglitz; Better Markets (Feb. 2012); Prof. Johnson. 

561See AFR et al. (Feb. 2012); Public Citizen. See 

also Paul Volcker (stating that at some point, greater 

liquidity, or the perception of greater liquidity, may 

encourage more speculative trading). 

562See Prof. Richardson. 

b. Comments Regarding the Potential 

Market Impact of the Proposed 

Exemption 

As discussed above, several 

commenters stated that the proposed 

rule would impact a banking entity’s 

ability to engage in market makingrelated activity. Many of these 

commenters represented that, as a 

result, the proposed exemption would 

likely result in reduced liquidity,550

wider bid-ask spreads,551 increased 

market volatility,552 reduced price 

discovery or price transparency,553

increased costs of raising capital or 

higher financing costs,554 greater costs 

for investors or consumers,555 and 

slower execution times.556 Some 

commenters expressed particular 

concern about potential impacts on 

institutional investors (e.g., mutual 

funds and pension funds) 557 or on small 

or midsized companies.558 A number of 

commenters discussed the 

interrelationship between primary and 

secondary market activity and indicated 

that restrictions on market making 

would impact the underwriting 

process.559

A few commenters expressed the view 

that reduced liquidity would not 

necessarily be a negative result.560 For 

example, two commenters noted that 

liquidity is vulnerable to liquidity 

spirals, in which a high level of market 

liquidity during one period feeds a 

sharp decline in liquidity during the 

next period by initially driving asset 

prices upward and supporting increased 

leverage. The commenters explained 

that liquidity spirals lead to ‘‘fire sales’’ 

by market speculators when events 

reveal that assets are overpriced and 

speculators must sell their assets to 

reduce their leverage.561 According to 

another commenter, banking entities’ 

access to the safety net allows them to 

distort market prices and, arguably, 

produce excess liquidity. The 

commenter further represented that it 

would be preferable to allow the 

discipline of the market to choose the 

pricing of securities and the amount of 

liquidity.562 Some commenters cited an 

economic study indicating that the U.S. 

financial system has become less 

efficient in generating economic growth 


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563See, e.g., Johnson & Prof. Stiglitz (citing 

Thomas Phillippon, ‘‘Has the U.S. Finance Industry 

Become Less Efficient?,’’ NYU Working Paper, Nov. 

2011); AFR et al. (Feb. 2012); Public Citizen; Better 

Markets (Feb. 2012); Prof. Johnson. 564See, e.g., Sens. Merkley & Levin (Feb. 2012) 

(stating that there is no convincing, independent 

evidence that the rule would increase trading costs 

or reduce liquidity, and the best evidence available 

suggests that the buy-side firms would greatly 

benefit from the competitive pressures that 

transparency can bring); Better Markets (Feb. 2012) 

(‘‘Industry’s claim that [section 13 of the BHC Act] 

will ‘reduce market liquidity, capital formation, and 

credit availability, and thereby hamper economic 

growth and job creation’ disregard the fact that the 

financial crisis did more damage to those concerns 

than any rule or reform possibly could.’’); Profs. 

Stout & Hastings; Prof. Johnson; Occupy; Public 

Citizen; Profs. Admati & Pfleiderer; Better Markets 

(June 2012); AFR et al. (Feb. 2012). One commenter 

stated that the proposed rule would improve market 

liquidity, efficiency, and price transparency. See 

Alfred Brock. 

565See, e.g., Sens. Merkley & Levin (Feb. 2012); 

Prof. Richardson; Better Markets (Feb. 2012); Profs. 

Stout & Hastings; Prof. Johnson; Occupy; Public 

Citizen; Profs. Admati & Pfleiderer; Better Markets 

(June 2012). Similarly, one commenter indicated 

that non-banking entity market participants could 

fill the current role of banking entities in the market 

if implementation of the rule is phased in. See ACLI 

(Feb. 2012). 

566See Better Markets (Feb. 2012). 567See Prof. Johnson. 568See AFR et al. (Feb. 2012). 

569See, e.g., Wellington; Prof. Duffie; Investure; 

IIF; Liberty Global; SIFMA et al. (Prop. Trading) 

(Feb. 2012); Credit Suisse (Seidel); JPMC; Morgan 

Stanley; Barclays; BoA; STANY; SIFMA (Asset 

Mgmt.) (Feb. 2012); FTN; Western Asset Mgmt.; 

IAA; PUC Texas; ICI (Feb. 2012); IIB/EBF; Invesco. 

In addition, some commenters recognized that other 

market participants are likely to fill banking 

entities’ roles in the long term, but not in the short 

term. See, e.g., ICFR; Comm. on Capital Markets 

Regulation; Oliver Wyman (Feb. 2012). 

570See Oliver Wyman (Feb. 2012) (‘‘Major bankaffiliated market makers have large capital bases, 

balance sheets, technology platforms, global 

operations, relationships with clients, sales forces, 

risk infrastructure, and management processes that 

would take smaller or new dealers years and 

billions of dollars to replicate.’’). 

571See SIFMA et al. (Prop. Trading) (Feb. 2012). 

572See Thakor Study. 

573See, e.g., Prof. Duffie; Oliver Wyman (Feb. 

2012). 

574See, e.g., MetLife; SIFMA et al. (Prop. Trading) 

(Feb. 2012); RBC; Credit Suisse (Seidel); JPMC; 

BoA; ACLI (Feb. 2012); AFR et al. (Feb. 2012); ISDA 

(Feb. 2012); Goldman (Prop. Trading); Oliver 

Wyman (Feb. 2012). 

575See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Chamber (Feb. 2012); Goldman (Prop. Trading). 

576See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); Credit Suisse (Seidel); Goldman (Prop. 

Trading); MFA; RBC. 

577See infra Part VI.A.3.c.1.b.ii. (discussing 

commenters’ requests for greater clarity regarding 

the permissibility of block positioning activity). 

578See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); Credit Suisse (Seidel); JPMC; Goldman (Prop. 

Trading); BoA; ICI (Feb. 2012); ICI Global; 

Vanguard; SSgA (Feb. 2012). 

579See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Credit Suisse (Seidel); JPMC; Goldman (Prop. 

Trading); FTN; RBC; ISDA (Feb. 2012). 

580See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); JPMC; Goldman (Prop. Trading); Banco de 

Me ́xico; IIB/EBF. 

581See CME Group (requesting clarification that 

the market-making exemption permits a banking 

entity to engage in market making in exchangetraded futures and options because the dealer 

registration requirement in § 75.4(b)(2)(iv) of the 

proposed rule did not refer to such instruments and 

stating that lack of an explicit exemption would 

reduce market-making activities in these 

instruments, which would decrease liquidity). But 

see Johnson & Prof. Stiglitz (stating that the 

Agencies should pay special attention to options 

trading and other derivatives because they are 

highly volatile assets that are difficult if not 

impossible to effectively hedge, except through a 

completely matched position, and suggesting that 

options and similar derivatives may need to be 

required to be sold only as riskless principal under 

§ 75.6(b)(1)(ii) of the proposed rule or significantly 

limited through capital charges); Sens. Merkley & 

Levin (Feb. 2012) (stating that asset classes that are 

particularly hard to hedge, such as options, should 

be given special attention under the hedging 

exemption). 

582See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); Credit Suisse (Seidel); JPMC; Goldman (Prop. 

Trading); SIFMA (Asset Mgmt.) (Feb. 2012). Other 

commenters, however, stated that banking entities 

should be limited in their ability to rely on the 

market-making exemption to conduct transactions 

in bespoke or customized derivatives. See, e.g., AFR 

et al. (Feb. 2012); Public Citizen. 

583See, e.g., Japanese Bankers Ass’n. (stating that 

transactions with affiliates and subsidiaries and 

related to hedging activities are a type of market 

making-related activity or risk-mitigating hedging 

activity that should be exempted by the rule); 

SIFMA et al. (Prop. Trading) (Feb. 2012). According 

to one of these commenters, inter-affiliate 

transactions should be viewed as part of a 

coordinated activity for purposes of determining 

whether a banking entity qualifies for an 

exemption. This commenter stated that, for 

example, if a market maker shifts positions held in 

inventory to an affiliate that is better able to manage 

the risk of such positions, both the market maker 

and its affiliate would be engaged in permitted 

market making-related activity. This commenter 

further represented that fitting the inter-affiliate 

swap into the exemption may be difficult (e.g., one 

of the affiliates entering into the swap may not be 

holding itself out as a willing counterparty). See 

SIFMA et al. (Prop. Trading) (Feb. 2012). 

in recent years, despite increased 

trading volumes.563

Some commenters stated that it is 

unlikely the proposed rule would result 

in the negative market impacts 

identified above, such as reduced 

market liquidity.564 For example, a few 

commenters stated that other market 

participants, who are not subject to 

section 13 of the BHC Act, may enter the 

market or increase their trading 

activities to make up for any reduction 

in banking entities’ market-making 

activity or other trading activity.565 For 

instance, one of these commenters 

suggested that the revenue and profits 

from market making will be sufficient to 

attract capital and competition to that 

activity.566 In addition, one commenter 

expressed the view that prohibiting 

proprietary trading may support more 

liquid markets by ensuring that banking 

entities focus on providing liquidity as 

market makers, rather than taking 

liquidity from the market in the course 

of ‘‘trading to beat’’ institutional buyers 

like pension funds, university 

endowments, and mutual funds.567

Another commenter stated that, while 

section 13 of the BHC Act may 

temporarily reduce trading volume and 

excessive liquidity at the peak of market 

bubbles, it should increase the long-run 

stability of the financial system and 

render genuine liquidity and credit 

availability more reliable over the long 

term.568

Other commenters, however, 

indicated that it is uncertain or unlikely 

that non-banking entities will enter the 

market or increase their trading 

activities, particularly in the short 

term.569 For example, one commenter 

noted the investment that banking 

entities have made in infrastructure for 

trading and compliance would take 

smaller or new firms years and billions 

of dollars to replicate.570 Another 

commenter questioned whether other 

market participants, such as hedge 

funds, would be willing to dedicate 

capital to fully serving customer needs, 

which is required to provide ongoing 

liquidity.571 One commenter stated that 

even if non-banking entities move in to 

replace lost trading activity from 

banking entities, the value of the current 

interdealer network among market 

makers will be reduced due to the exit 

of banking entities.572 Several 

commenters expressed the view that 

migration of market making-related 

activities to firms outside the banking 

system would be inconsistent with 

Congressional intent and would have 

potentially adverse consequences for the 

safety and soundness of the U.S. 

financial system.573

Many commenters requested 

additional clarification on how the 

proposed market-making exemption 

would apply to certain asset classes and 

markets or to particular types of market 

making-related activities. In particular, 

commenters requested greater clarity 

regarding the permissibility of: (i) 

Interdealer trading,574 including trading 

for price discovery purposes or to test 

market depth; 575 (ii) inventory 

management; 576 (iii) block positioning 

activity; 577 (iv) acting as an authorized 

participant or market maker in ETFs; 578

(v) arbitrage or other activities that 

promote price transparency and 

liquidity; 579 (vi) primary dealer 

activity; 580 (vii) market making in 

futures and options; 581 (viii) market 

making in new or bespoke products or 

customized hedging contracts; 582 and 

(ix) inter-affiliate transactions.583 As 

discussed in more detail in Part 

VI.B.2.c., a number of commenters 

requested that the market-making 

exemption apply to the restrictions on 

acquiring or retaining an ownership 


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584See, e.g., Cleary Gottlieb; JPMC; BoA; Credit 

Suisse (Williams). 

585See, e.g., Occupy; Alfred Brock. 

586See, e.g., Occupy; AFR et al. (Feb. 2012); 

Public Citizen; Johnson & Prof. Stiglitz; Sens. 

Merkley & Levin (Feb. 2012); John Reed. 

587Consistent with the FSOC study and the 

proposal, the final rule recognizes that the precise 

nature of a market maker’s activities often varies 

depending on the liquidity, trade size, market 

infrastructure, trading volumes and frequency, and 

geographic location of the market for any particular 

type of financial instrument. See Joint Proposal, 76 

FR at 68870; CFTC Proposal, 77 FR at 8356; FSOC 

study (stating that ‘‘characteristics of permitted 

activities in one market or asset class may not be 

the same in another market (e.g., permitted 

activities in a liquid equity securities market may 

vary significantly from an illiquid over-the-counter 

derivatives market)’’). 

588Certain of these requirements, like the 

requirements to have risk and inventory limits, risk 

management strategies, and monitoring and review 

requirements were included in the enhanced 

compliance program requirement in proposed 

Appendix C, but were not separately included in 

the proposed market-making exemption. Like the 

statute, the proposed rule would have required that 

market making-related activities be designed not to 

exceed the reasonably expected near term demand 

of clients, customers, or counterparties. The 

Agencies are adding an explicit requirement in the 

final rule that a trading desk conduct analyses of 

customer demand for purposes of complying with 

this statutory requirement. 

589See infra Part VI.A.3.c.1.c.ii. See also final rule 

§§ 75.4(b)(4), (5). 

590See infra Part VI.A.3.c.1.c.i. The term ‘‘trading 

desk’’ is defined as ‘‘the smallest discrete unit of 

organization of a banking entity that buys or sells 

financial instruments for the trading account of the 

banking entity or an affiliate thereof.’’ Final rule 

§ 75.3(e)(13). 

591See final rule § 75.4(b)(2)(i); infra Part 

VI.A.3.c.1.c.iii. 

592See final rule § 75.4(b)(2)(ii); infra Part 

VI.A.3.c.2.c. In addition, the Agencies are adopting 

a definition of the terms ‘‘client,’’ ‘‘customer,’’ and 

‘‘counterparty’’ in § 75.4(b)(3) of the final rule. 

interest in a covered fund.584 Some 

commenters stated that no other 

activities should be considered 

permitted market making-related 

activity under the rule.585 In addition, a 

few commenters requested clarification 

that high-frequency trading would not 

qualify for the market-making 

exemption.586

3. Final Market-Making Exemption 

After carefully considering comment 

letters, the Agencies are adopting 

certain refinements to the proposed 

market-making exemption. The 

Agencies are adopting a market-making 

exemption that is consistent with the 

statutory exemption for this activity and 

designed to permit banking entities to 

continue providing intermediation and 

liquidity services. The Agencies note 

that, while all market-making activity 

should ultimately be related to the 

intermediation of trading, whether 

directly to individual customers through 

bilateral transactions or more broadly to 

a given marketplace, certain 

characteristics of a market-making 

business may differ among markets and 

asset classes.587 The final rule is 

intended to account for these 

differences to allow banking entities to 

continue to engage in market makingrelated activities by providing customer 

intermediation and liquidity services 

across markets and asset classes, if such 

activities do not violate the statutory 

limitations on permitted activities (e.g., 

by involving or resulting in a material 

conflict of interest with a client, 

customer, or counterparty) and are 

conducted in conformance with the 

exemption. 

At the same time, the final rule 

requires development and 

implementation of trading, risk and 

inventory limits, risk management 

strategies, analyses of how the specific 

market making-related activities are 

designed not to exceed the reasonably 

expected near term demands of 

customers, compensation standards, and 

monitoring and review requirements 

that are consistent with market-making 

activities.588 These requirements are 

designed to distinguish exempt market 

making-related activities from 

impermissible proprietary trading. In 

addition, these requirements are 

designed to ensure that a banking entity 

is aware of, monitors, and limits the 

risks of its exempt activities consistent 

with the prudent conduct of market 

making-related activities. 

As described in detail below, the final 

market-making exemption consists of 

the following elements: 

• A framework that recognizes the 

differences in market making-related 

activities across markets and asset 

classes by establishing criteria that can 

be applied based on the liquidity, 

maturity, and depth of the market for 

the particular type of financial 

instrument. 

• A general focus on analyzing the 

overall ‘‘financial exposure’’ and 

‘‘market-maker inventory’’ held by any 

given trading desk rather than a 

transaction-by-transaction analysis. The 

‘‘financial exposure’’ reflects the 

aggregate risks of the financial 

instruments, and any associated loans, 

commodities, or foreign exchange or 

currency, held by a banking entity or its 

affiliate and managed by a particular 

trading desk as part of its market 

making-related activities. The ‘‘marketmaker inventory’’ means all of the 

positions, in the financial instruments 

for which the trading desk stands ready 

to make a market that are managed by 

the trading desk, including the trading 

desk’s open positions or exposures 

arising from open transactions.589

• A definition of the term ‘‘trading 

desk’’ that focuses on the operational 

functionality of the desk rather than its 

legal status, and requirements that apply 

at the trading desk level of organization 

within a single banking entity or across 

two or more affiliates.590

• Five requirements for determining 

whether a banking entity is engaged in 

permitted market making-related 

activities. Many of these criteria have 

similarities to the factors included in 

the proposed rule, but with important 

modifications in response to comments. 

These standards require that: 

Æ The trading desk that establishes 

and manages a financial exposure 

routinely stands ready to purchase and 

sell one or more types of financial 

instruments related to its financial 

exposure and is willing and available to 

quote, buy and sell, or otherwise enter 

into long and short positions in those 

types of financial instruments for its 

own account, in commercially 

reasonable amounts and throughout 

market cycles, on a basis appropriate for 

the liquidity, maturity, and depth of the 

market for the relevant types of financial 

instruments; 591

Æ The amount, types, and risks of the 

financial instruments in the trading 

desk’s market-maker inventory are 

designed not to exceed, on an ongoing 

basis, the reasonably expected near term 

demands of clients, customers, or 

counterparties, as required by the 

statute and based on certain factors and 

analysis; 592

Æ The banking entity has established 

and implements, maintains, and 

enforces an internal compliance 

program that is reasonably designed to 

ensure its compliance with the marketmaking exemption, including 

reasonably designed written policies 

and procedures, internal controls, 

analysis, and independent testing 

identifying and addressing: 

D The financial instruments each 

trading desk stands ready to purchase 

and sell in accordance with 

§ 75.4(b)(2)(i) of the final rule; 

D The actions the trading desk will 

take to demonstrably reduce or 

otherwise significantly mitigate 

promptly the risks of its financial 

exposure consistent with its established 

limits; the products, instruments, and 

exposures each trading desk may use for 

risk management purposes; the 

techniques and strategies each trading 

desk may use to manage the risks of its 

market making-related activities and 

inventory; and the process, strategies, 

and personnel responsible for ensuring 

that the actions taken by the trading 


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593Routine market making-related risk 

management activity by a trading desk is permitted 

under the market-making exemption and, provided 

the standards of the exemption are met, is not 

required to separately meet the requirements of the 

hedging exemption. The circumstances under 

which risk management activity relating to the 

trading desk’s financial exposure is permitted under 

the market-making exemption or must separately 

comply with the hedging exemption are discussed 

in more detail in Parts VI.A.3.c.1.c.ii. and 

VI.A.3.c.4., infra. 

594See final rule § 75.4(b)(2)(iii); infra Part 

VI.A.3.c.3. 

595See final rule § 75.4(b)(2)(iv). 

596See final rule § 75.4(b)(2)(v); infra Part 

VI.A.3.c.5. 

597See final rule § 75.4(b)(2)(vi); infra Part 

VI.A.3.c.6. As discussed further below, this 

provision pertains to legal registration or licensing 

requirements that may apply to an entity engaged 

in market making-related activities, depending on 

the facts and circumstances. This provision would 

not require a banking entity to comply with 

registration requirements that are not required by 

law, such as discretionary registration with a 

national securities exchange as a market maker on 

that exchange. 

598See infra Part VI.C.3. 

599See supra Part VI.A.3.b.2. 

600Certain approaches suggested by commenters, 

such as relying solely on capital requirements, 

requiring ring fencing, permitting all swap dealing 

activity, or focusing solely on how traders are 

compensated do not appear to be consistent with 

the statutory language because they do not appear 

to limit market making-related activity to that 

which is designed not to exceed the reasonably 

expected near term demands of clients, customers, 

or counterparties, as required by the statute. See 

Prof. Duffie; STANY; ICE; Shadow Fin. Regulatory 

Comm.; ISDA (Feb. 2012); ISDA (Apr. 2012); G2 

FinTech. 

601While an approach establishing a number of 

safe harbors that are each tailored to a specific asset 

class would address the need to recognize 

differences across asset classes, such an approach 

may also increase the complexity of the final rule. 

Further, commenters did not provide sufficient 

information to determine the appropriate 

parameters of a safe harbor-based approach. 

602As noted above, a number of commenters 

suggested the Agencies adopt a bright-line rule, 

provide a safe harbor for certain types of activities, 

or establish a presumption of compliance based on 

certain factors. See, e.g., Sens. Merkley & Levin 

(Feb. 2012); John Reed; Prof. Richardson; Johnson 

& Prof. Stiglitz; Capital Group; Invesco; BDA (Oct. 

2012); Flynn & Fusselman; Prof. Colesanti et al.; 

SIFMA et al. (Prop. Trading) (Feb. 2012); IIF; NYSE 

Euronext; Credit Suisse (Seidel); JPMC; Barclays; 

BoA; Wells Fargo (Prop. Trading); PNC et al.; Oliver 

Wyman (Feb. 2012). Many of these commenters 

expressed general concern that the proposed 

market-making exemption may create uncertainty 

for individual traders engaged in market makingrelated activity and suggested that their proposed 

approach would alleviate such concern. The 

Agencies believe that the enhanced focus on risk 

and inventory limits for each trading desk (which 

must be tied to the near term customer demand 

requirement) and the clarification that the final 

market-making exemption does not require a tradeby-trade analysis should address concerns about 

individual traders having to assess whether they are 

complying with the market-making exemption on a 

trade-by-trade basis. 

603Several commenters suggested a guidancebased approach, rather than requirements in the 

final rule. See, e.g., SIFMA et al. (Prop. Trading) 

(Feb. 2012) (suggesting that this guidance could 

then be incorporated in banking entities’ policies 

and procedures for purposes of complying with the 

rule, in addition to the establishment of risk limits, 

controls, and metrics); JPMC; BoA; PUC Texas; 

SSgA (Feb. 2012); PNC et al.; Wells Fargo (Prop. 

Trading). 

604See, e.g., Goldman (Prop. Trading); Morgan 

Stanley; Barclays; Wellington; CalPERS; BlackRock; 

SSgA (Feb. 2012); Invesco. 

605See infra Part VI.C.3. (discussing the final 

rule’s metrics requirement). See SIFMA et al. (Prop. 

Trading) (Feb. 2012); Wells Fargo (Prop. Trading); 

RBC; ICI (Feb. 2012); Occupy (stating that there are 

serious limits to the capabilities of the metrics and 

the potential for abuse and manipulation of the 

input data is significant); Alfred Brock. 

desk to mitigate these risks are and 

continue to be effective; 593

D Limits for each trading desk, based 

on the nature and amount of the trading 

desk’s market making-related activities, 

including factors used to determine the 

reasonably expected near term demands 

of clients, customers, or counterparties, 

on: the amount, types, and risks of its 

market-maker inventory; the amount, 

types, and risks of the products, 

instruments, and exposures the trading 

desk uses for risk management 

purposes; the level of exposures to 

relevant risk factors arising from its 

financial exposure; and the period of 

time a financial instrument may be held; 

D Internal controls and ongoing 

monitoring and analysis of each trading 

desk’s compliance with its limits; and 

D Authorization procedures, 

including escalation procedures that 

require review and approval of any 

trade that would exceed a trading desk’s 

limit(s), demonstrable analysis that the 

basis for any temporary or permanent 

increase to a trading desk’s limit(s) is 

consistent with the requirements of the 

market-making exemption, and 

independent review of such 

demonstrable analysis and approval; 594

Æ To the extent that any limit 

identified above is exceeded, the trading 

desk takes action to bring the trading 

desk into compliance with the limits as 

promptly as possible after the limit is 

exceeded; 595

Æ The compensation arrangements of 

persons performing market makingrelated activities are designed not to 

reward or incentivize prohibited 

proprietary trading; 596 and 

• The banking entity is licensed or 

registered to engage in market makingrelated activities in accordance with 

applicable law.597

• The use of quantitative 

measurements to highlight activities 

that warrant further review for 

compliance with the exemption.598 As 

discussed further in Part VI.C.3., the 

Agencies have reduced some of the 

compliance burdens by adopting a more 

tailored subset of metrics than was 

proposed to better focus on those 

metrics that the Agencies believe are 

most germane to the evaluation of the 

activities that firms conduct under the 

market-making exemption. 

In refining the proposed approach to 

implementing the statute’s marketmaking exemption, the Agencies closely 

considered the various alternative 

approaches suggested by 

commenters.599 However, like the 

proposed approach, the final marketmaking exemption continues to adhere 

to the statutory mandate that provides 

for an exemption to the prohibition on 

proprietary trading for market makingrelated activities. Therefore, the final 

rule focuses on providing a framework 

for assessing whether trading activities 

are consistent with market making. The 

Agencies believe this approach is 

consistent with the statute 600 and 

strikes an appropriate balance between 

commenters’ desire for both clarity and 

flexibility. For example, while a brightline or safe harbor based approach 

would generally provide a high degree 

of certainty about whether an activity 

qualifies for the market-making 

exemption, it would also provide less 

flexibility to recognize the differences in 

market-making activities across markets 

and asset classes.601 In addition, any 

bright-line approach would be more 

likely to be subject to gaming and 

avoidance as new products and types of 

trading activities are developed than 

other approaches to implementing the 

market-making exemption.602 Although 

a purely guidance-based approach 

would provide greater flexibility, it 

would also provide less clarity, which 

could make it difficult for trading 

personnel, internal compliance 

personnel, and Agency supervisors and 

examiners to determine whether an 

activity complies with the rule and 

would lead to an increased risk of 

evasion of the statutory requirements.603

Some commenters suggested an 

approach to implementing the marketmaking exemption that would focus on 

metrics or other objective factors.604 As 

discussed below, a number of 

commenters expressed support for using 

the metrics as a tool to monitor trading 

activity and not to determine 

compliance with the rule.605 While the 

Agencies agree that quantitative 

measurements are useful for purposes of 

monitoring a trading desk’s activities 

and are requiring certain banking 

entities to calculate, record, and report 

quantitative measurements to the 

Agencies in the final rule, the Agencies 

do not believe that quantitative 

measurements should be used as a 

dispositive tool for determining 


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606See infra Part VI.C.3. (discussing the final 

metrics requirement). 

607See, e.g., Japanese Bankers Ass’n.; Citigroup 

(Feb. 2012). 

608However, as discussed below, the Agencies 

believe risk limits can be a useful tool when they 

must account for the nature and amount of a 

particular trading desk’s market making-related 

activities, including the reasonably expected near 

term demands of clients, customers, or 

counterparties. 

609See MetLife; Fixed Income Forum/Credit 

Roundtable; ACLI (Feb. 2012). 

610The Agencies are not, however, adding certain 

additional requirements suggested by commenters, 

such as a new customer-facing criterion, margin 

requirements, or additional provisions regarding 

material conflicts of interest or high-risk assets or 

trading strategies. See, e.g., Morgan Stanley; 

Stephen Roach; WR Hambrecht; Sens. Merkley & 

Levin (Feb. 2012). The Agencies believe that the 

final rule includes sufficient requirements to ensure 

that a trading desk relying on the market-making 

exemption is engaged in customer-facing activity 

(for example, the final rule requires the trading desk 

to stand ready to buy and sell a type of financial 

instrument as market maker and that the trading 

desk’s market-maker inventory is designed not to 

exceed the reasonably expected near term demands 

of clients, customers, or counterparties). The 

Agencies decline to include margin requirements in 

the final exemption because banking entities are 

currently subject to a number of different margin 

requirements, including those applicable to, among 

others: SEC-registered broker-dealers; CFTCregistered swap dealers; SEC-registered securitybased swap dealers: and foreign dealer entities. 

Further, the Agencies are not providing new 

requirements regarding material conflicts of interest 

and high-risk assets and trading strategies in the 

market-making exemption because the Agencies 

believe these issues are adequately addressed in 

§ 75.7 of the final rule. The limitations in § 75.7 will 

apply to market making-related activities and all 

other exempted activities. 

611See supra note 550 and accompanying text. 

The Agencies acknowledge that reduced liquidity 

can be costly. One commenter provided estimated 

impacts on asset valuation, borrowing costs, and 

transaction costs in the corporate bond market 

based on certain hypothetical scenarios of reduced 

market liquidity. This commenter noted that its 

hypothetical liquidity shifts of 5, 10, and 15 

percentile points were ‘‘necessarily arbitrary’’ but 

judged ‘‘to be realistic potential outcomes of the 

proposed rule.’’ Oliver Wyman (Feb. 2012). Because 

the Agencies have made significant modifications to 

the proposed rule in response to comments, the 

Agencies believe this commenter’s concerns about 

the market impacts of the proposed rule have been 

substantially addressed. 

612As noted above, a few commenters stated that 

reduced liquidity may provide certain benefits. See, 

e.g., Paul Volcker; AFR et al. (Feb. 2012); Public 

Citizen; Prof. Richardson; Johnson & Prof. Stiglitz; 

Better Markets (Feb. 2012); Prof. Johnson. However, 

a number of commenters stated that reduced 

liquidity would have negative market impacts. See 

supra note 550 and accompanying text. 

613See supra Part VI.A.3.b.2.b. 

614See supra Part VI.A.3.b.2.b. As discussed 

above, a few other commenters suggested that to the 

extent liquidity is vulnerable to destabilizing 

liquidity spirals, any reduced liquidity stemming 

from section 13 of the BHC Act and its 

implementing rules would not necessarily be a 

negative result. See AFR et al. (Feb. 2012); Public 

Citizen. See also Paul Volcker. These commenters 

also suggested that the Agencies adopt stricter 

conditions in the market-making exemption, as 

discussed throughout this Part VI.A.3. However, 

liquidity—essentially, the ease with which assets 

can be converted into cash—is not destabilizing in 

and of itself. Rather, liquidity spirals are a function 

of how firms are funded. During market downturns, 

when margin requirements tend to increase, firms 

that fund their operations with leverage face higher 

costs of providing liquidity; firms that run up 

against their maximum leverage ratios may be 

forced to retreat from market making, contributing 

to the liquidity spiral. Viewed in this light, it is 

institutional features of financial markets—in 

particular, leverage—rather than liquidity itself that 

contributes to liquidity spirals. 

615Wider spreads can be costly for investors. For 

example, one commenter estimated that a 10 basis 

point increase in spreads in the corporate bond 

market would cost investors $29 billion per year. 

See Wellington. Wider spreads can also be 

particularly costly for open-end mutual funds, 

which must trade in and out of the fund’s portfolio 

holdings on a daily basis in order to satisfy 

Continued 

compliance with the market-making 

exemption.606

In response to two commenters’ 

request that the final rule focus on a 

banking entity’s risk management 

structures or risk limits and not on 

attempting to define market-making 

activities,607 the Agencies do not believe 

that management of risk, on its own, is 

sufficient to differentiate permitted 

market making-related activities from 

impermissible proprietary trading. For 

example, the existence of a risk 

management framework or risk limits, 

while important, would not ensure that 

a trading desk is acting as a market 

maker by engaging in customer-facing 

activity and providing intermediation 

and liquidity services.608 The Agencies 

also decline to take an approach to 

implementing the market-making 

exemption that would require the 

development of individualized plans for 

each banking entity in coordination 

with the Agencies, as suggested by a few 

commenters.609 The Agencies believe it 

is useful to establish a consistent 

framework that will apply to all banking 

entities to reduce the potential for 

unintended competitive impacts that 

could arise if each banking entity is 

subject to an individualized plan that is 

tailored to its specific organizational 

structure and trading activities and 

strategies. 

Although the Agencies are not in the 

final rule modifying the basic structure 

of the proposed market-making 

exemption, certain general items 

suggested by commenters, such as 

enhanced compliance program elements 

and risk limits, have been incorporated 

in the final rule text for the marketmaking exemption, instead of a separate 

appendix.610 Moreover, as described 

below, the final market-making 

exemption includes specific substantive 

changes in response to a wide variety of 

commenter concerns. 

The Agencies understand that the 

economics of market making—and 

financial intermediation in general— 

require a market maker to be active in 

markets. In determining the appropriate 

scope of the market-making exemption, 

the Agencies have been mindful of 

commenters’ views on market making 

and liquidity. Several commenters 

stated that the proposed rule would 

impact a banking entity’s ability to 

engage in market making-related 

activity, with corresponding reductions 

in market liquidity.611 However, 

commenters disagreed about whether 

reduced liquidity would be beneficial or 

detrimental to the market, or if any such 

reductions would even materialize.612

Many commenters stated that reduced 

liquidity could lead to other negative 

market impacts, such as wider spreads, 

higher transaction costs, greater market 

volatility, diminished price discovery, 

and increased cost of capital. 

The Agencies understand that market 

makers play an important role in 

providing and maintaining liquidity 

throughout market cycles and that 

restricting market-making activity may 

result in reduced liquidity, with 

corresponding negative market impacts. 

For instance, absent a market maker 

who stands ready to buy and sell, 

investors may have to make large price 

concessions or otherwise expend 

resources searching for counterparties. 

By stepping in to intermediate trades 

and provide liquidity, market makers 

thus add value to the financial system 

by, for example, absorbing supply and 

demand imbalances. This often means 

taking on financial exposures, in a 

principal capacity, to satisfy reasonably 

expected near term customer demand, 

as well as to manage the risks associated 

with meeting such demand. 

The Agencies recognize that, as noted 

by commenters, liquidity can be 

associated with narrower spreads, lower 

transaction costs, reduced volatility, 

greater price discovery, and lower costs 

of capital.613 The Agencies agree with 

these commenters that liquidity 

provides important benefits to the 

financial system, as more liquid markets 

are characterized by competitive market 

makers, narrow bid-ask spreads, and 

frequent trading, and that a narrowly 

tailored market-making exemption 

could negatively impact the market by, 

as described above, forcing investors to 

make price concessions or unnecessarily 

expend resources searching for 

counterparties.614 For example, while 

bid-ask spreads compensate market 

makers for providing liquidity when 

asset values are uncertain, under 

competitive forces, dealers compete 

with respect to spreads, thus lowering 

their profit margins on a per trade basis 

and benefitting investors.615 Volatility is 


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redemptions and subscriptions. See Wellington; 

AllianceBernstein. 

616A higher cost of capital increases financing 

costs and translates into reduced capital 

investment. While one commenter estimated that a 

one percent increase in the cost of capital would 

lead to a $55 to $82.5 billion decline in capital 

investments by U.S. nonfarm firms, the Agencies 

cannot independently verify these potential costs. 

Further, this commenter did not indicate what 

aspect of the proposed rule could cause a one 

percent increase in the cost of capital. See Thakor 

Study. In any event, the Agencies have made 

significant changes to the proposed approach to 

implementing the market-making exemption that 

should help address this commenter’s concern. 

617See, e.g., CIEBA; ACLI; PNC et al.; Morgan 

Stanley; Chamber (Feb. 2012); Abbott Labs et al. 

(Feb. 14, 2012); FEI; ICI (Feb. 2012); TMA Hong 

Kong; Sen. Casey. 

618See, e.g., Sens. Merkley & Levin (Feb. 2012); 

Prof. Richardson; Better Markets (Feb. 2012); Profs. 

Stout & Hastings; Prof. Johnson; Occupy; Public 

Citizen; Profs. Admati & Pfleiderer; Better Markets 

(June 2012). 

619See, e.g., Prof. Johnson. 

620See supra note 522 (discussing commenters’ 

concerns regarding a trade-by-trade analysis). 

621For example, by clarifying that individual 

trades will not be viewed in isolation and requiring 

strong compliance procedures, this approach will 

generally allow an individual trader to operate 

within the compliance framework established for 

his or her trading desk without having to assess 

whether each individual transaction complies with 

all requirements of the market-making exemption. 

622See supra notes 565 and 569 and 

accompanying text (discussing comments on the 

issue of whether non-banking entities are likely to 

enter the market or increase their trading activities 

in response to reduced trading activity by banking 

entities). For example, one commenter stated that 

broker-dealers that are not affiliated with a bank 

would have reduced access to lender-of-last resort 

liquidity from the central bank, which could limit 

their ability to make markets during times of market 

stress or when capital buffers are small. See Prof. 

Duffie. However, another commenter noted that the 

driven by both uncertainty about 

fundamental value and the liquidity 

needs of investors. When markets are 

illiquid, participants may have to make 

large price concessions to find a 

counterparty willing to trade, increasing 

the importance of the liquidity channel 

for addressing volatility. If liquiditybased volatility is not diversifiable, 

investors will require a risk premium for 

holding liquidity risk, increasing the 

cost of capital.616 Commenters 

additionally suggested that the effects of 

diminished liquidity could be 

concentrated in securities markets for 

small or midsize companies or for 

lesser-known issuers, where trading is 

already infrequent.617 Volume in these 

markets can be low, increasing the 

inventory risk of market makers. The 

Agencies recognize that, if the final rule 

creates disincentives for banking 

entities to provide liquidity, these low 

volume markets may be impacted first. 

As discussed above, the Agencies 

received several comments suggesting 

that the negative consequences 

associated with reduced liquidity would 

be unlikely to materialize under the 

proposed rule. For example, a few 

commenters stated that non-bank 

financial intermediaries, who are not 

subject to section 13 of the BHC Act, 

may increase their market-making 

activities in response to any reduction 

in market making by banking entities, a 

topic the Agencies discuss in more 

detail below.618 In addition, some 

commenters suggested that the 

restrictions on proprietary trading 

would support liquid markets by 

encouraging banking entities to focus on 

financial intermediation activities that 

supply liquidity, rather than proprietary 

trades that demand liquidity, such as 

speculative trades or trades that frontrun institutional investors.619 The 

statute prohibits proprietary trading 

activity that is not exempted. As such, 

the termination of nonexempt 

proprietary trading activities of banking 

entities may lead to some general 

reductions in liquidity of certain asset 

classes. Although the Agencies cannot 

say with any certainty, there is good 

reason to believe that to a significant 

extent the liquidity reductions of this 

type may be temporary since the statute 

does not restrict proprietary trading 

activities of other market participants. 

Thus, over time, non-banking entities 

may provide much of the liquidity that 

is lost by restrictions on banking 

entities’ trading activities. If so, 

eventually, the detrimental effects of 

increased trading costs, higher costs of 

capital, and greater market volatility 

should be mitigated. 

Based on the many detailed 

comments provided, the Agencies have 

made substantive refinements to the 

market-making exemption that the 

Agencies believe will reduce the 

likelihood that the rule, as 

implemented, will negatively impact the 

ability of banking entities to engage in 

the types of market making-related 

activities permitted under the statute 

and, therefore, will continue to promote 

the benefits to investors and other 

market participants described above, 

including greater market liquidity, 

narrower bid-ask spreads, reduced price 

concessions and price impact, lower 

volatility, and reduced counterparty 

search costs, thus reducing the cost of 

capital. For instance, the final marketmaking exemption does not require a 

trade-by-trade analysis, which was a 

significant source of concern from 

commenters who represented, among 

other things, that a trade-by-trade 

analysis could have a chilling effect on 

individual traders’ willingness to engage 

in market-making activities.620 Rather, 

the final rule has been crafted around 

the overall market making-related 

activities of individual trading desks, 

with various requirements that these 

activities be demonstrably related to 

satisfying reasonably expected near term 

customer demands and other marketmaking activities. The Agencies believe 

that applying certain requirements to 

the aggregate risk exposure of a trading 

desk, along with the requirement to 

establish risk and inventory limits to 

routinize a trading desk’s compliance 

with the near term customer demand 

requirement, will reduce negative 

potential impacts on individual traders’ 

decision-making process in the normal 

course of market making.621 In addition, 

in response to a large number of 

comments expressing concern that the 

proposed market-making exemption 

would restrict or prohibit market 

making-related activities in less liquid 

markets, the Agencies are clarifying that 

the application of certain requirements 

in the final rule, such as the frequency 

of required quoting and the near term 

demand requirement, will account for 

the liquidity, maturity, and depth of the 

market for a given type of financial 

instrument. Thus, banking entities will 

be able to continue to engage in market 

making-related activities across markets 

and asset classes. 

At the same time, the Agencies 

recognize that an overly broad marketmaking exemption may allow banking 

entities to mask speculative positions as 

liquidity provision or related hedges. 

The Agencies believe the requirements 

included in the final rule are necessary 

to prevent such evasion of the marketmaking exemption, ensure compliance 

with the statute, and facilitate internal 

banking entity and external Agency 

reviews of compliance with the final 

rule. Nevertheless, the Agencies 

acknowledge that these additional costs 

may have an impact on banking entities’ 

willingness to engage in market makingrelated activities. Banking entities will 

incur certain compliance costs in 

connection with their market makingrelated activities under the final rule. 

For example, banking entities may not 

currently limit their trading desks’ 

market-maker inventory to that which is 

designed not to exceed reasonably 

expected near term customer demand, 

as required by the statute. 

As discussed above, commenters 

presented diverging views on whether 

non-banking entities are likely to enter 

the market or increase their marketmaking activities if the final rule should 

cause banking entities to reduce their 

market-making activities.622 The 


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presence and evolution of market making after the 

enactment of the Glass-Steagall Act mutes this 

particular concern. See Prof. Richardson. 

623Certain non-banking entities, such as some 

SEC-registered broker-dealers that are not banking 

entities subject to the final rule, currently engage in 

market-making activities and, thus, should have the 

needed infrastructure and may attract additional 

capital. If the final rule has a marginal impact on 

banking entities’ willingness to engage in market 

making-related activities, these non-banking entities 

should be able to respond by increasing their 

market making-related activities. The Agencies 

recognize, however, that firms that do not have 

existing infrastructure or sufficient capital are 

unlikely to be able to act as market makers shortly 

after the final rule is implemented. Nevertheless, 

because some non-bank-affiliated broker-dealers 

currently operate market-making desks, and 

because it was the dominant model prior to the 

Gramm-Leach-Bliley Act, the Agencies believe that 

non-bank-affiliated financial intermediaries will be 

able to provide market-making services longer term. 

624See proposed rule § 75.4(b)(2)(ii). 

625See Joint Proposal, 76 FR at 68870 (‘‘Notably, 

this criterion requires that a banking entity relying 

on the exemption with respect to a particular 

transaction must actually make a market in the 

[financial instrument] involved; simply because a 

banking entity makes a market in one type of 

[financial instrument] does not permit it to rely on 

the market-making exemption for another type of 

[financial instrument].’’); CFTC Proposal, 77 FR at 

8355–8356. 

626See Joint Proposal, 76 FR at 68870; CFTC 

Proposal, 77 FR at 8356. 

627See Joint Proposal, 76 FR at 68870–68871; 

CFTC Proposal, 77 FR at 8356. These proposed 

factors are generally consistent with the indicia 

used by the SEC to assess whether a broker-dealer 

is engaged in bona fide market making for purposes 

of Regulation SHO under the Exchange Act. See 

Joint Proposal, 76 FR at 68871 n.148; CFTC 

Proposal, 77 FR at 8356 n.155. 

628The Agencies noted that, with respect to this 

factor, the frequency of regular quotations will vary, 

as moderately illiquid markets may involve 

quotations on a daily or more frequent basis, while 

highly illiquid markets may trade only by 

appointment. See Joint Proposal, 76 FR at 68871 

n.149; CFTC Proposal, 77 FR at 8356 n.156. 

629See Joint Proposal, 76 FR at 68871; CFTC 

Proposal, 77 FR at 8356. 

630 In the preamble to the proposed rule, the 

Agencies stated that the SEC’s definition of 

‘‘qualified block positioner’’ may serve as guidance 

in determining whether a block positioner engaged 

in block positioning is engaged in bona fide market 

making for purposes of § 75.4(b)(2)(ii) of the 

proposed rule. See Joint Proposal, 76 FR at 68871 

n.151; CFTC Proposal, 77 FR at 8356 n.157. 

631See Joint Proposal, 76 FR at 68871; CFTC 

Proposal, 77 FR at 8356–8357. 

632See Sens. Merkley & Levin (Feb. 2012); Alfred 

Brock. 

Agencies note that prior to the GrammLeach-Bliley Act of 1999, marketmaking services were more commonly 

provided by non-bank-affiliated brokerdealers than by banking entities. As 

discussed above, by intermediating and 

facilitating trading, market makers 

provide value to the markets and profit 

from providing liquidity. Should 

banking entities retreat from making 

markets, the profit opportunities 

available from providing liquidity will 

provide an incentive for non-bankaffiliated broker-dealers to enter the 

market and intermediate trades. The 

Agencies are unable to assess the likely 

effect with any certainty, but the 

Agencies recognize that a marketmaking operation requires certain 

infrastructure and capital, which will 

impact the ability of non-banking 

entities to enter the market-making 

business or to increase their presence. 

Therefore, should banking entities 

retreat from making markets, there 

could be a transition period with 

reduced liquidity as non-banking 

entities build up the needed 

infrastructure and obtain capital. 

However, because the Agencies have 

substantially modified this exemption 

in response to comments to ensure that 

market making related to near-term 

customer demand is permitted as 

contemplated by the statute, the 

Agencies do not believe the final rule 

should significantly impact currentlyavailable market-making services.623

c. Detailed Explanation of the MarketMaking Exemption 

1. Requirement to Routinely Stand 

Ready To Purchase and Sell 

a. Proposed Requirement To Hold Self 

Out 

Section 75.4(b)(2)(ii) of the proposed 

rule would have required the trading 

desk or other organizational unit that 

conducts the purchase or sale in 

reliance on the market-making 

exemption to hold itself out as being 

willing to buy and sell, including 

through entering into long and short 

positions in, the financial instrument for 

its own account on a regular or 

continuous basis.624 The proposal stated 

that a banking entity could rely on the 

proposed exemption only for the type of 

financial instrument that the entity 

actually made a market in.625

The proposal recognized that the 

precise nature of a market maker’s 

activities often varies depending on the 

liquidity, trade size, market 

infrastructure, trading volumes and 

frequency, and geographic location of 

the market for any particular financial 

instrument.626 To account for these 

variations, the Agencies proposed 

indicia for assessing compliance with 

this requirement that differed between 

relatively liquid markets and less liquid 

markets. Further, the Agencies 

recognized that the proposed indicia 

could not be applied at all times and 

under all circumstances because some 

may be inapplicable to the specific asset 

class or market in which the market 

making-related activity is conducted. 

In particular, the proposal stated that 

a trading desk or other organizational 

unit’s market making-related activities 

in relatively liquid markets, such as 

equity securities or other exchangetraded instruments, should generally 

include: (i) Making continuous, twosided quotes and holding oneself out as 

willing to buy and sell on a continuous 

basis; (ii) a pattern of trading that 

includes both purchases and sales in 

roughly comparable amounts to provide 

liquidity; (iii) making continuous 

quotations that are at or near the market 

on both sides; and (iv) providing widely 

accessible and broadly disseminated 

quotes.627 With respect to market 

making in less liquid markets, the 

proposal noted that the appropriate 

indicia of market making-related 

activities will vary, but should generally 

include: (i) Holding oneself out as 

willing and available to provide 

liquidity by providing quotes on a 

regular (but not necessarily continuous) 

basis; 628 (ii) with respect to securities, 

regularly purchasing securities from, or 

selling securities to, clients, customers, 

or counterparties in the secondary 

market; and (iii) transaction volumes 

and risk proportionate to historical 

customer liquidity and investments 

needs.629

In discussing this proposed 

requirement, the Agencies stated that 

bona fide market making-related activity 

may include certain block positioning 

and anticipatory position-taking. More 

specifically, the proposal indicated that 

the bona fide market making-related 

activity described in § 75.4(b)(2)(ii) of 

the proposed rule would include: (i) 

Block positioning if undertaken by a 

trading desk or other organizational unit 

of a banking entity for the purpose of 

intermediating customer trading; 630 and 

(ii) taking positions in securities in 

anticipation of customer demand, so 

long as any anticipatory buying or 

selling activity is reasonable and related 

to clear, demonstrable trading interest of 

clients, customers, or counterparties.631

b. Comments on the Proposed 

Requirement To Hold Self Out 

Commenters raised many issues 

regarding § 75.4(b)(2)(ii) of the proposed 

exemption, which would require a 

trading desk or other organizational unit 

to hold itself out as willing to buy and 

sell the financial instrument for its own 

account on a regular or continuous 

basis. As discussed below, some 

commenters viewed the proposed 

requirement as too restrictive, while 

other commenters stated that the 

requirement was too permissive. Two 

commenters expressed support for the 

proposed requirement.632 A number of 


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633See infra Part VI.A.3.c.1.c.iii. (addressing 

these concerns). 

634See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); Morgan Stanley; Barclays; Goldman (Prop. 

Trading); ABA; Chamber (Feb. 2012); BDA (Feb. 

2012); Fixed Income Forum/Credit Roundtable; 

ACLI (Feb. 2012); T. Rowe Price; PUC Texas; PNC; 

MetLife; RBC; IHS; SSgA (Feb. 2012). 

635See, e.g., PNC (stating that the proposed rule 

needs to account for market making by regional 

banks on behalf of small and middle-market 

customers whose securities are less liquid); ABA 

(stating that the rule should continue to permit 

banks to provide limited liquidity by buying 

securities that they feel are suitable for their retail 

and institutional customer base by stating that a 

bank is ‘‘holding itself out’’ when it buys and sells 

securities that are suitable for its customers). 

636This issue is further discussed in Part 

VI.A.3.c.1.c.iii., infra. 

637See, e.g., Goldman (Prop. Trading) (stating that 

it would be burdensome for a U.S. credit marketmaking business to be required to produce and 

disseminate quotes for thousands of individual 

bond CUSIPs that trade infrequently and noting that 

a market maker in credit markets will typically 

disseminate indicative prices for the most liquid 

instruments but, for the thousands of other 

instruments that trade infrequently, the market 

maker will generally provide a price for a trade 

upon request from another market participant); 

Morgan Stanley; SIFMA et al. (Prop. Trading) (Feb. 

2012); RBC. See also BDA (Feb. 2012); FTN (stating 

that in some markets, such as the markets for 

residential mortgage-backed securities and 

investment grade corporate debt, a market maker 

will hold itself out in a subset of instruments (e.g., 

particular issues in the investment grade corporate 

debt market with heavy trading volume or that are 

in the midst of particular credit developments), but 

will trade in other instruments within the group or 

sector upon inquiry from customers and other 

dealers); Oliver Wyman (Feb. 2012) (discussing data 

regarding the number of U.S. corporate bonds and 

frequency of trading in such bonds in 2009). 638See Goldman (Prop. Trading). 639See, e.g., RBC (recommending that the 

Agencies clarify that a trading desk is required to 

hold itself out as willing to buy and sell a particular 

type of ‘‘product’’); SIFMA et al. (Prop. Trading) 

(Feb. 2012) (suggesting that the Agencies use the 

term ‘‘instrument,’’ rather than ‘‘covered financial 

position,’’ to provide greater clarity); CIEBA 

(supporting alternative criteria that would require a 

banking entity to hold itself out generally as a 

market maker for the relevant asset class, but not 

for every instrument it purchases and sells); 

Goldman (Prop. Trading). One of these commenters 

recommended that the Agencies recognize and 

permit the following kinds of activity in related 

financial instruments: (i) Options market makers 

should be deemed to be engaged in market making 

in all put and call series related to a particular 

underlying security and should be permitted to 

trade the underlying security regardless of whether 

such trade qualifies for the hedging exemption; (ii) 

convertible bond traders should be permitted to 

trade in the associated equity security; (iii) a market 

maker in one issuer’s bonds should be considered 

a market maker in similar bonds of other issuers; 

and (iv) a market maker in standardized interest 

rate swaps should be considered to be engaged in 

market making-related activity if it engages in a 

customized interest rate swap with a customer upon 

request. See RBC. 

640See, e.g., Morgan Stanley (suggesting that the 

Agencies add the phrase ‘‘or, in markets where 

regular or continuous quotes are not typically 

provided, the trading unit stands ready to provide 

quotes upon request’’); Barclays (suggesting 

addition of the phrase ‘‘to the extent that two-sided 

markets are typically made by market makers in a 

given product,’’ as well as changing the reference 

to ‘‘purchase or sale’’ to ‘‘market making-related 

activity’’ to avoid any inference of a trade-by-trade 

analysis). See also Fixed Income Forum/Credit 

Roundtable. To address concerns about the 

requirement’s application to bespoke products, one 

commenter suggested that the rule clearly state that 

a banking entity fulfills this requirement if it 

markets structured transactions to its client base 

and stands ready to enter into such transactions 

with customers, even though transactions may 

occur on a relatively infrequent basis. See JPMC. 

641See Wells Fargo (Prop. Trading); RBC 

(supporting this approach as an alternative to 

removing the requirement from the rule, but 

primarily supporting its removal). See also ISDA 

(Feb. 2012) (stating that the analysis of compliance 

with the proposed requirement must carefully 

consider the degree of presence a market maker 

wishes to have in a given market, which may 

include being a leader in certain types of 

instruments, having a secondary presence in others, 

and potentially leaving or entering other 

submarkets). 

642See SIFMA et al. (Prop. Trading) (Feb. 2012). 

This commenter also suggested that such test be 

assessed at the ‘‘trading unit’’ level. See id. 

643See Goldman (Prop. Trading). 

644See FTN. 

645See Flynn & Fusselman; JPMorgan. 

646See JPMC. 

647See, e.g., Occupy; AFR et al. (Feb. 2012); 

Public Citizen; Johnson & Prof. Stiglitz; John Reed. 

See infra note 751 and accompanying text 

(responding to these comments). 

648See Occupy. 

commenters provided views on 

statements in the proposal regarding 

indicia of bona fide market making in 

more and less liquid markets and the 

permissibility of block positioning and 

anticipatory position-taking. 

Several commenters represented that 

the proposed requirement was too 

restrictive.633 For example, a number of 

these commenters expressed concern 

that the proposed requirement may limit 

a banking entity’s ability to act as a 

market maker under certain 

circumstances, including in less liquid 

markets, for instruments lacking a twosided market, or in customer-driven, 

structured transactions.634 In addition, a 

few commenters expressed specific 

concern about how this requirement 

would impact more limited marketmaking activity conducted by banks.635

Many commenters indicated that it 

was unclear whether this provision 

would require a trading desk or other 

organizational unit to regularly or 

continuously quote every financial 

instrument in which a market is made, 

but expressed concern that the proposed 

language could be interpreted in this 

manner.636 These commenters noted 

that there are thousands of individual 

instruments within a given asset class, 

such as corporate bonds, and that it 

would be burdensome for a market 

maker to provide quotes in such a large 

number of instruments on a regular or 

continuous basis.637 One of these 

commenters represented that, because 

customer demand may be infrequent in 

a particular instrument, requiring a 

banking entity to provide regular or 

continuous quotes in the instrument 

may not provide a benefit to its 

customers.638 A few commenters 

requested that the Agencies provide 

further guidance on this issue or modify 

the proposed standard to state that 

holding oneself out in a range of similar 

instruments will be considered to be 

within the scope of permitted market 

making-related activities.639

To address concerns about the 

restrictiveness of this requirement, 

commenters suggested certain 

modifications. For example, some 

commenters suggested adding language 

to the requirement to account for market 

making in markets that do not typically 

involve regular or continuous, or twosided, quoting.640 In addition, a few 

commenters requested that the 

requirement expressly include 

transactions in new instruments or 

transactions in instruments that occur 

infrequently to address situations where 

a banking entity may not have 

previously had the opportunity to hold 

itself out as willing to buy and sell the 

applicable instrument.641 Other 

commenters supported alternative 

criteria for assessing whether a banking 

entity is acting as a market maker, such 

as: (i) A willingness to respond to 

customer demand by providing prices 

upon request; 642 (ii) being in the 

business of providing prices upon 

request for that financial instrument or 

other financial instruments in the same 

or similar asset class or product 

class; 643 or (iii) a historical test of 

market-making activity, with 

compliance judged on the basis of actual 

trades.644 Finally, two commenters 

stated that this requirement should be 

moved to Appendix B of the rule,645

which, according to one of these 

commenters, would provide the 

Agencies greater flexibility to consider 

the facts and circumstances of a 

particular activity.646

Other commenters took the view that 

the proposed requirement was too 

permissive.647 For example, one 

commenter stated that the proposed 

standard provided too much room for 

interpretation and would be difficult to 

measure and monitor. This commenter 

expressed particular concern that a 

trading desk or other organizational unit 

could meet this requirement by 

regularly or continuously making wide, 

out of context quotes that do not present 

any real risk of execution and do not 

contribute to market liquidity.648 Some 

commenters suggested the Agencies 

place greater restrictions on a banking 

entity’s ability to rely on the marketmaking exemption in certain illiquid 


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649See Occupy; AFR et al. (Feb. 2012); Public 

Citizen; Johnson & Prof. Stiglitz; Sens. Merkley & 

Levin (Feb. 2012); John Reed. 

650See AFR et al. (Feb. 2012); Occupy. 

651See Occupy. 

652See John Reed. 

653See Johnson & Prof. Stiglitz. 

654See Sens. Merkley & Levin (Feb. 2012) (stating 

that a banking entity must have or reasonably 

expect at least two customers—one for each side of 

the trade—and must have a reasonable expectation 

of the second customer coming to take the position 

or risk off its books in the ‘‘near term’’); AFR et al. 

(Feb. 2012); Public Citizen. 

655See AFR et al. (Feb. 2012) (stating that the rule 

should ban market making in illiquid and opaque 

securities with no genuine external market, but 

permit market making in somewhat illiquid 

securities, such as certain corporate bonds, as long 

as the securities can be reliably valued with 

reference to other extremely similar securities that 

are regularly traded in liquid markets and the 

financial outcome of the transaction is reasonably 

predictable); Johnson & Prof. Stiglitz 

(recommending that permitted market making be 

limited to assets that can be reliably valued in, at 

a minimum, a moderately liquid market evidenced 

by trading within a reasonable period, such as a 

week, through a real transaction and not simply 

with interdealer trades); Public Citizen (stating that 

market making should be limited to assets that can 

be reliably valued in a market where transactions 

take place on a weekly basis). 

656See AFR et al. (Feb. 2012) (stating that such 

a limitation would be consistent with the proposed 

limitation on ‘‘high-risk assets’’ and the discussion 

of this limitation in proposed Appendix C); Public 

Citizen; Prof. Richardson. 

657See Prof. Richardson. 

658Two commenters recommended that banking 

entities be required to treat trading in assets that 

cannot be reliably valued and that trade only by 

appointment, such as bespoke derivatives and 

structured products, as providing an illiquid 

bespoke loan, which are subject to higher capital 

charges under the Federal banking agencies’ capital 

rules. See Johnson & Prof. Stiglitz; John Reed. 

Another commenter suggested that, if not directly 

prohibited, trading in bespoke instruments that 

cannot be reliably valued should be assessed an 

appropriate capital charge. See Public Citizen. 

659See Occupy. This commenter further 

suggested that the exemption exclude all activities 

that include: (i) Assets whose changes in value 

cannot be mitigated by effective hedges; (ii) new 

products with rapid growth, including those that do 

not have a market history; (iii) assets or strategies 

that include significant imbedded leverage; (iv) 

assets or strategies that have demonstrated 

significant historical volatility; (v) assets or 

strategies for which the application of capital and 

liquidity standards would not adequately account 

for the risk; and (vi) assets or strategies that result 

in large and significant concentrations to sectors, 

risk factors, or counterparties. See id. 

660See AFR et al. (Feb. 2012); Johnson & Prof. 

Stiglitz. 

661See supra Part VI.A.3.c.1.a. 

662See Occupy; AFR et al. (Feb. 2012); NYSE 

Euronext (expressing support for the indicia set 

forth in the FSOC study, which are substantially the 

same as the indicia in the proposal); Alfred Brock. 

663See AFR et al. (Feb. 2012). 

664See Goldman (Prop. Trading); SIFMA et al. 

(Prop. Trading) (Feb. 2012). 

665See ICI (Feb. 2012); ICI Global. 

666See supra Part VI.A.3.c.1.a. 

markets, such as assets that cannot be 

reliably valued, products that do not 

have a genuine external market, or 

instruments for which a banking entity 

does not expect to have customers 

wishing to both buy and sell.649 In 

support of these requests, commenters 

stated that trading in illiquid products 

raises certain concerns under the rule, 

including: A lack of reliable data for 

purposes of using metrics to monitor a 

banking entity’s market making-related 

activity (e.g., products whose valuations 

are determined by an internal model 

that can be manipulated, rather than an 

observable market price); 650 relation to 

the last financial crisis; 651 lack of 

important benefits to the real 

economy; 652 similarity to prohibited 

proprietary trading; 653 and 

inconsistency with the statute’s 

requirements that market makingrelated activity must be ‘‘designed not to 

exceed the reasonably expected near 

term demands of clients, customers, or 

counterparties’’ and must not result in 

a material exposure to high-risk assets 

or high-risk trading strategies.654

These commenters also requested that 

the proposed requirement be modified 

in certain ways. In particular, several 

commenters stated that the proposed 

exemption should only permit market 

making in assets that can be reliably 

valued through external market 

transactions.655 In order to implement 

such a limitation, three commenters 

suggested that the Agencies prohibit 

banking entities from market making in 

assets classified as Level 3 under FAS 

157.656 One of these commenters 

explained that Level 3 assets are 

generally highly illiquid assets whose 

fair value cannot be determined using 

either market prices or models.657 In 

addition, a few commenters suggested 

that banking entities be subject to 

additional capital charges for market 

making in illiquid products.658 Another 

commenter stated that the Agencies 

should require all market makingrelated activity to be conducted on a 

multilateral organized electronic trading 

platform or exchange to make it possible 

to monitor and confirm certain trading 

data.659 Two commenters emphasized 

that their recommended restrictions on 

market making in illiquid markets 

should not prohibit banking entities 

from making markets in corporate 

bonds.660

i. The Proposed Indicia 

As noted above, the proposal set forth 

certain indicia of bona fide market 

making-related activity in liquid and 

less liquid markets that the Agencies 

proposed to apply when evaluating 

whether a banking entity was eligible 

for the proposed exemption.661 Several 

commenters provided their views 

regarding the effectiveness of the 

proposed indicia. 

With respect to the proposed indicia 

for liquid markets, a few commenters 

expressed support for the proposed 

indicia.662 One of these commenters 

stated that while the proposed factors 

are reasonably consistent with bona fide 

market making, the Agencies should 

add two other factors: (i) A willingness 

to transact in reasonable quantities at 

quoted prices, and (ii) inventory 

turnover.663

Other commenters, however, stated 

that the proposed use of factors from the 

SEC’s analysis of bona fide market 

making under Regulation SHO was 

inappropriate in this context. In 

particular, these commenters 

represented that bona fide market 

making for purposes of Regulation SHO 

is a purposefully narrow concept that 

permits a subset of market makers to 

qualify for an exception from the 

‘‘locate’’ requirement in Rule 203 of 

Regulation SHO. The commenters 

further expressed the belief that the 

policy goals of section 13 of the BHC 

Act do not necessitate a similarly 

narrow interpretation of market 

making.664

A few commenters expressed 

particular concern about how the factor 

regarding patterns of purchases and 

sales in roughly comparable amounts 

would apply to market making in 

exchange-traded funds (‘‘ETFs’’). 

According to these commenters, 

demonstrating this factor could be 

difficult because ETF market making 

involves a pattern of purchases and 

sales of groups of equivalent securities 

(i.e., the ETF shares and the basket of 

securities and cash that is exchanged for 

them), not a single security. In addition, 

the commenters were unsure whether 

this factor could be demonstrated in 

times of limited trading in ETF 

shares.665

The preamble to the proposed rule 

also provided certain proposed indicia 

of bona fide market making-related 

activity in less liquid markets.666 As 

discussed above, commenters had 

differing views about whether the 

exemption for market making-related 

activity should permit banking entities 

to engage in market making in some or 

all illiquid markets. Thus, with respect 

to the proposed indicia for market 

making in less liquid markets, 

commenters generally stated that the 

indicia should be broader or narrower, 

depending on the commenter’s overall 

view on the issue of market making in 

illiquid markets. One commenter stated 


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667See Alfred Brock. 

668See supra note 634 accompanying text. With 

respect to this factor, one commenter requested that 

the Agencies delete the parenthetical of ‘‘but not 

necessarily continuous’’ from the proposed factor as 

part of a broader effort to recognize the relative 

illiquidity of swap markets. See ISDA (Feb. 2012). 

669See SIFMA et al. (Prop. Trading) (Feb. 2012); 

CIEBA. These commenters requested greater clarity 

or guidance on the meaning of ‘‘regular’’ in the 

instance of a market maker trading only by 

appointment. See id. 

670See Goldman (Prop. Trading). 

671See Public Citizen; Occupy. One of these 

commenters further noted that most markets lack a 

structural framework that would enable monitoring 

of compliance with this requirement. See Occupy. 

672See, e.g., Sens. Merkley & Levin (Feb. 2012); 

Johnson & Prof. Stiglitz; John Reed; Public Citizen. 

673See, e.g., John Reed; Public Citizen. 

674See AFR et al. (Feb. 2012); Occupy. 

675See AFR et al. (Feb. 2012) 

676See Occupy. 

677See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Goldman (Prop. Trading); Occupy. 

678See Goldman (Prop. Trading). 

679See Occupy. 

680See Joint Proposal, 76 FR at 68871. 

681See, e.g., RBC; SIFMA (Asset Mgmt.) (Feb. 

2012); Goldman (Prop. Trading). See also infra note 

740 (responding to these comments). 

682See RBC (expressing concern about fire sales); 

SIFMA (Asset Mgmt.) (Feb. 2012) (expressing 

concern about fire sales, particularly in less liquid 

markets where a block position would overwhelm 

the market and undercut the price a market maker 

can obtain); Goldman (Prop. Trading) (representing 

that this requirement could create uncertainty about 

whether a longer unwind would be permissible 

and, if so, under what circumstances). 

683See Goldman (Prop. Trading). 

684See RBC. 

685See SIFMA (Asset Mgmt.) (Feb. 2012); Fidelity 

(requesting that the Agencies explicitly recognize 

that block trades qualify for the market-making 

exemption); Oliver Wyman (Feb. 2012). 

that the proposed indicia are 

effective.667

The first proposed factor of market 

making-related activity in less liquid 

markets was holding oneself out as 

willing and available to provide 

liquidity by providing quotes on a 

regular (but not necessarily continuous) 

basis. As noted above, several 

commenters expressed concern about a 

requirement that market makers provide 

regular quotations in less liquid 

instruments, including in fixed income 

markets and bespoke, customized 

derivatives.668 With respect to the 

interaction between the rule language 

requiring ‘‘regular’’ quoting and the 

proposal’s language permitting trading 

by appointment under certain 

circumstances, some of these 

commenters expressed uncertainty 

about how a market maker trading only 

by appointment would be able to satisfy 

the proposed rule’s regular quotation 

requirement.669 In addition, another 

commenter stated that the proposal’s 

recognition of trading by appointment 

does not alleviate concerns about 

applying the ‘‘regular’’ quotation 

requirement to market making in less 

liquid instruments in markets that are 

not, as a whole, highly illiquid, such as 

credit and interest rate markets.670

Other commenters expressed concern 

about only requiring a market maker to 

provide regular quotations or permitting 

trading by appointment to qualify for 

the market-making exemption. With 

respect to regular quotations, some 

commenters stated that such a 

requirement enables evasion of the 

prohibition on proprietary trading 

because a proprietary trader may post a 

quote at a time of little interest in a 

financial product or may post wide, out 

of context quotes on a regular basis with 

no real risk of execution.671 Several 

commenters stated that trading only by 

appointment should not qualify as 

market making for purposes of the 

proposed rule.672 Some of these 

commenters stated that there is no 

‘‘market’’ for assets that trade only by 

appointment, such as customized, 

structured products and OTC 

derivatives.673

The second proposed criterion for 

market making-related activity in less 

liquid markets was, with respect to 

securities, regularly purchasing 

securities from, or selling securities to, 

clients, customers, or counterparties in 

the secondary market. Two commenters 

expressed concern about this proposed 

factor.674 In particular, one of these 

commenters stated that the language is 

fundamentally inconsistent with market 

making because it contemplates that 

only taking one side of the market is 

sufficient, rather than both buying and 

selling an instrument.675 The other 

commenter expressed concern that 

banking entities would be allowed to 

accumulate a significant amount of 

illiquid risk because the indicia for 

market making-related activity in less 

liquid markets did not require a market 

maker to buy and sell in comparable 

amounts (as required by the indicia for 

liquid markets).676

Finally, the third proposed factor of 

market making in less liquid markets 

would consider transaction volumes 

and risk proportionate to historical 

customer liquidity and investment 

needs. A few commenters indicated that 

there may not be sufficient information 

available for a banking entity to conduct 

such an analysis.677 For example, one 

commenter stated that historical 

information may not necessarily be 

available for new businesses or 

developing markets in which a market 

maker may seek to establish trading 

operations.678 Another commenter 

expressed concern that this factor would 

not help differentiate market making 

from prohibited proprietary trading 

because most illiquid markets do not 

have a source for such historical risk 

and volume data.679

ii. Treatment of Block Positioning 

Activity 

The proposal provided that the 

activity described in § 75.4(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.680

A number of commenters supported 

the general language in the proposal 

permitting block positioning, but 

expressed concern about the reference 

to the definition of ‘‘qualified block 

positioner’’ in SEC Rule 3b–8(c).681

With respect to using Rule 3b–8(c) as 

guidance under the proposed rule, these 

commenters represented that Rule 3b– 

8(c)’s requirement to resell block 

positions ‘‘as rapidly as possible’’ would 

cause negative results (e.g., fire sales) or 

create market uncertainty (e.g., when, if 

ever, a longer unwind would be 

permitted).682 According to one of these 

commenters, gradually disposing of a 

large long position purchased from a 

customer may be the best means of 

reducing near term price volatility 

associated with the supply shock of 

trying to sell the position at once.683

Another commenter expressed concern 

about the second requirement of Rule 

3b–8(c), which provides that the dealer 

must determine in the exercise of 

reasonable diligence that the block 

cannot be sold to or purchased from 

others on equivalent or better terms. 

This commenter stated that this kind of 

determination would be difficult in less 

liquid markets because those markets do 

not have widely disseminated quotes 

that dealers can use for purposes of 

comparison.684

Beyond the reference to Rule 3b–8(c), 

a few commenters expressed more 

general concern about the proposed 

rule’s application to block positioning 

activity.685 One commenter noted that 

the proposal only discussed block 

positioning in the context of the 

proposed requirement to hold oneself 

out, which implies that block 

positioning activity also must meet the 

other requirements of the marketmaking exemption. This commenter 

requested an explicit recognition that 

banking entities meet the requirements 

of the market-making exemption when 

they enter into block trades for 

customers, including related trades 

entered to support the block, such as 


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686See SIFMA (Asset Mgmt.) (Feb. 2012). 

687See Oliver Wyman (Feb. 2012). This 

commenter estimated that investors trading out of 

large block positions on their own, without a 

market maker directly providing liquidity, would 

have to pay incremental transaction costs between 

$1.7 and $3.4 billion per year. This commenter 

estimated a block trading size of $850 billion, based 

on a haircut of total block trading volume reported 

for NYSE and Nasdaq. The commenter then 

estimated, based on market interviews and analysis 

of standard market impact models provided by 

dealers, that the market impact of executing large 

block orders without direct market maker liquidity 

provision would be the difference between the 

market impact costs of executing a block trade over 

a 5-day period versus a 1-day period—which would 

be approximately 20 to 50 basis points, depending 

on the size of the trade. See id. 

688 Joint Proposal, 76 FR at 68871; CFTC Proposal, 

77 FR at 8356–8357. 

689See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012) (expressing concern that requiring trades to 

be related to clear demonstrable trading interest 

could curtail the market-making function by 

removing a market maker’s discretion to develop 

inventory to best serve its customers and adversely 

restrict liquidity); Goldman (Prop. Trading); 

Chamber (Feb. 2012); Comm. on Capital Markets 

Regulation. See also Morgan Stanley (requesting 

certain revisions to more closely track the statute); 

SIFMA (Asset Mgmt.) (Feb. 2012) (expressing 

general concern that the standard creates 

limitations on a market maker’s inventory). These 

comments are addressed in Part VI.A.3.c.2., infra. 

690See Goldman (Prop. Trading); Occupy. See 

also Public Citizen (expressing general concern that 

accumulating positions in anticipation of demand 

opens issues of front running). 

691See Goldman (Prop. Trading). 

692See Occupy. 

693See Goldman (Prop. Trading); ISDA (Feb. 

2012); SIFMA et al. (Prop. Trading) (Feb. 2012). 

694See BoA (stating that a market maker must 

acquire inventory in advance of express customer 

demand and customers expect a market maker’s 

inventory to include not only the financial 

instruments in which customers have previously 

traded, but also instruments that the banking entity 

believes they may want to trade); Occupy. 

695See Morgan Stanley (suggesting a new 

standard providing that a purchase or sale must be 

‘‘reasonably consistent with observable customer 

demand patterns and, in the case of new asset 

classes or markets, with reasonably expected future 

developments on the basis of the trading unit’s 

client relationships’’); Chamber (Feb. 2012) 

(requesting that the final rule permit market makers 

to make individualized assessments of anticipated 

customer demand based on their expertise and 

experience in the markets and make trades 

according to those assessments); Goldman (Prop. 

Trading) (recommending that the Agencies instead 

focus on how trading activities are ‘‘designed’’ to 

meet the reasonably expected near term demands of 

clients over time, rather than whether those 

demands have actually manifested themselves at a 

given point in time); ISDA (Feb. 2012) (stating that 

the Agencies should clarify this language to 

recognize differences between liquid and illiquid 

markets and noting that illiquid and low volume 

markets necessitate that swap dealers take a longer 

and broader view than dealers in liquid markets). 

696See, e.g., Better Markets (Feb. 2012); Occupy; 

Public Citizen. 

697See Better Markets (Feb. 2012). See also infra 

note 747 (addressing this issue). 

698See Occupy. 

699See supra Part VI.A.3.c.1.b. (discussing 

comments on this issue). The Agencies did not 

intend for the reference to ‘‘covered financial 

Continued 

hedging transactions.686 Finally, one 

commenter expressed concern that the 

inventory metrics in proposed 

Appendix A would make dealers 

reluctant to execute large, principal 

transactions because such trades would 

have a transparent impact on inventory 

metrics in the relevant asset class.687

iii. Treatment of Anticipatory Market 

Making 

In the proposal, the Agencies 

proposed that ‘‘bona fide market 

making-related activity may include 

taking positions in securities in 

anticipation of customer demand, so 

long as any anticipatory buying or 

selling activity is reasonable and related 

to clear, demonstrable trading interest of 

clients, customers, or 

counterparties.’’ 688 Many commenters 

indicated that the language in the 

proposal is inconsistent with the 

statute’s language regarding near term 

demands of clients, customers, or 

counterparties. According to these 

commenters, the statute’s ‘‘designed’’ 

and ‘‘reasonably expected’’ language 

expressly acknowledges that a market 

maker may need to accumulate 

inventory before customer demand 

manifests itself. Commenters further 

represented that the proposed standard 

may unduly limit a banking entity’s 

ability to accumulate inventory in 

anticipation of customer demand.689

In addition, two commenters 

expressed concern that the proposal’s 

language would effectively require a 

banking entity to engage in 

impermissible front running.690 One of 

these commenters indicated that the 

Agencies should not restrict 

anticipatory trading to such a short time 

period.691 To the contrary, the other 

commenter stated that anticipatory 

accumulation of inventory should be 

considered to be prohibited proprietary 

trading.692 A few commenters noted that 

the standard in the proposal explicitly 

refers to securities and requested that 

the reference be changed to encompass 

the full scope of financial instruments 

covered by the rule to avoid 

ambiguity.693 Several commenters 

recommended that the language be 

eliminated 694 or modified 695 to address 

the concerns discussed above. 

iv. High-Frequency Trading 

A few commenters stated that highfrequency trading should be considered 

prohibited proprietary trading under the 

rule, not permitted market makingrelated activity.696 For example, one 

commenter stated that the Agencies 

should not confuse high volume trading 

and market making. This commenter 

emphasized that algorithmic traders in 

general—and high-frequency traders in 

particular—do not hold themselves out 

in the manner required by the proposed 

rule, but instead only offer to buy and 

sell when they think it is profitable.697

Another commenter suggested the 

Agencies impose a resting period on any 

order placed by a banking entity in 

reliance on any exemption in the rule 

by, for example, prohibiting a banking 

entity from buying and subsequently 

selling a position within a span of two 

seconds.698

c. Final Requirement To Routinely 

Stand Ready To Purchase and Sell 

Section 75.4(b)(2)(i) of the final rule 

provides that the trading desk that 

establishes and manages the financial 

exposure must routinely stand ready to 

purchase and sell one or more types of 

financial instruments related to its 

financial exposure and be willing and 

available to quote, buy and sell, or 

otherwise enter into long and short 

positions in those types of financial 

instruments for its own account, in 

commercially reasonable amounts and 

throughout market cycles, on a basis 

appropriate for the liquidity, maturity, 

and depth of the market for the relevant 

types of financial instruments. As 

discussed in more detail below, the 

standard of ‘‘routinely’’ standing ready 

to purchase and sell one or more types 

of financial instruments will be 

interpreted to account for differences 

across markets and asset classes. In 

addition, this requirement provides that 

a trading desk must be willing and 

available to provide quotations and 

transact in the particular types of 

financial instruments in commercially 

reasonable amounts and throughout 

market cycles. Thus, a trading desk’s 

activities would not meet the terms of 

the market-making exemption if, for 

example, the trading desk only provides 

wide quotations on one or both sides of 

the market relative to prevailing market 

conditions or is only willing to trade on 

an irregular, intermittent basis. 

While this provision of the marketmaking exemption has some similarity 

to the requirement to hold oneself out 

in § 75.4(b)(2)(ii) of the proposed rule, 

the Agencies have made a number of 

refinements in response to comments. 

Specifically, a number of commenters 

expressed concern that the proposed 

requirement did not sufficiently account 

for differences between markets and 

asset classes and would unduly limit 

certain types of market making by 

requiring ‘‘regular or continuous’’ 

quoting in a particular instrument.699


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position’’ in the proposed rule to imply a single 

instrument, although commenters contended that 

the proposal may not have been sufficiently clear 

on this point. 700 Joint Proposal, 76 FR at 68871; CFTC Proposal, 

77 FR at 8356. 701See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); Morgan Stanley; Barclays; Goldman (Prop. 

Trading); ABA; Chamber (Feb. 2012); BDA (Feb. 

2012); Fixed Income Forum/Credit Roundtable; 

ACLI (Feb. 2012); T. Rowe Price; PUC Texas; PNC; 

MetLife; RBC; SSgA (Feb. 2012). Some commenters 

suggested alternative criteria, such as providing 

prices upon request, using a historical test of market 

making, or a purely guidance-based approach. See 

SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman 

(Prop. Trading); FTN; Flynn & Fusselman; JPMC. 

The Agencies are not adopting a requirement that 

the trading desk only provide prices upon request 

because the Agencies believe it would be 

inconsistent with market making in liquid 

exchange-traded instruments where market makers 

regularly or continuously post quotes on an 

exchange. With respect to one commenter’s 

suggested approach of a historical test of market 

making, this commenter did not provide enough 

information about how such a test would work for 

the Agencies’ consideration. Finally, the final rule 

does not adopt a purely guidance-based approach 

because, as discussed further above, the Agencies 

believe it could lead to an increased risk of evasion. 

702See Further Definition of ‘‘Swap Dealer,’’ 

‘‘Security-Based Swap Dealer,’’ ‘‘Major Swap 

Participant,’’ ‘‘Major Security-Based Swap 

Participant’’ and ‘‘Eligible Contract Participant,’’ 77 

FR 30596, 30609 (May 23, 2012) (describing market 

making in swaps as ‘‘routinely standing ready to 

enter into swaps at the request or demand of a 

counterparty’’). 703As a result, activity that is considered market 

making under this final rule may not necessarily be 

considered market making for purposes of other 

laws or regulations, such as the U.S. securities laws, 

the rules and regulations thereunder, or selfregulatory organization rules. In addition, the 

Agencies note that a banking entity acting as an 

underwriter would continue to be treated as an 

underwriter for purposes of the securities laws and 

the regulations thereunder, including any liability 

arising under the securities laws as a result of acting 

in such capacity, regardless of whether it is able to 

meet the terms of the market-making exemption for 

its activities. See Sens. Merkley & Levin (Feb. 2012). 

704See Joint Proposal, 76 FR at 68957; CFTC 

Proposal, 77 FR at 8436. 

705See Wellington; SIFMA et al. (Prop. Trading) 

(Feb. 2012). 

706Morgan Stanley. 

707See Joint Proposal, 76 FR at 68957 n.2. 

708See, e.g., Occupy (expressing concern that, 

with respect to the proposed definition of ‘‘trading 

unit,’’ an ‘‘oversized’’ unit could combine 

significantly unrelated trading desks, which would 

impede detection of proprietary trading activity). 

709The Agencies recognize that the proposed 

rule’s application to a trading desk ‘‘or other 

organizational unit’’ would have provided banking 

entities with this type of flexibility to determine the 

level of organization at which the market-making 

exemption should apply based on the entity’s 

particular business structure and trading strategies, 

which would likely reduce the burdens of this 

aspect of the final rule. However, for the reasons 

noted above regarding application of this exemption 

to a higher organizational level than the trading 

The explanation of this requirement in 

the proposal was intended to address 

many of these concerns. For example, 

the Agencies stated that the proposed 

‘‘indicia cannot be applied at all times 

and under all circumstances because 

some may be inapplicable to the specific 

asset class or market in which the 

market-making activity is 

conducted.’’ 700 Nonetheless, the 

Agencies believe that certain 

modifications are warranted to clarify 

the rule and to prevent a potential 

chilling effect on market making-related 

activities conducted by banking entities. 

Commenters represented that the 

requirement that a trading desk hold 

itself out as being willing to buy and sell 

‘‘on a regular or continuous basis,’’ as 

was originally proposed, was impossible 

to meet or impractical in the context of 

many markets, especially less liquid 

markets.701 Accordingly, the final rule 

requires a trading desk that establishes 

and manages the financial exposure to 

‘‘routinely’’ stand ready to trade one or 

more types of financial instruments 

related to its financial exposure. As 

discussed below, the meaning of 

‘‘routinely’’ will account for the 

liquidity, maturity, and depth of the 

market for a type of financial 

instrument, which should address 

commenter concern that the proposed 

standard would not work in less liquid 

markets and would have a chilling effect 

on banking entities’ ability to act as 

market makers in less liquid markets. A 

concept of market making that is 

applicable across securities, commodity 

futures, and derivatives markets has not 

previously been defined by any of the 

Agencies. Thus, while this standard is 

based generally on concepts from the 

securities laws and is consistent with 

the CFTC’s and SEC’s description of 

market making in swaps,702 the 

Agencies note that it is not directly 

based on an existing definition of 

market making.703 Instead, the approach 

taken in the final rule is intended to 

take into account and accommodate the 

conditions in the relevant market for the 

financial instrument in which the 

banking entity is making a market. 

i. Definition of ‘‘Trading Desk’’ 

The Agencies are adopting a marketmaking exemption with requirements 

that generally focus on a financial 

exposure managed by a ‘‘trading desk’’ 

of a banking entity and such trading 

desk’s market-maker inventory. The 

market-making exemption as originally 

proposed would have applied to ‘‘a 

trading desk or other organizational 

unit’’ of a banking entity. In addition, 

for purposes of the proposed 

requirement to report and record certain 

quantitative measurements, the proposal 

defined the term ‘‘trading unit’’ as each 

of the following units of organization of 

a banking entity: (i) Each discrete unit 

that is engaged in the coordinated 

implementation of a revenue-generation 

strategy and that participates in the 

execution of any covered trading 

activity; (ii) each organizational unit 

that is used to structure and control the 

aggregate risk-taking activities and 

employees of one or more trading units 

described in paragraph (i); and (iii) all 

trading operations, collectively.704

The Agencies received few comments 

regarding the organizational level at 

which the requirements of the marketmaking exemption should apply, and 

many of the commenters that addressed 

this issue did not describe their 

suggested approach in detail.705 One 

commenter suggested that the marketmaking exemption apply to each 

‘‘trading unit’’ of a banking entity, 

defined as ‘‘each organizational unit 

that is used to structure and control the 

aggregate risk-taking activities and 

employees that are engaged in the 

coordinated implementation of a 

customer-facing revenue generation 

strategy and that participate in the 

execution of any covered trading 

activity.’’ 706 This suggested approach is 

substantially similar to the second 

prong of the Agencies’ proposed 

definition of ‘‘trading unit’’ in Appendix 

A of the proposal. The Agencies 

described this prong as generally 

including management or reporting 

divisions, groups, sub-groups, or other 

intermediate units of organization used 

by the banking entity to manage one or 

more discrete trading units (e.g., ‘‘North 

American Credit Trading,’’ ‘‘Global 

Credit Trading,’’ etc.).707 The Agencies 

are concerned that this commenter’s 

suggested approach, or any other 

approach applying the exemption’s 

requirements to a higher level of 

organization than the trading desk, 

would impede monitoring of market 

making-related activity and detection of 

impermissible proprietary trading by 

combining a number of different trading 

strategies and aggregating a larger 

volume of trading activities.708 Further, 

key requirements in the market-making 

exemption, such as the required limits 

and risk management procedures, are 

generally used by banking entities for 

risk control and applied at the trading 

desk level. Thus, applying them at a 

broader organizational level than the 

trading desk would create a separate 

system for compliance with this 

exemption designed to permit a banking 

entity to aggregate disparate trading 

activities and apply limits more 

generally. Applying the conditions of 

the exemption at a more aggregated 

level would allow banking entities more 

flexibility in trading and could result in 

a higher volume of trading that could 

contribute modestly to liquidity.709


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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 5863 

desk, the Agencies are not adopting the ‘‘or other 

organizational unit’’ language. 

710See final rule § 75.3(e)(13). 

711For example, the Agencies expect a banking 

entity may determine the foreign exchange options 

desk to be a trading desk; however, the Agencies 

do not expect a banking entity to consider an 

individual Japanese Yen options trader (i.e., the 

trader in charge of all Yen-based options trades) as 

a trading desk, unless the banking entity manages 

its profit and loss, market making, and hedging in 

Japanese Yen options independently of all other 

financial instruments. 

712See infra note 729 and accompanying text. 

Several commenters noted that market-making 

activities may be conducted across separate 

affiliated legal entities. See, e.g., SIFMA et al. (Prop. 

Trading) (Feb. 2012); Goldman (Prop. Trading). 

713See infra note 732 and accompanying text. 

Instead of taking that approach, the 

Agencies have determined to permit a 

broader range of market making-related 

activities that can be effectively 

controlled by building on risk controls 

used by trading desks for business 

purposes. This will allow an individual 

trader to use instruments or strategies 

within limits established in the 

compliance program to confidently 

trade in the type of financial 

instruments in which his or her trading 

desk makes a market. The Agencies 

believe this addresses concerns that 

uncertainty would negatively impact 

liquidity. It also addresses concerns that 

applying the market-making exemption 

at a higher level of organization would 

reduce the effectiveness of the 

requirements in the final rule aimed at 

ensuring that the quality and character 

of trading is consistent with market 

making-related activity and would 

increase the risk of evasion. Moreover, 

several provisions of the final rule are 

intended to account for the liquidity, 

maturity, and depth of the market for a 

given type of financial instrument in 

which the trading desk makes a market. 

The final rule takes account of these 

factors to, among other things, respond 

to commenters’ concerns about the 

proposed rule’s potential impact on 

market making in less liquid markets. 

Applying these requirements at an 

organizational level above the trading 

desk would be more likely to result in 

aggregation of trading in various types 

of instruments with differing levels of 

liquidity, which would make it more 

difficult for these market factors to be 

taken into account for purposes of the 

exemption (for example, these factors 

are considered for purposes of tailoring 

the analysis of reasonably expected 

near-term demands of customers and 

establishing risk, inventory, and 

duration limits). 

Thus, the Agencies continue to 

believe that certain requirements of the 

exemption should apply to a relatively 

granular level of organization within a 

banking entity (or across two or more 

affiliated banking entities). These 

requirements of the final market-making 

exemption have been formulated to best 

reflect the nature of activities at the 

trading desk level of granularity. 

As explained below, the Agencies are 

applying certain requirements to a 

‘‘trading desk’’ of a banking entity and 

adopting a definition of this term in the 

final rule.710 The definition of ‘‘trading 

desk’’ is similar to the first prong of the 

proposed definition of ‘‘trading unit.’’ 

The Agencies are not adopting the 

proposed ‘‘or other organizational unit’’ 

language because the Agencies are 

concerned that approach would have 

provided banking entities with too 

much discretion to independently 

determine the organizational level at 

which the requirements should apply, 

including a more aggregated level of 

organization, which could lead to 

evasion of the general prohibition on 

proprietary trading and the other 

concerns noted above. The Agencies 

believe that adopting an approach 

focused on the trading desk level will 

allow banking entities and the Agencies 

to better distinguish between permitted 

market making-related activities and 

trading that is prohibited by section 13 

of the BHC Act and, thus, will prevent 

evasion of the statutory requirements, as 

discussed in more detail below. Further, 

as discussed below, the Agencies 

believe that applying requirements at 

the trading desk level is balanced by the 

financial exposure-based approach, 

which will address commenters’ 

concerns about the burdens of trade-bytrade analyses. 

In the final rule, trading desk is 

defined to mean the smallest discrete 

unit of organization of a banking entity 

that buys or sells financial instruments 

for the trading account of the banking 

entity or an affiliate thereof. The 

Agencies expect that a trading desk 

would be managed and operated as an 

individual unit and should reflect the 

level at which the profit and loss of 

market-making traders is attributed.711

The geographic location of individual 

traders is not dispositive for purposes of 

the analysis of whether the traders may 

comprise a single trading desk. For 

instance, a trading desk making markets 

in U.S. investment grade telecom 

corporate credits may use trading 

personnel in both New York (to trade 

U.S. dollar-denominated bonds issued 

by U.S.-incorporated telecom 

companies) and London (to trade Eurodenominated bonds issued by the same 

type of companies). This approach 

allows more effective management of 

risks of trading activity by requiring the 

establishment of limits, management 

oversight, and accountability at the level 

where trading activity actually occurs. It 

also allows banking entities to tailor the 

limits and procedures to the type of 

instruments traded and markets served 

by each trading desk. 

In response to comments, and as 

discussed below in the context of the 

‘‘financial exposure’’ definition, a 

trading desk may manage a financial 

exposure that includes positions in 

different affiliated legal entities.712

Similarly, a trading desk may include 

employees working on behalf of 

multiple affiliated legal entities or 

booking trades in multiple affiliated 

entities. Using the previous example, 

the U.S. investment grade telecom 

corporate credit trading desk may 

include traders working for or booking 

into a broker-dealer entity (for corporate 

bond trades), a security-based swap 

dealer entity (for single-name CDS 

trades), and/or a swap dealer entity (for 

index CDS or interest rate swap hedges). 

To clarify this issue, the definition of 

‘‘trading desk’’ specifically provides that 

the desk can buy or sell financial 

instruments ‘‘for the trading account of 

a banking entity or an affiliate thereof.’’ 

Thus, a trading desk need not be 

constrained to a single legal entity, 

although it is permissible for a trading 

desk to only trade for a single legal 

entity. A trading desk booking positions 

in different affiliated legal entities must 

have records that identify all positions 

included in the trading desk’s financial 

exposure and where such positions are 

held, as discussed below.713

The Agencies believe that establishing 

a defined organizational level at which 

many of the market-making exemption’s 

requirements apply will address 

potential evasion concerns. Applying 

certain requirements of the marketmaking exemption at the trading desk 

level will strengthen their effectiveness 

and prevent evasion of the exemption 

by ensuring that the aggregate trading 

activities of a relatively limited group of 

traders on a single desk are conducted 

in a manner that is consistent with the 

exemption’s standards. In particular, 

because many of the requirements in the 

market-making exemption look to the 

specific type(s) of financial instruments 

in which a market is being made, and 

such requirements are designed to take 

into account differences among markets 

and asset classes, the Agencies believe 

it is important that these requirements 

be applied to a discrete and identifiable 

unit engaged in, and operated by 

personnel whose responsibilities relate 

to, making a market in a specific set or 


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5864 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

714See proposed rule § 75.4(b). 

715Some commenters also contended that 

language in proposed Appendix B raised 

transaction-by-transaction implications. See supra 

notes 522 to 529 and accompanying text (discussing 

commenters’ transaction-by-transaction concerns). 

716The Agencies are not adopting a transactionby-transaction approach because the Agencies are 

concerned that such an approach would be unduly 

burdensome or impractical and inconsistent with 

the manner in which bona fide market makingrelated activity is conducted. Additionally, the 

Agencies are concerned that the burdens of such an 

approach would cause banking entities to 

significantly reduce or cease market making-related 

activities, which would cause negative market 

impacts harmful to both investors and issuers, as 

well as the financial system generally. 

717See Joint Proposal, 76 FR at 68870 n.146 (‘‘The 

Agencies note that a market maker may often make 

a market in one type of [financial instrument] and 

hedge its activities using different [financial 

instruments] in which it does not make a market.’’); 

CFTC Proposal, 77 FR at 8356 n.152. 

718See final rule § 75.4(b)(2)(iv). 

719See final rule § 75.4(b)(2)(iii)(E). 

720See final rule § 75.4(b)(5). 

721As noted in the proposal, certain types of 

market making-related activities, such as market 

making in derivatives, involves the retention of 

principal exposures rather than the retention of 

actual financial instruments. See Joint Proposal, 76 

FR at 68869 n.143; CFTC Proposal, 77 FR at 8354 

n.149. This type of activity would be included 

under the concept of ‘‘inventory’’ in the final rule. 

722The Agencies recognize that under the statute 

a banking entity’s positions in loans, spot 

commodities, and spot foreign exchange or 

currency are not subject to the final rule’s 

restrictions on proprietary trading. Thus, a banking 

entity’s trading in these instruments does not need 

to comply with the market-making exemption or 

any other exemption to the prohibition on 

proprietary trading. A banking entity may, however, 

include exposures in loans, spot commodities, and 

spot foreign exchange or currency that are related 

to the desk’s market-making activities in 

determining the trading desk’s financial exposure 

and in turn, the desk’ s financial exposure limits 

under the market-making exemption. The Agencies 

believe this will provide a more accurate picture of 

the trading desk’s financial exposure. For example, 

a market maker in foreign exchange forwards or 

swaps may mitigate the risks of its market-maker 

inventory with spot foreign exchange. 

type of financial instruments. Further, 

applying requirements at the trading 

desk level should facilitate banking 

entity monitoring and review of 

compliance with the exemption by 

limiting the aggregate trading volume 

that must be reviewed, as well as 

allowing consideration of the particular 

facts and circumstances of the desk’s 

trading activities (e.g., the liquidity, 

maturity, and depth of the market for 

the relevant types of financial 

instruments). As discussed above, the 

Agencies believe that applying the 

requirements of the market-making 

exemption to a higher level of 

organization would reduce the ability to 

consider the liquidity, maturity, and 

depth of the market for a type of 

financial instrument, would impede 

effective monitoring and compliance 

reviews, and would increase the risk of 

evasion. 

ii. Definitions of ‘‘Financial Exposure’’ 

and ‘‘Market-Maker Inventory’’ 

Certain requirements of the proposed 

market-making exemption referred to a 

‘‘purchase or sale of a [financial 

instrument].’’ 714 Even though the 

Agencies did not intend to require a 

trade-by-trade review, a significant 

number of commenters expressed 

concern that this language could be read 

to require compliance with the 

proposed market-making exemption on 

a transaction-by-transaction basis.715 In 

response to these concerns, the 

Agencies are modifying the exemption 

to clarify the manner in which 

compliance with certain provisions will 

be assessed. In particular, rather than a 

transaction-by-transaction focus, the 

market-making exemption in the final 

rule focuses on two related aspects of 

market-making activity: A trading desk’s 

‘‘market-maker inventory’’ and its 

overall ‘‘financial exposure.’’716

The Agencies are adopting an 

approach that focuses on both a trading 

desk’s financial exposure and marketmaker inventory in recognition that 

market making-related activity is best 

viewed in a holistic manner and that, 

during a single day, a trading desk may 

engage in a large number of purchases 

and sales of financial instruments. 

While all these transactions must be 

conducted in compliance with the 

market-making exemption, the Agencies 

recognize that they involve financial 

instruments for which the trading desk 

acts as market maker (i.e., by standing 

ready to purchase and sell that type of 

financial instrument) and instruments 

that are acquired to manage the risks of 

positions in financial instruments for 

which the desk acts as market maker, 

but in which the desk is not itself a 

market maker.717

The final rule requires that activity by 

a trading desk under the market-making 

exemption be evaluated by a banking 

entity through monitoring and setting 

limits for the trading desk’s marketmaker inventory and financial exposure. 

The market-maker inventory of a trading 

desk includes the positions in financial 

instruments, including derivatives, in 

which the trading desk acts as market 

maker. The financial exposure of the 

trading desk includes the aggregate risks 

of financial instruments in the marketmaker inventory of the trading desk plus 

the financial instruments, including 

derivatives, that are acquired to manage 

the risks of the positions in financial 

instruments for which the trading desk 

acts as a market maker, but in which the 

trading desk does not itself make a 

market, as well as any associated loans, 

commodities, and foreign exchange that 

are acquired as incident to acting as a 

market maker. In addition, the trading 

desk generally must maintain its 

market-maker inventory and financial 

exposure within its market-maker 

inventory limit and its financial 

exposure limit, respectively and, to the 

extent that any limit of the trading desk 

is exceeded, the trading desk must take 

action to bring the trading desk into 

compliance with the limits as promptly 

as possible after the limit is 

exceeded.718 Thus, if market movements 

cause a trading desk’s financial 

exposure to exceed one or more of its 

risk limits, the trading desk must 

promptly take action to reduce its 

financial exposure or obtain approval 

for an increase to its limits through the 

required escalation procedures, detailed 

below. A trading desk may not, 

however, enter into a trade that would 

cause it to exceed its limits without first 

receiving approval through its 

escalation procedures.719

Under the final rule, the term marketmaker inventory is defined to mean all 

of the positions, in the financial 

instruments for which the trading desk 

stands ready to make a market in 

accordance with paragraph (b)(2)(i) of 

this section, that are managed by the 

trading desk, including the trading 

desk’s open positions or exposures 

arising from open transactions.720 Those 

financial instruments in which a trading 

desk acts as market maker must be 

identified in the trading desk’s 

compliance program under 

§ 75.4(b)(2)(iii)(A) of the final rule. As 

used throughout this SUPPLEMENTARY

INFORMATION, the term ‘‘inventory’’ 

refers to both the retention of financial 

instruments (e.g., securities) and, in the 

context of derivatives trading, the risk 

exposures arising out of market-making 

related activities.721 Consistent with the 

statute, the final rule requires that the 

market-maker inventory of a trading 

desk be designed not to exceed, on an 

ongoing basis, the reasonably expected 

near term demands of clients, 

customers, or counterparties. 

The financial exposure concept is 

broader in scope than market-maker 

inventory and reflects the aggregate 

risks of the financial instruments (as 

well as any associated loans, spot 

commodities, or spot foreign exchange 

or currency) the trading desk manages 

as part of its market making-related 

activities.722 Thus, a trading desk’s 

financial exposure will take into 

account a trading desk’s positions in 

instruments for which it does not act as 

a market maker, but which are 


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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 5865 

723See infra Part VI.A.3.c.2.c.; final rule 

§ 75.4(b)(2)(iii)(C). 

724See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012) (stating that modern trading units generally 

view individual positions as a bundle of 

characteristics that contribute to their complete 

portfolio). See also Federal Reserve Board, Trading 

and Capital-Markets Activities Manual § 2000.1 

(Feb. 1998) (‘‘The risk-measurement system should 

also permit disaggregation of risk by type and by 

customer, instrument, or business unit to effectively 

support the management and control of risks.’’). 

725See ACLI (Feb. 2012); Fixed Income Forum/

Credit Roundtable; SIFMA et al. (Prop. Trading) 

(Feb. 2012). 

established as part of its market makingrelated activities, which includes risk 

mitigation and hedging. For instance, a 

trading desk that acts as a market maker 

in Euro-denominated corporate bonds 

may, in addition to Euro-denominated 

bonds, enter into credit default swap 

transactions on individual European 

corporate bond issuers or an index of 

European corporate bond issuers in 

order to hedge its exposure arising from 

its corporate bond inventory, in 

accordance with its documented 

hedging policies and procedures. 

Though only the corporate bonds would 

be considered as part of the trading 

desk’s market-maker inventory, its 

overall financial exposure would also 

include the credit default swaps used 

for hedging purposes. 

As noted above, the Agencies believe 

the extent to which a trading desk is 

engaged in permitted market makingrelated activities is best determined by 

evaluating both the financial exposure 

that results from the desk’s trading 

activity and the amount, types, and risks 

of the financial instruments in the 

desk’s market-maker inventory. Both 

concepts are independently valuable 

and will contribute to the effectiveness 

of the market-making exemption. 

Specifically, a trading desk’s financial 

exposure will highlight the net exposure 

and risks of its positions and, along with 

an analysis of the actions the trading 

desk will take to demonstrably reduce 

or otherwise significantly mitigate 

promptly the risks of that exposure 

consistent with its limits, the extent to 

which it is appropriately managing the 

risk of its market-maker inventory 

consistent with applicable limits, all of 

which are significant to an analysis of 

whether a trading desk is engaged in 

market making-related activities. An 

assessment of the amount, types, and 

risks of the financial instruments in a 

trading desk’s market-maker inventory 

will identify the aggregate amount of the 

desk’s inventory in financial 

instruments for which it acts as market 

maker, the types of these financial 

instruments that the desk holds at a 

particular time, and the risks arising 

from such holdings. Importantly, an 

analysis of a trading desk’s marketmaker inventory will inform the extent 

to which this inventory is related to the 

reasonably expected near term demands 

of clients, customers, or counterparties. 

Because the market-maker inventory 

concept is more directly related to the 

financial instruments that a trading desk 

buys and sells from customers than the 

financial exposure concept, the 

Agencies believe that requiring review 

and analysis of a trading desk’s marketmaker inventory, as well as its financial 

exposure, will enhance compliance with 

the statute’s near-term customer 

demand requirement. While the 

amount, types, and risks of a trading 

desk’s market-maker inventory are 

constrained by the near-term customer 

demand requirement, any other 

positions in financial instruments 

managed by the trading desk as part of 

its market making-related activities (i.e., 

those reflected in the trading desk’s 

financial exposure, but not included in 

the trading desk’s market-maker 

inventory) are also constrained because 

they must be consistent with the 

market-maker inventory or, if taken for 

hedging purposes, designed to reduce 

the risks of the trading desk’s marketmaker inventory. 

The Agencies note that disaggregating 

the trading desk’s market-maker 

inventory from its other exposures also 

allows for better identification of the 

trading desk’s hedging positions in 

instruments for which the trading desk 

does not make a market. As a result, a 

banking entity’s systems should be able 

to readily identify and monitor the 

trading desk’s hedging positions that are 

not in its market-maker inventory. As 

discussed in Part VI.A.3.c.3., a trading 

desk must have certain inventory and 

risk limits on its market-maker 

inventory, the products, instruments, 

and exposures the trading desk may use 

for risk management purposes, and its 

financial exposure that are designed to 

facilitate the trading desk’s compliance 

with the exemption and that are based 

on the nature and amount of the trading 

desk’s market making-related activities, 

including analyses regarding the 

reasonably expected near term demands 

of customers.723

The final rule also requires these 

policies and procedures to contain 

escalation procedures if a trade would 

exceed the limits set for the trading 

desk. However, the final rule does not 

permit a trading desk to exceed the 

limits solely based on customer 

demand. Rather, before executing a 

trade that would exceed the desk’s 

limits or changing the desk’s limits, a 

trading desk must first follow the 

relevant escalation procedures, which 

may require additional approval within 

the banking entity and provide 

demonstrable analysis that the basis for 

any temporary or permanent increase in 

limits is consistent with the reasonably 

expected near term demands of 

customers. 

Due to these considerations, the 

Agencies believe the final rule should 

result in more efficient compliance 

analyses on the part of both banking 

entities and Agency supervisors and 

examiners and should be less costly for 

banking entities to implement than a 

transaction-by-transaction or 

instrument-by-instrument approach. For 

example, the Agencies believe that some 

banking entities already compute and 

monitor most trading desks’ financial 

exposures for risk management or other 

purposes.724 The Agencies also believe 

that focusing on the financial exposure 

and market-maker inventory of a trading 

desk, as opposed to each separate 

individual transaction, is consistent 

with the statute’s goal of reducing 

proprietary trading risk in the banking 

system and its exemption for market 

making-related activities. The Agencies 

recognize that banking entities may not 

currently disaggregate trading desks’ 

market-maker inventory from their 

financial exposures and that, to the 

extent banking entities do not currently 

separately identify trading desks’ 

market-maker inventory, requiring such 

disaggregation for purposes of this rule 

will impose certain costs. In addition, 

the Agencies understand that an 

approach focused solely on the 

aggregate of all the unit’s trading 

positions, as suggested by some 

commenters, would present fewer 

burdens.725 However, for the reasons 

discussed above, the Agencies believe 

such disaggregation is necessary to give 

full effect to the statute’s near term 

customer demand requirement. 

The Agencies note that whether a 

financial instrument or exposure 

stemming from a derivative is 

considered to be market-maker 

inventory is based only on whether the 

desk makes a market in the financial 

instrument, regardless of the type of 

counterparty or the purpose of the 

transaction. Thus, the Agencies believe 

that banking entities should be able to 

develop a standardized methodology for 

identifying a trading desk’s positions 

and exposures in the financial 

instruments for which it acts as a market 

maker. As further discussed in this Part, 

a trading desk’s financial exposure must 

reflect the aggregate risks managed by 

the trading desk as part of its market 


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5866 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

726See final rule § 75.4(b)(4). 

727Final rule § 75.4(b)(4). For example, in the 

case of derivatives, a trading desk’s financial 

position will be the residual risks of the trading 

desk’s open positions. For instance, an options desk 

may have thousands of open trades at any given 

time, including hedges, but the desk will manage, 

among other risk factors, the trading desk’s portfolio 

delta, gamma, rho, and volatility. 

728As discussed in Part VI.A.3.c.3., a banking 

entity must establish, implement, maintain, and 

enforce policies and procedures, internal controls, 

analysis, and independent testing regarding the 

financial instruments each trading desk stands 

ready to purchase and sell and the products, 

instruments, or exposures each trading desk may 

use for risk management purposes. See final rule 

§ 75.4(b)(2)(iii). 

729Other statutory or regulatory requirements, 

including those based on prudential safety and 

soundness concerns, may prevent or limit a banking 

entity from booking hedging positions in a legal 

entity other than the entity taking the underlying 

position. 

730See infra Part VI.A.3.c.4. 731Under these circumstances, the other 

organizational unit would also be required to meet 

the hedging exemption’s documentation 

requirement for the risk-mitigating transaction. See 

final rule § 75.5(c). 

making-related activities,726 and a 

banking entity should be able to 

demonstrate that the financial exposure 

of a trading desk is related to its marketmaking activities. 

The final rule defines ‘‘financial 

exposure’’ to mean the ‘‘aggregate risks 

of one or more financial instruments 

and any associated loans, commodities, 

or foreign exchange or currency, held by 

a banking entity or its affiliate and 

managed by a particular trading desk as 

part of the trading desk’s market 

making-related activities.’’ 727 In this 

context, the term ‘‘aggregate’’ does not 

imply that a long exposure in one 

instrument can be combined with a 

short exposure in a similar or related 

instrument to yield a total exposure of 

zero. Instead, such a combination may 

reduce a trading desk’s economic 

exposure to certain risk factors that are 

common to both instruments, but it 

would still retain any basis risk between 

those financial instruments or 

potentially generate a new risk exposure 

in the case of purposeful hedging. 

With respect to the frequency with 

which a trading desk should determine 

its financial exposure and the amount, 

types, and risks of the financial 

instruments in its market-maker 

inventory, a trading desk’s financial 

exposure and market-maker inventory 

should be evaluated and monitored at a 

frequency that is appropriate for the 

trading desk’s trading strategies and the 

characteristics of the financial 

instruments the desk trades, including 

historical intraday volatility. For 

example, a trading desk that repeatedly 

acquired and then terminated 

significant financial exposures 

throughout the day but that had little or 

no financial exposure at the end of the 

day should assess its financial exposure 

based on its intraday activities, not 

simply its end-of-day financial 

exposure. The frequency with which a 

trading desk’s financial exposure and 

market-maker inventory will be 

monitored and analyzed should be 

specified in the trading desk’s 

compliance program. 

A trading desk’s financial exposure 

reflects its aggregate risk exposures. The 

types of ‘‘aggregate risks’’ identified in 

the trading desk’s financial exposure 

should reflect consideration of all 

significant market factors relevant to the 

financial instruments in which the 

trading desk acts as market maker or 

that the desk uses for risk management 

purposes pursuant to this exemption, 

including the liquidity, maturity, and 

depth of the market for the relevant 

types of financial instruments. Thus, 

market factors reflected in a trading 

desk’s financial exposure should 

include all significant and relevant 

factors associated with the products and 

instruments in which the desk trades as 

market maker or for risk management 

purposes, including basis risk arising 

from such positions.728 Similarly, an 

assessment of the risks of the trading 

desk’s market-maker inventory must 

reflect consideration of all significant 

market factors relevant to the financial 

instruments in which the trading desk 

makes a market. Importantly, a trading 

desk’s financial exposure and the risks 

of its market-maker inventory will 

change based on the desk’s trading 

activity (e.g., buying an instrument that 

it did not previously hold, increasing its 

position in an instrument, or decreasing 

its position in an instrument) as well as 

changing market conditions related to 

instruments or positions managed by 

the trading desk. 

Because the final rule defines ‘‘trading 

desk’’ based on operational 

functionality rather than corporate 

formality, a trading desk’s financial 

exposure may include positions that are 

booked in different affiliated legal 

entities.729 The Agencies understand 

that positions may be booked in 

different legal entities for a variety of 

reasons, including regulatory reasons. 

For example, a trading desk that makes 

a market in corporate bonds may book 

its corporate bond positions in an SECregistered broker-dealer and may book 

index CDS positions acquired for 

hedging purposes in a CFTC-registered 

swap dealer. A financial exposure that 

reflects both the corporate bond position 

and the index CDS position better 

reflects the economic reality of the 

trading desk’s risk exposure (i.e., by 

showing that the risk of the corporate 

bond position has been reduced by the 

index CDS position). 

In addition, a trading desk engaged in 

market making-related activities in 

compliance with the final rule may 

direct another organizational unit of the 

banking entity or an affiliate to execute 

a risk-mitigating transaction on the 

trading desk’s behalf.730 The other 

organizational unit may rely on the 

market-making exemption for these 

purposes only if: (i) The other 

organizational unit acts in accordance 

with the trading desk’s risk management 

policies and procedures established in 

accordance with § 75.4(b)(2)(iii) of the 

final rule; and (ii) the resulting riskmitigating position is attributed to the 

trading desk’s financial exposure (and 

not the other organizational unit’s 

financial exposure) and is included in 

the trading desk’s daily profit and loss 

calculation. If another organizational 

unit of the banking entity or an affiliate 

establishes a risk-mitigating position for 

the trading desk on its own accord (i.e., 

not at the direction of the trading desk) 

or if the risk-mitigating position is 

included in the other organizational 

unit’s financial exposure or daily profit 

and loss calculation, then the other 

organizational unit must comply with 

the requirements of the hedging 

exemption for such activity.731 It may 

not rely on the market-making 

exemption under these circumstances. If 

a trading desk engages in a riskmitigating transaction with a second 

trading desk of the banking entity or an 

affiliate that is also engaged in 

permissible market making-related 

activities, then the risk-mitigating 

position would be included in the first 

trading desk’s financial exposure and 

the contra-risk would be included in the 

second trading desk’s market-maker 

inventory and financial exposure. The 

Agencies believe the net effect of the 

final rule is to allow individual trading 

desks to efficiently manage their own 

hedging and risk mitigation activities on 

a holistic basis, while only allowing for 

external hedging directed by staff 

outside of the trading desk under the 

additional requirements of the hedging 

exemption. 

To include in a trading desk’s 

financial exposure either positions held 

at an affiliated legal entity or positions 

established by another organizational 

unit on the trading desk’s behalf, a 

banking entity must be able to provide 

supervisors or examiners of any Agency 

that has regulatory authority over the 

banking entity pursuant to section 


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732A banking entity must be able to provide such 

records when a related position is held at an 

affiliate, even if the affiliate and the banking entity 

are not subject to the same Agency’s regulatory 

jurisdiction. 

733The Agencies believe it is appropriate to apply 

the requirements of the exemption to the financial 

exposure of a ‘‘trading desk,’’ rather than the 

portfolio of a higher level of organization, for the 

reasons discussed above, including our concern that 

aggregating a large number of disparate positions 

and exposures across a range of trading desks could 

increase the risk of evasion. See supra Part 

VI.A.3.c.1.c.i. (discussing the determination to 

apply requirements at the trading desk level). 

734See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012). 

735See, e.g., Occupy. 

736 Indeed, in the most specialized situations, 

such quotations may only be provided upon 

request. See infra note 740 and accompanying text 

(discussing permissible block positioning). 

13(b)(2)(B) of the BHC Act with records, 

promptly upon request, that identify 

any related positions held at an 

affiliated entity that are being included 

in the trading desk’s financial exposure 

for purposes of the market-making 

exemption. Similarly, the supervisors 

and examiners of any Agency that has 

supervisory authority over the banking 

entity that holds financial instruments 

that are being included in another 

trading desk’s financial exposure for 

purposes of the market-making 

exemption must have the same level of 

access to the records of the trading 

desk.732 Banking entities should be 

prepared to provide all records that 

identify all positions included in a 

trading desk’s financial exposure and 

where such positions are held. 

As an example of how a trading desk’s 

market-maker inventory and financial 

exposure will be analyzed under the 

market-making exemption, assume a 

trading desk makes a market in a variety 

of U.S. corporate bonds and hedges its 

aggregated positions with a combination 

of exposures to corporate bond indexes 

and specific name CDS in which the 

desk does not make a market. To qualify 

for the market-making exemption, the 

trading desk would have to 

demonstrate, among other things, that: 

(i) The desk routinely stands ready to 

purchase and sell the U.S. corporate 

bonds, consistent with the requirement 

of § 75.4(b)(2)(i) of the final rule, and 

these instruments (or category of 

instruments) are identified in the 

trading desk’s compliance program; (ii) 

the trading desk’s market-maker 

inventory in U.S. corporate bonds is 

designed not to exceed, on an ongoing 

basis, the reasonably expected near term 

demands of clients, customers, or 

counterparties, consistent with the 

analysis and limits established by the 

banking entity for the trading desk; (iii) 

the trading desk’s exposures to 

corporate bond indexes and single name 

CDS are designed to mitigate the risk of 

its financial exposure, are consistent 

with the products, instruments, or 

exposures and the techniques and 

strategies that the trading desk may use 

to manage its risk effectively (and such 

use continues to be effective), and do 

not exceed the trading desk’s limits on 

the amount, types, and risks of the 

products, instruments, and exposures 

the trading desk uses for risk 

management purposes; and (iv) the 

aggregate risks of the trading desk’s 

exposures to U.S. corporate bonds, 

corporate bond indexes, and single 

name CDS do not exceed the trading 

desk’s limits on the level of exposures 

to relevant risk factors arising from its 

financial exposure. 

Our focus on the financial exposure of 

a trading desk, rather than a trade-bytrade requirement, is designed to give 

banking entities the flexibility to acquire 

not only market-maker inventory, but 

positions that facilitate market making, 

such as positions that hedge marketmaker inventory.733 As commenters 

pointed out, a trade-by-trade 

requirement would view trades in 

isolation and could fail to recognize that 

certain trades that are not customerfacing are nevertheless integral to 

market making and financial 

intermediation.734 The Agencies 

understand that the risk-reducing effects 

of combining large diverse portfolios 

could, in certain instances, mask 

otherwise prohibited proprietary 

trading.735 However, the Agencies do 

not believe that taking a transaction-bytransaction approach is necessary to 

address this concern. Rather, the 

Agencies believe that the broader 

definitions of ‘‘financial exposure’’ and 

‘‘market-maker inventory’’ coupled with 

the tailored definition of ‘‘trading desk’’ 

facilitates the analysis of aggregate risk 

exposures and positions in a manner 

best suited to apply and evaluate the 

market-making exemption. 

In short, this approach is designed to 

mitigate the costs of a trade-by-trade 

analysis identified by commenters. The 

Agencies recognize, however, that this 

approach is only effective at achieving 

the goals of the section 13 of the BHC 

Act—promoting financial 

intermediation and limiting speculative 

risks within banking entities—if there 

are limits on a trading desk’s financial 

exposure. That is, a permissive marketmaking exemption that gives banking 

entities maximum discretion in 

acquiring positions to provide liquidity 

runs the risk of also allowing banking 

entities to engage in speculative trades. 

As discussed more fully in the following 

Parts of this SUPPLEMENTARY

INFORMATION, the final market-making 

exemption provides a number of 

controls on a trading desk’s financial 

exposure. These controls include, 

among others, a provision requiring that 

a trading desk’s market-maker inventory 

be designed not to exceed, on an 

ongoing basis, the reasonably expected 

near term demands of customers and 

that any other financial instruments 

managed by the trading desk be 

designed to mitigate the risk of such 

desk’s market-maker inventory. In 

addition, the final market-making 

exemption requires the trading desk’s 

compliance program to include 

appropriate risk and inventory limits 

tied to the near term demand 

requirement, as well as escalation 

procedures if a trade would exceed such 

limits. The compliance program, which 

includes internal controls and 

independent testing, is designed to 

prevent instances where transactions 

not related to providing financial 

intermediation services are part of a 

desk’s financial exposure. 

iii. Routinely Standing Ready To Buy 

and Sell 

The requirement to routinely stand 

ready to buy and sell a type of financial 

instrument in the final rule recognizes 

that market making-related activities 

differ based on the liquidity, maturity, 

and depth of the market for the relevant 

type of financial instrument. For 

example, a trading desk acting as a 

market maker in highly liquid markets 

would engage in more regular quoting 

activity than a market maker in less 

liquid markets. Moreover, the Agencies 

recognize that the maturity and depth of 

the market also play a role in 

determining the character of a market 

maker’s activity. 

As noted above, the standard of 

‘‘routinely’’ standing ready to buy and 

sell will differ across markets and asset 

classes based on the liquidity, maturity, 

and depth of the market for the type of 

financial instrument. For instance, a 

trading desk that is a market maker in 

liquid equity securities generally should 

engage in very regular or continuous 

quoting and trading activities on both 

sides of the market. In less liquid 

markets, a trading desk should engage in 

regular quoting activity across the 

relevant type(s) of financial instruments, 

although such quoting may be less 

frequent than in liquid equity 

markets.736 Consistent with the CFTC’s 

and SEC’s interpretation of market 

making in swaps and security-based 

swaps for purposes of the definitions of 


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737The Agencies will consider factors similar to 

those identified by the CFTC and SEC in connection 

with this standard. See Further Definition of ‘‘Swap 

Dealer,’’ ‘‘Security-Based Swap Dealer,’’ ‘‘Major 

Swap Participant,’’ ‘‘Major Security-Based Swap 

Participant’’ and ‘‘Eligible Contract Participant’’, 77 

FR 30596, 30609 (May 23, 2012) 

738The Agencies recognize that, as noted by 

commenters, preventing a banking entity from 

conducting customized transactions with customers 

may impact customers’ risk exposures or 

transaction costs. See Goldman (Prop. Trading); 

SIFMA (Asset Mgmt.) (Feb. 2012). The Agencies are 

not prohibiting this activity under the final rule, as 

discussed in this Part. 

739The Agencies have considered comments on 

the issue of whether trading by appointment should 

be permitted under the final market-making 

exemption. The Agencies believe it is appropriate 

to permit trading by appointment to the extent that 

there is customer demand for liquidity in the 

relevant products. 

740As noted in the preamble to the proposed rule, 

the size of a block will vary among different asset 

classes. The Agencies also stated in the proposal 

that the SEC’s definition of ‘‘qualified block 

positioner’’ in Rule 3b–8(c) under the Exchange Act 

may serve as guidance for determining whether 

block positioning activity qualifies for the marketmaking exemption. In referencing that rule as 

guidance, the Agencies did not intend to imply that 

a banking entity engaged in block positioning 

activity would be required to meet all terms of the 

‘‘qualified block positioner’’ definition at all times. 

Nonetheless, a number of commenters indicated 

that it was unclear when a banking entity would 

need to act as a qualified block positioner in 

accordance with Rule 3b–8(c) and expressed 

concern that uncertainty could have a chilling effect 

on a banking entity’s willingness to facilitate 

customer block trades. See, e.g., RBC; SIFMA (Asset 

Mgmt.) (Feb. 2012); Goldman (Prop. Trading). For 

example, a few commenters stated that certain 

requirements in Rule 3b–8(c) could cause fire sales 

or general market uncertainty. See id. After 

considering comments, the Agencies have decided 

that the reference to Rule 3b–8(c) is unnecessary for 

purposes of the final rule. In particular, the 

Agencies believe that the requirements in the 

market-making exemption provide sufficient 

safeguards, and the additional requirements of the 

‘‘qualified block positioner’’ definition may present 

unnecessary burdens or redundancies with the rule, 

as adopted. For example, the Agencies believe that 

there is some overlap between § 75.4(b)(2)(ii) of the 

exemption, which provides that the amount, types, 

and risks of the financial instruments in the trading 

desk’s market-maker inventory must be designed 

not to exceed the reasonably expected near term 

demands of clients, customers, or counterparties, 

and Rule 3b–8(c)(iii), which requires the sale of the 

shares comprising the block as rapidly as possible 

commensurate with the circumstances. In other 

words, the market-making exemption would require 

a banking entity to appropriately manage its 

inventory when engaged in block positioning 

activity, but would not speak directly to the timing 

element given the diversity of markets to which the 

exemption applies. 

As noted above, one commenter analyzed the 

potential market impact of a complete restriction on 

a market maker’s ability to provide direct liquidity 

to help a customer execute a large block trade. See 

supra note 687 and accompanying text. Because the 

Agencies are not restricting a banking entity’s 

ability to engage in block positioning in the manner 

suggested by this commenter, the Agencies do not 

believe that the final rule will cause the cited 

market impact of incremental transaction costs 

between $1.7 and $3.4 billion per year. The 

Agencies address this commenter’s concern about 

the impact of inventory metrics on a banking 

entity’s willingness to engage in block trading in 

Part VI.C.3. (discussing the metrics requirement in 

the final rule and noting that metrics will not be 

used to determine compliance with the rule but, 

rather, will be monitored for patterns over time to 

identify activities that may warrant further review). 

One commenter appeared to request that block 

trading activity not be subject to all requirements 

of the market-making exemption. See SIFMA (Asset 

Mgmt.) (Feb. 2012). Any activity conducted in 

reliance on the market-making exemption, 

including block trading activity, must meet the 

requirements of the market-making exemption. The 

Agencies believe the requirements in the final rule 

are workable for block positioning activity and do 

not believe it would be appropriate to subject block 

positioning to lesser requirements than general 

market-making activity. For example, trading in 

large block sizes can expose a trading desk to 

greater risk than market making in smaller sizes, 

particularly absent risk management requirements. 

Thus, the Agencies believe it is important for block 

positioning activity to be subject to the same 

requirements, including the requirements to 

establish risk limits and risk management 

procedures, as general market-making activity. 

741This approach is generally consistent with 

commenters’ requested clarification that a trading 

desk’s quoting activity will not be assessed on an 

instrument-by-instrument basis, but rather across a 

range of similar instruments for which the trading 

desk acts as a market maker. See, e.g., RBC; SIFMA 

et al. (Prop. Trading) (Feb. 2012); CIEBA; Goldman 

(Prop. Trading). 

742See, e.g., Goldman (Prop. Trading); Morgan 

Stanley; RBC; SIFMA et al. (Prop. Trading) (Feb. 

2012). 

743The Agencies recognize that there could be 

limited circumstances under which a trading desk’s 

financial exposure does not relate to the types of 

financial instruments that it is standing ready to 

buy and sell for a short period of time. However, 

the Agencies would expect for such occurrences to 

be minimal. For example, this scenario could occur 

if a trading desk unwinds a hedge position after the 

‘‘swap dealer’’ and ‘‘security-based 

swap dealer,’’ ‘‘routinely’’ in the swap 

market context means that the trading 

desk should stand ready to enter into 

swaps or security-based swaps at the 

request or demand of a counterparty 

more frequently than occasionally.737

The Agencies note that a trading desk 

may routinely stand ready to enter into 

derivatives on both sides of the market, 

or it may routinely stand ready to enter 

into derivatives on either side of the 

market and then enter into one or more 

offsetting positions in the derivatives 

market or another market, particularly 

in the case of relatively less liquid 

derivatives. While a trading desk may 

respond to requests to trade certain 

products, such as custom swaps, even if 

it does not normally quote in the 

particular product, the trading desk 

should hedge against the resulting 

exposure in accordance with its 

financial exposure and hedging 

limits.738 Further, the Agencies 

continue to recognize that market 

makers in highly illiquid markets may 

trade only intermittently or at the 

request of particular customers, which 

is sometimes referred to as trading by 

appointment.739 A trading desk’s block 

positioning activity would also meet the 

terms of this requirement provided that, 

from time to time, the desk engages in 

block trades (i.e., trades of a large 

quantity or with a high dollar value) 

with customers.740

Regardless of the liquidity, maturity, 

and depth of the market for a particular 

type of financial instrument, a trading 

desk should have a pattern of providing 

price indications on either side of the 

market and a pattern of trading with 

customers on each side of the market. In 

particular, in the case of relatively 

illiquid derivatives or structured 

instruments, it would not be sufficient 

to demonstrate that a trading desk on 

occasion creates a customized 

instrument or provides a price quote in 

response to a customer request. Instead, 

the trading desk would need to be able 

to demonstrate a pattern of taking these 

actions in response to demand from 

multiple customers with respect to both 

long and short risk exposures in 

identified types of instruments. 

This requirement of the final rule 

applies to a trading desk’s activity in 

one or more ‘‘types’’ of financial 

instruments.741 The Agencies recognize 

that, in some markets, such as the 

corporate bond market, a market maker 

may regularly quote a subset of 

instruments (generally the more liquid 

instruments), but may not provide 

regular quotes in other related but less 

liquid instruments that the market 

maker is willing and available to trade. 

Instead, the market maker would 

provide a price for those instruments 

upon request.742 The trading desk’s 

activity, in the aggregate for a particular 

type of financial instrument, indicates 

whether it is engaged in activity that is 

consistent with § 75.4(b)(2)(i) of the 

final rule. 

Notably, this requirement provides 

that the types of financial instruments 

for which the trading desk routinely 

stands ready to purchase and sell must 

be related to its authorized marketmaker inventory and it authorized 

financial exposure. Thus, the types of 

financial instruments for which the desk 

routinely stands ready to buy and sell 

should compose a significant portion of 

its overall financial exposure. The only 

other financial instruments contributing 

to the trading desk’s overall financial 

exposure should be those designed to 

hedge or mitigate the risk of the 

financial instruments for which the 

trading desk is making a market. It 

would not be consistent with the 

market-making exemption for a trading 

desk to hold only positions in, or be 

exposed to, financial instruments for 

which the trading desk is not a market 

maker.743


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market-making position has already been unwound 

or if a trading desk acquires an anticipatory hedge 

position prior to acquiring a market-making 

position. As discussed more thoroughly in Part 

VI.A.3.c.3., a banking entity must establish written 

policies and procedures, internal controls, analysis, 

and independent testing that establish appropriate 

parameters around such activities. 

744See, e.g., Occupy; Better Markets (Feb. 2012). 

745One commenter expressed concern that a 

banking entity may be able to rely on the marketmaking exemption when it is providing only wide, 

out of context quotes. See Occupy. 

746As discussed below, this may include 

providing quotes in the interdealer trading market. 

747Algorithmic trading strategies that only trade 

when market factors are favorable to the strategy’s 

objectives or that otherwise frequently exit the 

market would not be considered to be standing 

ready to purchase or sell a type of financial 

instrument throughout market cycles and, thus, 

would not qualify for the market-making 

exemption. The Agencies believe this addresses 

commenters’ concerns about high-frequency trading 

activities that are only active in the market when 

it is believed to be profitable, rather than to 

facilitate customers. See, e.g., Better Markets (Feb. 

2012). The Agencies are not, however, prohibiting 

all high-frequency trading activities under the final 

rule or otherwise limiting high-frequency trading by 

banking entities by imposing a resting period on 

their orders, as requested by certain commenters. 

See, e.g., Better Markets (Feb. 2012); Occupy; Public 

Citizen. 

748See final rule § 75.4(b)(2)(iii)(A). 

749See final rule § 75.4(b)(2)(ii). 

750See final rule § 75.4(b)(2)(iii)(C). 

751For example, a few commenters requested that 

the rule prohibit banking entities from market 

making in assets classified as Level 3 under FAS 

157. See supra note 656 and accompanying text. 

The Agencies continue to believe that it would be 

inappropriate to incorporate accounting standards 

in the rule because accounting standards could 

change in the future without consideration of the 

potential impact on the final rule. See Joint 

Proposal, 76 FR at 68859 n.101 (explaining why the 

Agencies declined to incorporate certain accounting 

standards in the proposed rule); CFTC Proposal, 77 

FR at 8344 n.107. 

Further, a few commenters suggested that the 

exemption should only be available for trading on 

an organized trading facility. This type of limitation 

would require significant and widespread market 

structure changes (with associated systems and 

infrastructure costs) in a relatively short period of 

time, as market making in certain assets is primarily 

or wholly conducted in the OTC market, and 

organized trading platforms may not currently exist 

for these assets. The Agencies do not believe that 

the costs of such market structure changes would 

be warranted for purposes of this rule. 

752As discussed above, a number of commenters 

expressed concern about the potential market 

impacts of the perceived restrictions on market 

making under the proposed rule, particularly with 

respect to less liquid markets, such as the corporate 

bond market. See, e.g., Prof. Duffie; Wellington; 

BlackRock; ICI. 

753 Joint Proposal, 76 FR at 68871 (stating that 

‘‘bona fide market making-related activity may 

include taking positions in securities in 

anticipation of customer demand, so long as any 

anticipatory buying or selling activity is reasonable 

and related to clear, demonstrable trading interest 

of clients, customers, or counterparties’’); CFTC 

Proposal, 77 FR at 8356–8357; see also Morgan 

Stanley (requesting certain revisions to more closely 

track the statute); SIFMA et al. (Prop. Trading) (Feb. 

2012); Goldman (Prop. Trading); Chamber (Feb. 

2012); Comm. on Capital Markets Regulation; 

SIFMA (Asset Mgmt.) (Feb. 2012). 

754See final rule § 75.4(b)(2)(ii); infra Part 

VI.A.3.c.2.c. 

755See BoA; SIFMA et al. (Prop. Trading) (Feb. 

2012); Goldman (Prop. Trading); Morgan Stanley; 

Chamber (Feb. 2012); Comm. on Capital Markets 

Regulation; SIFMA (Asset Mgmt.) (Feb. 2012). 

756For example, some commenters suggested that 

the final rule allow market makers to make 

individualized assessments of anticipated customer 

demand, based on their expertise and experience, 

and account for differences between liquid and less 

liquid markets. See Chamber (Feb. 2012); ISDA 

(Feb. 2012). The final rule allows such assessments, 

Continued 

A trading desk’s routine presence in 

the market for a particular type of 

financial instrument would not, on its 

own, be sufficient grounds for relying 

on the market-making exemption. This 

is because the frequency at which a 

trading desk is active in a particular 

market would not, on its own, 

distinguish between permitted market 

making-related activity and 

impermissible proprietary trading. In 

response to comments, the final rule 

provides that a trading desk also must 

be willing and available to quote, buy 

and sell, or otherwise enter into long 

and short positions in the relevant 

type(s) of financial instruments for its 

own account in commercially 

reasonable amounts and throughout 

market cycles.744 Importantly, a trading 

desk would not meet the terms of this 

requirement if it provides wide 

quotations relative to prevailing market 

conditions and is not engaged in other 

activity that evidences a willingness or 

availability to provide intermediation 

services.745 Under these circumstances, 

a trading desk would not be standing 

ready to purchase and sell because it is 

not genuinely quoting or trading with 

customers. 

In the context of this requirement, 

‘‘commercially reasonable amounts’’ 

means that the desk generally must be 

willing to quote and trade in sizes 

requested by other market 

participants.746 For trading desks that 

engage in block trading, this would 

include block trades requested by 

customers, and this language is not 

meant to restrict a trading desk from 

acting as a block positioner. Further, a 

trading desk must act as a market maker 

on an appropriate basis throughout 

market cycles and not only when it is 

most favorable for it to do so.747 For 

example, a trading desk should be 

facilitating customer needs in both 

upward and downward moving markets. 

As discussed further in Part 

VI.A.3.c.3., the financial instruments the 

trading desk stands ready to buy and 

sell must be identified in the trading 

desk’s compliance program.748 Certain 

requirements in the final exemption 

apply to the amount, types, and risks of 

these financial instruments that a 

trading desk can hold in its marketmaker inventory, including the near 

term customer demand requirement 749

and the need to have certain risk and 

inventory limits.750

In response to the proposed 

requirement that a trading desk or other 

organizational unit hold itself out, some 

commenters requested that the Agencies 

limit the availability of the marketmaking exemption to trading in 

particular asset classes or trading on 

particular venues (e.g., organized 

trading platforms). The Agencies are not 

limiting the availability of the marketmaking exemption in the manner 

requested by these commenters.751

Provided there is customer demand for 

liquidity in a type of financial 

instrument, the Agencies do not believe 

the availability of the market-making 

exemption should depend on the 

liquidity of that type of financial 

instrument or the ability to trade such 

instruments on an organized trading 

platform. The Agencies see no basis in 

the statutory text for either approach 

and believe that the likely harms to 

investors seeking to trade affected 

instruments (e.g., reduced ability to 

purchase or sell a particular instrument, 

potentially higher transaction costs) and 

market quality (e.g., reduced liquidity) 

that would arise under such an 

approach would not be justified,752

particularly in light of the minimal 

benefits that might result from 

restricting or eliminating a banking 

entity’s ability to hold less liquid assets 

in connection with its market makingrelated activities. The Agencies believe 

these commenters’ concerns are 

adequately addressed by the final rule’s 

requirements in the market-making 

exemption that are designed to ensure 

that a trading desk cannot hold risk in 

excess of what is appropriate to provide 

intermediation services designed not to 

exceed, on an ongoing basis, the 

reasonably expected near term demands 

of clients, customers, or counterparties. 

In response to comments on the 

proposed interpretation regarding 

anticipatory position-taking,753 the 

Agencies note that the near term 

demand requirement in the final rule 

addresses when a trading desk may take 

positions in anticipation of reasonably 

expected near term customer 

demand.754 The Agencies believe this 

approach is generally consistent with 

the comments the Agencies received on 

this issue.755 In addition, the Agencies 

note that modifications to the proposed 

near term demand requirement in the 

final rule also address commenters 

concerns on this issue.756


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based on historical customer demand and other 

relevant factors, and recognizes that near term 

demand may differ based on the liquidity, maturity, 

and depth of the market for a particular type of 

financial instrument. See infra Part VI.A.3.c.2.c.iii. 

757See proposed rule § 75.4(b)(2)(iii). 

758See Joint Proposal, 76 FR at 68871; CFTC 

Proposal, 77 FR at 8357. 

759See id. 

760See Joint Proposal, 76 FR at 68871–68872; 

CFTC Proposal, 77 FR at 8357. 761See supra Part VI.A.3.c.2.a. 762See, e.g., Sens. Merkley & Levin (Feb. 2012); 

Flynn & Fusselman; Better Markets (Feb. 2012). 763See Better Markets (Feb. 2012); Sens. Merkley 

& Levin (Feb. 2012). 

764See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); Chamber (Feb. 2012); T. Rowe Price; SIFMA 

(Asset Mgmt.) (Feb. 2012); ACLI (Feb. 2012); 

MetLife; Comm. on Capital Markets Regulation; 

CIEBA; Credit Suisse (Seidel); SSgA (Feb. 2012); 

IAA (stating that the proposed requirement is too 

subjective and would be difficult to administer in 

a range of scenarios); Barclays; Prof. Duffie. 

765See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); T. Rowe Price; CIEBA; Credit Suisse (Seidel); 

Barclays; Wellington; MetLife; Chamber (Feb. 2012); 

RBC; Prof. Duffie; ICI (Feb. 2012); SIFMA (Asset 

Mgmt.) (Feb. 2012). The Agencies respond to these 

comments in Part VI.A.3.c.2.c., infra. For a 

discussion of comments regarding inventory 

management activity conducted in connection with 

market making, see Part VI.A.3.c.2.b.vi., infra. 

766See, e.g., ACLI (Feb. 2012); MetLife; Comm. on 

Capital Markets Regulation (noting that a market 

maker may need to hold significant inventory to 

accommodate potential block trade requests). Two 

of these commenters stated that a market maker 

may provide a worse price or may be unwilling to 

intermediate a large customer position if the market 

maker has to determine whether holding such 

position will meet the near term demand 

requirement, particularly if the market maker would 

be required to sell the block position over a short 

period of time. See ACLI (Feb. 2012); MetLife. 

These comments are addressed in Part 

VI.A.3.c.2.c.iii., infra. 

767See supra Part VI.A.3.c.2.a. 

768See SIFMA et al. (Prop. Trading) (Feb. 2012). 

Another commenter suggested that the Agencies 

‘‘establish clear criteria that reflect appropriate 

revenue from changes in the bid-ask spread,’’ noting 

that a legitimate market maker should be both 

selling and buying in a rising market (or, likewise, 

in a declining market). Public Citizen. 

769See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); Credit Suisse (Seidel); JPMC; Goldman (Prop. 

Trading); BoA; ICI (Feb. 2012); ICI Global; 

Vanguard; SSgA (Feb. 2012); see also infra Part 

VI.A.3.c.2.b.viii. (discussing comments on whether 

arbitrage trading should be permitted under the 

market-making exemption under certain 

circumstances). 

770See Goldman (Prop. Trading); RBC. One of 

these commenters agreed, however, that a trading 

desk that is ‘‘wholly’’ engaged in trading that is 

unrelated to customer demand should not qualify 

for the proposed market-making exemption. See 

Goldman (Prop. Trading). 

2. Near Term Customer Demand 

Requirement 

a. Proposed Near Term Customer 

Demand Requirement 

Consistent with the statute, the 

proposed rule required that the trading 

desk or other organizational unit’s 

market making-related activities be, 

with respect to the financial instrument, 

designed not to exceed the reasonably 

expected near term demands of clients, 

customers, or counterparties.757 This 

requirement is intended to prevent a 

trading desk from taking a speculative 

proprietary position that is unrelated to 

customer needs as part of the desk’s 

purported market making-related 

activities.758

In the proposal, the Agencies stated 

that a banking entity’s expectations of 

near term customer demand should 

generally be based on the unique 

customer base of the banking entity’s 

specific market-making business lines 

and the near term demand of those 

customers based on particular factors, 

beyond a general expectation of price 

appreciation. The Agencies further 

stated that they would not expect the 

activities of a trading desk or other 

organizational unit to qualify for the 

market-making exemption if the trading 

desk or other organizational unit is 

engaged wholly or principally in trading 

that is not in response to, or driven by, 

customer demands, regardless of 

whether those activities promote price 

transparency or liquidity. The proposal 

stated that, for example, a trading desk 

or other organizational unit of a banking 

entity that is engaged wholly or 

principally in arbitrage trading with 

non-customers would not meet the 

terms of the proposed rule’s marketmaking exemption.759

With respect to market making in a 

security that is executed on an exchange 

or other organized trading facility, the 

proposal provided that a market maker’s 

activities are generally consistent with 

reasonably expected near term customer 

demand when such activities involve 

passively providing liquidity by 

submitting resting orders that interact 

with the orders of others in a nondirectional or market-neutral trading 

strategy and the market maker is 

registered, if the exchange or organized 

trading facility registers market makers. 

Under the proposal, activities on an 

exchange or other organized trading 

facility that primarily take liquidity, 

rather than provide liquidity, would not 

qualify for the market-making 

exemption, even if conducted by a 

registered market maker.760

b. Comments Regarding the Proposed 

Near Term Customer Demand 

Requirement 

As noted above, the proposed near 

term customer demand requirement 

would implement language found in the 

statute’s market-making exemption.761

Some commenters expressed general 

support for this requirement.762 For 

example, these commenters emphasized 

that the proposed near term demand 

requirement is an important component 

that restricts disguised position-taking 

or market making in illiquid markets.763

Several other commenters expressed 

concern that the proposed requirement 

is too restrictive 764 because, for 

example, it may impede a market 

maker’s ability to build or retain 

inventory 765 or may impact a market 

maker’s willingness to engage in block 

trading.766 Comments on particular 

aspects of this proposed requirement are 

discussed below, including the 

proposed interpretation of this 

requirement in the proposal, the 

requirement’s potential impact on 

market maker inventory, potential 

differences in this standard across asset 

classes, whether it is possible to predict 

near term customer demand, and 

whether the terms ‘‘client,’’ ‘‘customer,’’ 

or ‘‘counterparty’’ should be defined for 

purposes of the exemption. 

i. The Proposed Guidance for 

Determining Compliance With the Near 

Term Customer Demand Requirement 

As discussed in more detail above, the 

proposal set forth proposed guidance on 

how a banking entity may comply with 

the proposed near term customer 

demand requirement.767 With respect to 

the language indicating that a banking 

entity’s determination of near term 

customer demand should generally be 

based on the unique customer base of a 

specific market-making business line 

(and not merely an expectation of future 

price appreciation), one commenter 

stated that it is unclear how a banking 

entity would be able to make such 

determinations in markets where trades 

occur infrequently and customer 

demand is hard to predict.768

Several commenters expressed 

concern about the proposal’s statement 

that a trading desk or other 

organizational unit engaged wholly or 

principally in trading that is not in 

response to, or driven by, customer 

demands (e.g., arbitrage trading with 

non-customers) would not qualify for 

the exemption, regardless of whether 

the activities promote price 

transparency or liquidity.769 In 

particular, commenters stated that it 

would be difficult for a market-making 

business to try to divide its activities 

that are in response to customer demand 

(e.g., customer intermediation and 

hedging) from activities that promote 

price transparency and liquidity (e.g., 

interdealer trading to test market depth 

or arbitrage trading) in order to 

determine their proportionality.770

Another commenter stated that, as a 

matter of organizational efficiency, firms 

will often restrict arbitrage trading 


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771See JPMC. 

772See Joint Proposal, 76 FR at 68871–68,872; 

CFTC Proposal, 77 FR at 8357. 

773See, e.g., NYSE Euronext; SIFMA et al. (Prop. 

Trading) (Feb. 2012); Goldman (Prop. Trading); 

RBC. Comments on proposed Appendix B are 

discussed further in Part VI.A.3.c.8.b., infra. This 

issue is addressed in note 944 and its 

accompanying text, infra. 

774Some commenters stated that market makers 

may need to use market or marketable limit orders 

to build inventory in anticipation of customer 

demand or in connection with positioning a block 

trade for a customer. See SIFMA et al. (Prop. 

Trading) (Feb. 2012); RBC; Goldman (Prop. 

Trading). Two of these commenters noted that these 

order types may be needed to dispose of positions 

taken into inventory as part of market making. See 

RBC; Goldman (Prop. Trading). 

775See NYSE Euronext. 

776See Goldman (Prop. Trading). 

777See SIFMA et al. (Prop. Trading) (Feb. 2012). 

778See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Goldman (Prop. Trading). 

779See NYSE Euronext; SIFMA et al. (Prop. 

Trading) (Feb. 2012); Goldman (Prop. Trading); 

Occupy. See also infra notes 945 to 946 and 

accompanying text (addressing these comments). 

780See SIFMA et al. (Prop. Trading) (Feb. 2012) 

(stating that trading units may currently register as 

market makers with particular, primary exchanges 

on which they trade, but will serve in a marketmaking capacity on other trading venues from time 

to time); Goldman (Prop. Trading) (noting that there 

are more than 12 exchanges and 40 alternative 

trading systems currently trading U.S. equities). 

781See Occupy. In the alternative, this commenter 

would require all market making to be performed 

on an exchange or organized trading facility. See id. 

782See NYSE Euronext (recognizing that 

registration status is not necessarily conclusive of 

engaging in market making-related activities); 

SIFMA et al. (Prop. Trading) (Feb. 2012) (stating 

that to the extent a trading unit is registered on a 

particular exchange or organized trading facility for 

any type of financial instrument, all of its activities 

on that exchange or organized trading facility 

should be presumed to be market making); 

Goldman (Prop. Trading). See also infra note 945 

(responding to these comments). Two commenters 

noted that certain exchange rules may require 

market makers to deal for their own account under 

certain circumstances in order to maintain fair and 

orderly markets. See NYSE Euronext (discussing 

NYSE rules); Goldman (Prop. Trading) (discussing 

NYSE and CBOE rules). For example, according to 

these commenters, NYSE Rule 104(f)(ii) requires a 

market maker to maintain fair and orderly markets, 

which may involve dealing for their own account 

when there is a lack of price continuity, lack of 

depth, or if a disparity between supply and demand 

exists or is reasonably anticipated. See id. 

783See Goldman (Prop. Trading). This commenter 

further stated that trading activities of exchange 

market makers may be particularly difficult to 

evaluate with customer-facing metrics (because 

‘‘specialist’’ market makers may not have 

‘‘customers’’), so conferring a positive presumption 

of compliance on such market makers would ensure 

that they can continue to contribute to liquidity, 

which benefits customers. This commenter noted 

that, for example, NYSE designated market makers 

(‘‘DMMs’’) are generally prohibited from dealing 

with customers and companies must ‘‘wall off’’ any 

trading units that act as DMMs. See id. (citing NYSE 

Rule 98). 

784See id. (stating that spread-related metrics, 

such as Spread Profit and Loss, may be useful for 

this purpose). 

785See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); T. Rowe Price; CIEBA; Credit Suisse (Seidel); 

Barclays; Wellington; MetLife; Chamber (Feb. 2012); 

RBC; Prof. Duffie; ICI (Feb. 2012); SIFMA (Asset 

Mgmt.) (Feb. 2012). These concerns are addressed 

in Part VI.A.3.c.2.c., infra. 

786See, e.g., SIFMA (Asset Mgmt.) (Feb. 2012); T. 

Rowe Price; CIEBA; ICI (Feb. 2012); RBC. 

787See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); Chamber (Feb. 2012). 

788See Prof. Duffie. However, another commenter 

stated that a legitimate market maker should 

respond to customer demand rather than initiate 

transactions, which is indicative of prohibited 

proprietary trading. See Public Citizen. 

strategies to certain specific individual 

traders within the market-making 

organization, who may sometimes be 

referred to as a ‘‘desk,’’ and expressed 

concern that this would be prohibited 

under the rule.771

In response to the proposed 

interpretation regarding market making 

on an exchange or other organized 

trading facility (and certain similar 

language in proposed Appendix B),772

several commenters indicated that the 

reference to passive submission of 

resting orders may be too restrictive and 

provided examples of scenarios where 

market makers may need to use market 

or marketable limit orders.773 For 

example, many of these commenters 

stated that market makers may need to 

enter market or marketable limit orders 

to: (i) Build or reduce inventory; 774 (ii) 

address order imbalances on an 

exchange by, for example, using market 

orders to lessen volatility and restore 

pricing equilibrium; (iii) hedge marketmaking positions; (iv) create markets; 775

(v) test the depth of the markets; (vi) 

ensure that ETFs, American depositary 

receipts (‘‘ADRs’’), options, and other 

instruments remain appropriately 

priced; 776 and (vii) respond to 

movements in prices in the markets.777

Two commenters noted that distinctions 

between limit and market or marketable 

limit orders may not be workable in the 

international context, where exchanges 

may not use the same order types as 

U.S. trading facilities.778

A few commenters also addressed the 

proposed use of a market maker’s 

exchange registration status as part of 

the analysis.779 Two commenters stated 

that the proposed rule should not 

require a market maker to be registered 

with an exchange to qualify for the 

proposed market-making exemption. 

According to these commenters, there 

are a large number of exchanges and 

organized trading facilities on which 

market makers may need to trade to 

maintain liquidity across the markets 

and to provide customers with favorable 

prices. These commenters indicated that 

any restrictions or burdens on such 

trading may decrease liquidity or make 

it harder to provide customers with the 

best price for their trade.780 One 

commenter, however, stated that the 

exchange registration requirement is 

reasonable and further supported 

adding a requirement that traders 

demonstrate adherence to the same or 

commensurate standards in markets 

where registration is not possible.781

Some commenters recommended 

certain modifications to the proposed 

analysis. For example, a few 

commenters requested that the rule 

presume that a trading unit is engaged 

in permitted market making-related 

activity if it is registered as a market 

maker on a particular exchange or 

organized trading facility.782 In support 

of this recommendation, one commenter 

represented that it would be warranted 

because registered market makers 

directly contribute to maintaining liquid 

and orderly markets and are subject to 

extensive regulatory requirements in 

that capacity.783 Another commenter 

suggested that the Agencies instead use 

metrics to compare, in the aggregate and 

over time, the liquidity that a market 

maker makes rather than takes as part of 

a broader consideration of the marketmaking character of the relevant trading 

activity.784

ii. Potential Inventory Restrictions and 

Differences Across Asset Classes 

A number of commenters expressed 

concern that the proposed requirement 

may unduly restrict a market maker’s 

ability to manage its inventory.785

Several of these commenters stated that 

limitations on inventory would be 

especially problematic for market 

making in less liquid markets, like the 

fixed-income market, where customer 

demand is more intermittent and 

positions may need to be held for a 

longer period of time.786 Some 

commenters stated that the Agencies’ 

proposed interpretation of this 

requirement would restrict a market 

maker’s inventory in a manner that is 

inconsistent with the statute. These 

commenters indicated that the 

‘‘designed’’ and ‘‘reasonably expected’’ 

language of the statute seem to 

recognize that market makers must 

anticipate customer requests and 

accumulate sufficient inventory to meet 

those reasonably expected demands.787

In addition, one commenter represented 

that a market maker must have wide 

latitude and incentives for initiating 

trades, rather than merely reacting to 

customer requests for quotes, to 

properly risk manage its positions or to 

prepare for anticipated customer 

demand or supply.788 Many 

commenters requested certain 

modifications to the proposed 

requirement to limit its impact on 


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789See Credit Suisse (Seidel) (suggesting that the 

rule allow market makers to build inventory in 

products where they believe customer demand will 

exist, regardless of whether the inventory can be 

tied to a particular customer in the near term or to 

historical trends in customer demand); Barclays 

(recommending the rule require that ‘‘the market 

making-related activity is conducted by each 

trading unit such that its activities (including the 

maintenance of inventory) are designed not to 

exceed the reasonably expected near term demands 

of clients, customers, or counterparties consistent 

with the market and trading patterns of the relevant 

product, and consistent with the reasonable 

judgment of the banking entity where such demand 

cannot be determined with reasonable accuracy’’); 

CIEBA. In addition, some commenters suggested an 

interpretation that would provide greater discretion 

to market makers to enter into trades based on 

factors such as experience and expertise dealing in 

the market and market exigencies. See SIFMA et al. 

(Prop. Trading) (Feb. 2012); Chamber (Feb. 2012). 

Two commenters suggested that the proposed 

requirement should be interpreted to permit 

market-making activity as it currently exists. See 

MetLife; ACLI (Feb. 2012). One commenter 

requested that the proposed requirement be moved 

to Appendix B of the rule to provide greater 

flexibility to consider facts and circumstances of a 

particular activity. See JPMC. 

790See CIEBA; Morgan Stanley; RBC; ICI (Feb. 

2012); ISDA (Feb. 2012); Comm. on Capital Markets 

Regulation; Alfred Brock. The Agencies respond to 

these comments in Part VI.A.3.c.2.c.ii., infra. 

791See ICI (Feb. 2012); CIEBA (stating that, absent 

a different interpretation for illiquid instruments, 

market makers will err on the side of holding less 

inventory to avoid sanctions for violating the rule); 

RBC. 

792See Morgan Stanley. 

793See Wellington; MetLife; SIFMA et al. (Prop. 

Trading) (Feb. 2012); Sens. Merkley & Levin (Feb. 

2012); Chamber (Feb. 2012); FTN; RBC; Alfred 

Brock. These comments are addressed in Part 

VI.A.3.c.2.c.iii., infra. 

794See Sens. Merkley & Levin (Feb. 2012); FTN. 

795See FTN. The commenter further indicated 

that errors in estimating customer demand are 

managed through kick-out rules and oversight by 

risk managers and committees, with latitude in 

decisions being closely related to expected or 

empirical costs of hedging positions until they 

result in trading with counterparties. See id. 

796See Sens. Merkley & Levin (Feb. 2012) (stating 

that banking entities should be required to collect 

inventory data, evaluate the data, develop policies 

on how to handle particular positions, and make 

regular adjustments to ensure a turnover of assets 

commensurate with near term demand of 

customers). This commenter also suggested that the 

rule specify the types of inventory metrics that 

should be collected and suggested that the rate of 

inventory turnover would be helpful. See id. 

797See MetLife; Chamber (Feb. 2012); RBC; 

CIEBA; Wellington; ICI (Feb. 2012); Alfred Brock. 

This issue is addressed in Part VI.A.3.c.2.c.iii., 

infra. 

798See ICI (Feb. 2012); CIEBA; RBC; Wellington; 

Invesco. 

799See CIEBA. 

800See Joint Proposal, 76 FR at 68960; CFTC 

Proposal, 77 FR at 8439. More specifically, 

Appendix B stated: ‘‘In the context of market 

making in a security that is executed on an 

organized trading facility or an exchange, a 

‘customer’ is any person on behalf of whom a buy 

or sell order has been submitted by a broker-dealer 

or any other market participant. In the context of 

market making in a [financial instrument] in an 

OTC market, a ‘customer’ generally would be a 

market participant that makes use of the market 

maker’s intermediation services, either by 

requesting such services or entering into a 

continuing relationship with the market maker with 

respect to such services.’’ Id. On this last point, the 

proposal elaborated that in certain cases, depending 

on the conventions of the relevant market (e.g., the 

OTC derivatives market), such a ‘‘customer’’ may 

consider itself or refer to itself more generally as a 

‘‘counterparty.’’ See Joint Proposal, 76 FR at 68960 

n.2; CFTC Proposal, 77 FR at 8439 n.2. 

801See Joint Proposal, 76 FR at 68874; CFTC 

Proposal, 77 FR at 8359. In particular, Question 99 

states: ‘‘Should the terms ‘client,’ ‘customer,’ or 

‘counterparty’ be defined for purposes of the market 

making exemption? If so, how should these terms 

be defined? For example, would an appropriate 

definition of ‘customer’ be: (i) A continuing 

relationship in which the banking entity provides 

one or more financial products or services prior to 

the time of the transaction; (ii) a direct and 

substantive relationship between the banking entity 

and a prospective customer prior to the transaction; 

(iii) a relationship initiated by the banking entity to 

a prospective customer to induce transactions; or 

(iv) a relationship initiated by the prospective 

customer with a view to engaging in transactions?’’ 

Id. 

802Comments on this issue are addressed in Part 

VI.A.3.c.2.c.i., infra. 

market maker inventory.789

Commenters’ views on the importance 

of permitting inventory management 

activity in connection with market 

making are discussed below in Part 

VI.A.3.c.2.b.vi. 

Several commenters requested that 

the Agencies recognize that near term 

customer demand may vary across 

different markets and asset classes and 

implement this requirement flexibly.790

In particular, many of these commenters 

emphasized that the concept of ‘‘near 

term demand’’ should be different for 

less liquid markets, where transactions 

may occur infrequently, and for liquid 

markets, where transactions occur more 

often.791 One commenter requested that 

the Agencies add the phrase ‘‘based on 

the characteristics of the relevant market 

and asset class’’ to the end of the 

requirement to explicitly acknowledge 

these differences.792

iii. Predicting Near Term Customer 

Demand 

Commenters provided views on 

whether and, if so how, a banking entity 

may be able to predict near term 

customer demand for purposes of the 

proposed requirement.793 For example, 

two commenters suggested ways in 

which a banking entity could predict 

near term customer demand.794 One of 

these commenters indicated that 

banking entities should be able to utilize 

current risk management tools to predict 

near term customer demand, although 

these tools may need to be adapted to 

comply with the rule’s requirements. 

According to this commenter, dealers 

commonly assess the following factors 

across product lines, which can relate to 

expected customer demand: (i) Recent 

volumes and customer trends; (ii) 

trading patterns of specific customers; 

(iii) analysis of whether the firm has an 

ability to win new customer business; 

(iv) comparison of the current market 

conditions to prior similar periods; (v) 

liquidity of large investors; and (vi) the 

schedule of maturities in customers’ 

existing positions.795 Another 

commenter stated that the 

reasonableness of a market maker’s 

inventory can be measured by looking to 

the specifics of the particular market, 

the size of the customer base being 

served, and expected customer demand, 

which banking entities should be 

required to take into account in both 

their inventory practices and policies 

and their actual inventories. This 

commenter recommended that the rule 

permit a banking entity to assume a 

position under the market-making 

exemption if it can demonstrate a track 

record or reasonable expectation that it 

can dispose of a position in the near 

term.796

Some commenters, however, 

emphasized that reasonably expected 

near term customer demand cannot 

always be accurately predicted.797

Several of these commenters requested 

the Agencies clarify that banking 

entities will not be subject to regulatory 

sanctions if reasonably anticipated near 

term customer demand does not 

materialize.798 One commenter further 

noted that a banking entity entering a 

new market, or gaining or losing 

customers, may need greater flexibility 

in applying the near term demand 

requirement because its anticipated 

demand may fluctuate.799

iv. Potential Definitions of ‘‘Client,’’ 

‘‘Customer,’’ or ‘‘Counterparty’’ 

Appendix B of the proposal discussed 

the proposed meaning of the term 

‘‘customer’’ in the context of permitted 

market making-related activity.800 In 

addition, the proposal inquired whether 

the terms ‘‘client,’’ ‘‘customer,’’ or 

‘‘counterparty’’ should be defined in the 

rule for purposes of the market-making 

exemption.801 Commenters expressed 

varying views on the proposed 

interpretations in the proposal and on 

whether these terms should be defined 

in the final rule.802

With respect to the proposed 

interpretations of the term ‘‘customer’’ 

in Appendix B, one commenter agreed 

with the proposed interpretations and 

expressed the belief that the 

interpretations will allow interdealer 

market making where brokers or other 

dealers act as customers. However, this 

commenter also requested that the 

Agencies expressly incorporate 


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803See SIFMA et al. (Prop. Trading) (Feb. 2012). 

See also Credit Suisse (Seidel); RBC (requesting that 

the Agencies recognize ‘‘wholesale’’ market making 

as permissible and representing that ‘‘[i]t is 

irrelevant to an investor whether market liquidity 

is provided by a broker-dealer with whom the 

investor maintains a customer account, or whether 

that broker-dealer looks to another dealer for market 

liquidity’’). 

804See Comm. on Capital Markets Regulation. 

805See FTN; ISDA (Feb. 2012); Alfred Brock. 

806See Japanese Bankers Ass’n.; Credit Suisse 

(Seidel); Occupy; AFR et al. (Feb. 2012); Public 

Citizen. 

807See AFR et al. (Feb. 2012); Occupy; Public 

Citizen. One of these commenters also requested 

that the Agencies remove the terms ‘‘client’’ and 

‘‘counterparty’’ from the proposed near term 

demand requirement. See Occupy. 

808See AFR et al. (Feb. 2012); Occupy; Public 

Citizen. These commenters stated that other 

banking entities should never be ‘‘customers’’ under 

the rule. See id. In addition, one of these 

commenters would further prevent a banking 

entity’s employees and covered funds from being 

‘‘customers’’ under the rule. See AFR et al. (Feb. 

2012). 

809See AFR et al. (Feb. 2012) (providing a similar 

definition for the term ‘‘client’’ as well); Public 

Citizen. 

810See AFR et al. (Feb. 2012); Public Citizen. See 

also Sens. Merkley & Levin (Feb. 2012) (stating that 

a banking entity’s activities that involve attempting 

to sell clients financial instruments that it 

originated, rather than facilitating a secondary 

market for client trades in previously existing 

financial products, should be analyzed under the 

underwriting exemption, not the market-making 

exemption; in addition, compiling inventory of 

financial instruments that the bank originated 

should be viewed as proprietary trading). 

811See AFR et al. (Feb. 2012). 

812See Credit Suisse (Seidel) (stating that 

‘‘customer’’ should be explicitly defined to include 

any counterparty to whom a banking entity is 

providing liquidity); ISDA (Feb. 2012) 

(recommending that, if the Agencies decide to 

define these terms, a ‘‘counterparty’’ should be 

defined as the entity on the other side of a 

transaction, and the terms ‘‘client’’ and ‘‘customer’’ 

should not be interpreted to require a relationship 

beyond the isolated provision of a transaction); 

Japanese Bankers Ass’n. (requesting that it be 

clearly noted that interbank participants can be 

customers for interbank market makers). 

813See ISDA (Feb. 2012). This commenter’s 

primary position was that further definitions are not 

required and could create additional and 

unnecessary complexity. See id. 

814See, e.g., JPMC; Morgan Stanley; Goldman 

(Prop. Trading); Chamber (Feb. 2012); MetLife; 

Credit Suisse (Seidel); BoA; ACLI (Feb. 2012); RBC; 

AFR et al. (Feb. 2012); ISDA (Feb. 2012); Oliver 

Wyman (Dec. 2011); Oliver Wyman (Feb. 2012). A 

few commenters noted that the proposed rule 

would permit a certain amount of interdealer 

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

2012) (citing statements in the proposal providing 

that a market maker’s ‘‘customers’’ vary depending 

on the asset class and market in which 

intermediation services are provided and 

interpreting such statements as allowing interdealer 

market making where brokers or other dealers act 

as ‘‘customers’’ within the proposed construct); 

Goldman (Prop. Trading) (stating that interdealer 

trading related to hedging or exiting a customer 

position would be permitted, but expressing 

concern that requiring each banking entity to justify 

each of its interdealer trades as being related to one 

of its own customers would be burdensome and 

would reduce the effectiveness of the interdealer 

market). Commenters’ concerns regarding 

interdealer trading are addressed in Part 

VI.A.3.c.2.c.i., infra. 

815See infra Part VI.A.3.c.8. 

816See, e.g., JPMC; SIFMA et al. (Prop. Trading) 

(Feb. 2012); Oliver Wyman (Feb. 2012) (recognizing 

that the proposed rule did not include specific 

limits on interdealer trading, but expressing 

concern that explicit or implicit limits could be 

established by supervisors during or after the 

conformance period). 

817See MetLife; SIFMA et al. (Prop. Trading) 

(Feb. 2012); RBC; Credit Suisse (Seidel); JPMC; 

BoA; ACLI (Feb. 2012); AFR et al. (Feb. 2012); ISDA 

(Feb. 2012); Goldman (Prop. Trading); Oliver 

Wyman (Feb. 2012). 

818See RBC (suggesting that explicitly 

incorporating liquidity provision to other brokers 

and dealers in the market-making exemption would 

be consistent with the statute’s reference to meeting 

the needs of ‘‘counterparties,’’ in addition to the 

needs of clients and customers); AFR et al. (Feb. 

2012) (recognizing that the ability to manage 

inventory through interdealer transactions should 

be accommodated in the rule, but recommending 

that this activity be conditioned on a market maker 

having an appropriate level of inventory after an 

interdealer transaction); Goldman (Prop. Trading) 

(representing that the Agencies could evaluate and 

monitor the amount of interdealer trading that is 

consistent with a particular trading unit’s market 

making-related or hedging activity through the 

customer-facing activity category of metrics); Oliver 

Wyman (Feb. 2012) (recommending removal or 

modification of any metrics or principles that 

would indicate that interdealer trading is not 

permitted). 

819See Prof. Duffie; MetLife; ACLI (Feb. 2012); 

BDA (Feb. 2012). 

820See Oliver Wyman (Dec. 2011); Oliver Wyman 

(Feb. 2012); MetLife; ACLI (Feb. 2012). See also 

Thakor Study (stating that, when a market maker 

provides immediacy to a customer, it relies on 

being able to unwind its positions at opportune 

times by trading with other market makers, who 

may have knowledge about impending orders from 

their own customers that may induce them to trade 

with the market maker). 

821See MetLife; ACLI (Feb. 2012); Goldman 

(Prop. Trading); Morgan Stanley; Oliver Wyman 

(Dec. 2011); Oliver Wyman (Feb. 2012). 

822See Goldman (Prop. Trading); Chamber (Feb. 

2012). See also Prof. Duffie (stating that a market 

maker acquiring a position from a customer may 

wish to rebalance its inventory relatively quickly 

through the interdealer network, which is often 

more efficient than requesting immediacy from 

another customer or waiting for another customer 

who wants to take the opposite side of the trade). 

823See Chamber (Feb. 2012); Goldman (Prop. 

Trading). 

providing liquidity to other brokers and 

dealers into the rule text.803 Another 

commenter similarly stated that instead 

of focusing solely on customer demand, 

the rule should be clarified to reflect 

that demand can come from other 

dealers or future customers.804

In response to the proposal’s question 

about whether the terms ‘‘client,’’ 

‘‘customer,’’ and ‘‘counterparty’’ should 

be further defined, a few commenters 

stated that that the terms should not be 

defined in the rule.805 Other 

commenters indicated that further 

definition of these terms would be 

appropriate.806 Some of these 

commenters suggested that there should 

be greater limitations on who can be 

considered a ‘‘customer’’ under the 

rule.807 These commenters generally 

indicated that a ‘‘customer’’ should be a 

person or institution with whom the 

banking entity has a continuing, or a 

direct and substantive, relationship 

prior to the time of the transaction.808 In 

the case of a new customer, some of 

these commenters suggested requiring a 

relationship initiated by the prospective 

customer with a view to engaging in 

transactions.809 A few commenters 

indicated that a party should not be 

considered a client, customer, or 

counterparty if the banking entity: (i) 

Originates a financial product and then 

finds a counterparty to take the other 

side of the transaction; 810 or (ii) engages 

in transactions driven by algorithmic 

trading strategies.811 Three commenters 

requested more permissive definitions 

of these terms.812 According to one of 

these commenters, because these terms 

are listed in the disjunctive in the 

statute, the broadest term—a 

‘‘counterparty’’—should prevail.813

v. Interdealer Trading and Trading for 

Price Discovery or To Test Market Depth 

With respect to interdealer trading, 

many commenters expressed concern 

that the proposed rule could be 

interpreted to restrict a market maker’s 

ability to engage in interdealer 

trading.814 As a general matter, 

commenters attributed these concerns to 

statements in proposed Appendix B815

or to the Customer-Facing Trade Ratio 

metric in proposed Appendix A.816 A 

number of commenters requested that 

the rule be modified to clearly recognize 

interdealer trading as a component of 

permitted market making-related 

activity 817 and suggested ways in which 

this could be accomplished (e.g., 

through a definition of ‘‘customer’’ or 

‘‘counterparty’’).818

Commenters emphasized that 

interdealer trading provides certain 

market benefits, including increased 

market liquidity; 819 more efficient 

matching of customer order flow; 820

greater hedging options to reduce 

risks; 821 enhanced ability to accumulate 

inventory for current or near term 

customer demand, work down 

concentrated positions arising from a 

customer trade, or otherwise exit a 

position acquired from a customer; 822

and general price discovery among 

dealers.823 Regarding the impact of 

interdealer trading on a market maker’s 

ability to intermediate customer needs, 

one commenter studied the potential 

impact of interdealer trading limits—in 

combination with inventory limits—on 

trading in the U.S. corporate bond 

market. According to this commenter, if 

interdealer trading had been prohibited 


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824See Oliver Wyman (Feb. 2012) (basing its 

finding on data from 2009). This commenter also 

represented that the natural level of interdealer 

volume in the U.S. corporate bond market made up 

16 percent of total trading volume in 2010. See id. 

825See Goldman (Prop. Trading); Morgan Stanley. 

See also BDA (Feb. 2012) (stating that if dealers in 

the fixed-income market are not able to trade with 

other dealers to ‘‘cooperate with each other to 

provide adequate liquidity to the market as a 

whole,’’ an essential source of liquidity will be 

eliminated from the market and existing values of 

fixed income securities will decline and become 

volatile, harming both investors who currently hold 

such positions and issuers, who will experience 

increased interest costs). 

826See Chamber (Feb. 2012); Goldman (Prop. 

Trading). 

827See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Chamber (Feb. 2012); Goldman (Prop. Trading). One 

commenter provided the following example of such 

activity: if Security A and Security B have some 

price correlation but neither trades regularly, then 

a trader may execute a trade in Security A for price 

discovery purposes, using the price of Security A 

to make an informed bid-ask market to a customer 

in Security B. See SIFMA et al. (Prop. Trading) 

(Feb. 2012). 

828See Goldman (Prop. Trading); Chamber (Feb. 

2012) (stating that this type of trading is necessary 

in more illiquid markets); SIFMA et al. (Prop. 

Trading) (Feb. 2012). 

829See Goldman (Prop. Trading). 

830See Chamber (Feb. 2012). 

831See id. 

832See Goldman (Prop. Trading). This commenter 

represented that market makers often make trades 

with other dealers to test the depth of the markets 

at particular price points and to understand where 

supply and demand exist (although such trading is 

not conducted exclusively with other dealers). This 

commenter stated that testing the depth of the 

market is necessary to provide accurate prices to 

customers, particularly when customers seeks to 

enter trades in amounts larger than the amounts 

offered by dealers who have sent indications to 

inter-dealer brokers. See id. 

833See id. 

834See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); Credit Suisse (Seidel); Goldman (Prop. 

Trading); MFA; RBC. Inventory management is 

addressed in Part VI.A.3.c.2.c., infra. 

835See, e.g., MFA (stating that it is critical for 

banking entities to continue to be able to maintain 

sufficient levels of inventory, which is dynamic in 

nature and requires some degree of flexibility in 

application); RBC (requesting that the Agencies 

explicitly acknowledge that, depending on market 

conditions or the characteristics of a particular 

security, it may be appropriate or necessary for a 

firm to maintain inventories over extended periods 

of time in the course of market making-related 

activities). 

836See, e.g., RBC; NYSE Euronext; Fidelity. These 

commenters cited a colloquy in the Congressional 

Record between Senator Bayh and Senator Dodd, in 

which Senator Bayh stated: ‘‘With respect to 

[section 13 of the BHC Act], the conference report 

states that banking entities are not prohibited from 

purchasing and disposing of securities and other 

instruments in connection with underwriting or 

market-making activities, provided that activity 

does not exceed the reasonably expected near-term 

demands of clients, customers, or counterparties. I 

want to clarify this language would allow banks to 

maintain an appropriate dealer inventory and 

residual risk positions, which are essential parts of 

the market-making function. Without that 

flexibility, market makers would not be able to 

provide liquidity to markets.’’ 156 Cong. Rec. S5906 

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

837See, e.g., RBC. 

838See Goldman (Prop. Trading). 

839See id. 

840See MFA. 

841See RBC. 

842See Goldman (Prop. Trading); BoA. 

843See Oliver Wyman (Feb. 2012). As this 

commenter explained, some mutual funds and ETFs 

track major equity indices and, when the 

composition of an index changes (e.g., due to the 

addition or removal of a security or to rising or 

falling values of listed shares), an announcement is 

made and all funds tracking the index need to 

rebalance their portfolios. According to the 

commenter, banking entities may need to step in to 

provide liquidity for rebalances of less liquid 

indices because trades executed on the open market 

would substantially affect share prices. The 

commenter estimated that if market makers are not 

able to provide direct liquidity for rebalance trades, 

investors tracking these indices could potentially 

pay incremental costs of $600 million to $1.8 

billion every year. This commenter identified the 

proposed inventory metrics in Appendix A as 

potentially limiting a banking entity’s willingness 

or ability to facilitate index rebalance trades. See id. 

Two other commenters also discussed the index 

rebalancing scenario. See Prof. Duffie; Thakor 

Study. Index rebalancing is addressed in note 931, 

infra. 

and a market maker’s inventory had 

been limited to the average daily 

volume of the market as a whole, 69 

percent of customer trades would have 

been prevented.824 Some commenters 

stated that a banking entity would be 

less able or willing to provide marketmaking services to customers if it could 

not engage in interdealer trading.825

As noted above, a few commenters 

stated that market makers may use 

interdealer trading for price discovery 

purposes.826 Some commenters 

separately discussed the importance of 

this activity and requested that, when 

conducted in connection with marketmaking activity, trading for price 

discovery be considered permitted 

market making-related activity under 

the rule.827 Commenters indicated that 

price discovery-related trading results in 

certain market benefits, including 

enhancing the accuracy of prices for 

customers,828 increasing price 

efficiency, preventing market 

instability,829 improving market 

liquidity, and reducing overall costs for 

market participants.830 As a converse, 

one of these commenters stated that 

restrictions on such activity could result 

in market makers setting their prices too 

high, exposing them to significant risk 

and causing a reduction of marketmaking activity or widening of spreads 

to offset the risk.831 One commenter 

further requested that trading to test 

market depth likewise be permitted 

under the market-making exemption.832

This commenter represented that the 

Agencies would be able to evaluate the 

extent to which trading for price 

discovery and market depth are 

consistent with market making-related 

activities for a particular market through 

a combination of customer-facing 

activity metrics, including the Inventory 

Risk Turnover metric, and knowledge of 

a banking entity’s trading business 

developed by regulators as part of the 

supervisory process.833

vi. Inventory Management 

Several commenters requested that 

the rule provide banking entities with 

greater discretion to manage their 

inventories in connection with market 

making-related activity, including 

acquiring or disposing of positions in 

anticipation of customer demand.834

Commenters represented that market 

makers need to be able to build, manage, 

and maintain inventories to facilitate 

customer demand. These commenters 

further stated that the rule needs to 

provide some degree of flexibility for 

inventory management activities, as 

inventory needs may differ based on 

market conditions or the characteristics 

of a particular instrument.835 A few 

commenters cited legislative history in 

support of allowing banking entities to 

hold and manage inventory in 

connection with market making-related 

activities.836 Several commenters noted 

benefits that are associated with a 

market maker’s ability to appropriately 

manage its inventory, including being 

able to meet reasonably anticipated 

future client, customer, or counterparty 

demand; 837 accommodating customer 

transactions more quickly and at 

favorable prices; reducing near term 

price volatility (in the case of selling a 

customer block position); 838 helping 

maintain an orderly market and provide 

the best price to customers (in the case 

of accumulating long or short positions 

in anticipation of a large customer sale 

or purchase); 839 ensuring that markets 

continue to have sufficient liquidity; 840

fostering a two-way market; and 

establishing a market-making 

presence.841 Some commenters noted 

that market makers may need to 

accumulate inventory to meet customer 

demand for certain products or under 

certain trading scenarios, such as to 

create units of structured products (e.g., 

ETFs and asset-backed securities) 842

and in anticipation of an index 

rebalance.843

Commenters also expressed views 

with respect to how much discretion a 

banking entity should have to manage 

its inventory under the exemption and 

how to best monitor inventory levels. 

For example, one commenter 

recommended that the rule allow 

market makers to build inventory in 

products where they believe customer 


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844See Credit Suisse (Seidel). 

845See CalPERS; Vanguard. These commenters 

represented that placing increasing capital 

requirements on aged inventory would ease the 

rule’s impact on investor liquidity, allow banking 

entities to internalize the cost of continuing to hold 

a position at the expense of its ability to take on 

new positions, and potentially decrease the 

possibility of a firm realizing a loss on a position 

by decreasing the time such position is held. See 

id. One commenter noted that some banking entities 

already use this approach to manage risk on their 

market-making desks. See Vanguard. See also 

Capital Group (suggesting that one way to 

implement the statutory exemption would be to 

charge a trader or a trading desk for positions held 

on its balance sheet beyond set time periods and to 

increase the charge at set intervals). These 

comments are addressed in note 923, infra. 

846See Goldman (Prop. Trading) (representing 

that the Inventory Risk Turnover metric will allow 

the Agencies to evaluate the length of time that a 

trading unit tends to hold risk positions in 

inventory and whether that holding time is 

consistent with market making-related activities in 

the relevant market). 

847See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); Credit Suisse (Seidel); JPMC; Goldman (Prop. 

Trading); BoA; ICI (stating that an AP may trade 

with the ETF issuer in different capacities—in 

connection with traditional market-making activity, 

on behalf of customers, or for the AP’s own 

account); ICI Global (discussing non-U.S. ETFs 

specifically); Vanguard; SSgA (Feb. 2012). One 

commenter represented that an AP’s transactions in 

ETFs do not create risks associated with proprietary 

trading because, when an AP trades with an ETF 

issuer for its own account, the AP typically enters 

into an offsetting transaction in the underlying 

portfolio of securities, which cancels out 

investment risk and limits the AP’s exposure to the 

difference between the market price for ETF shares 

and the ETF’s net asset value (‘‘NAV’’). See 

Vanguard. 

With respect to market-making activity in an ETF, 

several commenters noted that market makers play 

an important role in maintaining price alignment by 

engaging in arbitrage transactions between the ETF 

shares and the shares of the underlying 

components. See, e.g., JPMC; Goldman (Prop. 

Trading) (making similar statement with respect to 

ADRs as well); SSgA (Feb. 2012); SIFMA et al. 

(Prop. Trading) (Feb. 2012); Credit Suisse (Seidel); 

RBC. AP and market maker activity in ETFs are 

addressed in Part VI.A.3.c.2.c.i., infra. 

848See SIFMA et al. (Prop. Trading) (Feb. 2012); 

BoA; ICI (Feb. 2012) ICI Global; Vanguard; SSgA 

(Feb. 2012). 

849See JPMC; Goldman (Prop. Trading); SIFMA et 

al. (Prop. Trading) (Feb. 2012); SSgA (Feb. 2012); 

ICI (Feb. 2012) ICI Global. 

850See ICI Global; ICI (Feb. 2012) SIFMA et al. 

(Prop. Trading) (Feb. 2012); BoA. 

851See BoA; ICI (Feb. 2012); ICI Global. 

852See BoA (stating that lending the ETF shares 

to an investor gives the investor a more efficient 

way to hedge its exposure to assets correlated with 

those underlying the ETF). 

853See ICI Global; ICI (Feb. 2012). 

854See, e.g., Vanguard (noting that APs may not 

engage in market-making activity in the ETF and 

expressing concern that if AP activities are not 

separately permitted, banking entities may exit or 

not enter the ETF market); SSgA (Feb. 2012) (stating 

that APs are under no obligation to make markets 

in ETF shares and requiring such an obligation 

would discourage banking entities from acting as 

APs); ICI (Feb. 2012). 

855See SSgA (Feb. 2012). This commenter further 

stated that as of 2011, an estimated 3.5 million— 

or 3 percent—of U.S. households owned ETFs and, 

as of September 2011, ETFs represented assets of 

approximately $951 billion. See id. 

856See BoA; Vanguard (stating that this 

determination may be particularly difficult in the 

case of a new ETF). 

857See BoA. This commenter noted that the 

proposed source of revenue requirement could be 

interpreted to prevent a banking entity acting as AP 

from entering into creation and redemption 

transactions, ‘‘seeding’’ an ETF, engaging in ‘‘create 

to lend’’ transactions, and performing secondary 

market making in an ETF because all of these 

activities require an AP to build an inventory— 

either in ETF shares or the underlying 

components—which often result in revenue 

attributable to price movements. See id. 

858Commenters noted that this language would 

restrict an AP from engaging in price arbitrage to 

maintain efficient markets in ETFs. See Vanguard; 

RBC; Goldman (Prop. Trading); JPMC; SIFMA et al. 

(Prop. Trading) (Feb. 2012). See supra Part 

VI.A.3.c.2.a. (discussing the proposal’s proposed 

interpretation regarding arbitrage trading). 

859See BoA; Vanguard (stating that this 

determination may be particularly difficult in the 

case of a new ETF). 

860See ICI Global; ICI (Feb. 2012). 

861See ICI (Feb. 2012) ICI Global. These 

commenters provided suggested rule text on this 

issue and suggested that the Agencies could require 

a banking entity’s compliance policies and internal 

controls to take a comprehensive approach to the 

entirety of an AP’s trading activity, which would 

facilitate easy monitoring of the activity to ensure 

compliance. See id. 

862See Joint Proposal, 76 FR at 68873 (question 

91) (inquiring whether the proposed exemption 

should be modified to permit certain arbitrage 

trading activities engaged in by market makers that 

promote liquidity or price transparency but do not 

Continued 

demand will exist, regardless of whether 

the inventory can be tied to a particular 

customer in the near term or to 

historical trends in customer 

demand.844 A few commenters 

suggested that the Agencies provide 

banking entities with greater discretion 

to accumulate inventory, but discourage 

market makers from holding inventory 

for long periods of time by imposing 

increasingly higher capital requirements 

on aged inventory.845 One commenter 

represented that a trading unit’s 

inventory management practices could 

be monitored with the Inventory Risk 

Turnover metric, in conjunction with 

other metrics.846

vii. Acting as an Authorized Participant 

or Market Maker in Exchange-Traded 

Funds 

With respect to ETF trading, 

commenters generally requested 

clarification that a banking entity can 

serve as an authorized participant 

(‘‘AP’’) to an ETF issuer or can engage 

in ETF market making under the 

proposed exemption.847 According to 

commenters, APs may engage in the 

following types of activities with respect 

to ETFs: (i) Trading directly with the 

ETF issuer to create or redeem ETF 

shares, which involves trading in ETF 

shares and the underlying 

components; 848 (ii) trading to maintain 

price alignment between the ETF shares 

and the underlying components; 849 (iii) 

traditional market-making activity; 850

(iv) ‘‘seeding’’ a new ETF by entering 

into several initial creation transactions 

with an ETF issuer and holding the ETF 

shares, possibly for an extended period 

of time, until the ETF establishes regular 

trading and liquidity in the secondary 

markets; 851 (v) ‘‘create to lend’’ 

transactions, where an AP enters a 

creation transaction with the ETF issuer 

and lends the ETF shares to an 

investor; 852 and (vi) hedging.853 A few 

commenters noted that an AP may not 

engage in traditional market-making 

activity in the relevant ETF and 

expressed concern that the proposed 

rule may limit a banking entity’s ability 

to act in an AP capacity.854 One 

commenter estimated that APs that are 

banking entities make up between 20 

percent to 100 percent of creation and 

redemption activity for individual ETFs, 

with an average of approximately 35 

percent of creation and redemption 

activity across all ETFs attributed to 

banking entities. This commenter 

expressed the view that, if the rule 

limits banking entities’ ability to serve 

as APs, then individual investors’ 

investments in ETFs will become more 

expensive due to higher premiums and 

discounts versus the ETF’s NAV.855

A number of commenters stated that 

certain requirements of the proposed 

exemption may limit a banking entity’s 

ability to serve as AP to an ETF, 

including the proposed near term 

customer demand requirement,856 the 

proposed source of revenue 

requirement,857 and language in the 

proposal regarding arbitrage trading.858

With respect to the proposed near term 

customer demand requirement, a few 

commenters noted that this requirement 

could prevent an AP from building 

inventory to assemble creation units.859

Two other commenters expressed the 

view that the ETF issuer would be the 

banking entity’s ‘‘counterparty’’ when 

the banking entity trades directly with 

the ETF issuer, so this trading and 

inventory accumulation would meet the 

terms of the proposed requirement.860

To permit banking entities to act as APs, 

two commenters suggested that trading 

in the capacity of an AP should be 

deemed permitted market makingrelated activity, regardless of whether 

the AP is acting as a traditional market 

maker.861

viii. Arbitrage or Other Activities That 

Promote Price Transparency and 

Liquidity 

In response to a question in the 

proposal,862 a number of commenters 


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service client, customer, or counterparty demand); 

CFTC Proposal, 77 FR at 8359. 

863See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); Credit Suisse (Seidel); JPMC; Goldman (Prop. 

Trading); FTN; RBC; ISDA (Feb. 2012). Arbitrage 

trading is further discussed in Part VI.A.3.c.2.c.i., 

infra. 

864See SIFMA et al. (Prop. Trading) (Feb. 2012). 

865See SIFMA et al. (Prop. Trading) (Feb. 2012); 

JPMC. 

866See Credit Suisse (Seidel). 

867See RBC. 

868See SIFMA et al. (Prop. Trading) (Feb. 2012). 

869See Credit Suisse (Seidel); RBC. 

870See RBC. 

871See SIFMA et al. (Prop. Trading) (Feb. 2012); 

JPMC; FTN; ISDA (Feb. 2012) (stating that arbitrage 

activities often yield positions that are ultimately 

put to use in serving customer demand and 

representing that the process of consistently trading 

makes a dealer ready and available to serve 

customers on a competitive basis). 

872See JPMC (stating that firms commonly 

organize their market-making activities so that risks 

delivered to client-facing desks are aggregated and 

transferred by means of internal transactions to a 

single utility desk (which hedges all of the risks in 

the aggregate), and this may optically bear some 

characteristics of arbitrage, although the commenter 

requested that such activity be recognized as 

permitted market making-related activity under the 

rule); ISDA (Feb. 2012) (stating that in some swaps 

markets, dealers hedge through multiple 

instruments, which can give an impression of 

arbitrage in a function that is risk reducing; for 

example, a dealer in a broad index equity swap may 

simultaneously hedge in baskets of stocks, futures, 

and ETFs). But see Sens. Merkley & Levin (Feb. 

2012) (‘‘When banks use complex hedging 

techniques or otherwise engage in trading that is 

suggestive of arbitrage, regulators should require 

them to provide evidence and analysis 

demonstrating what risk is being reduced.’’). 

873See FTN. 

874See SIFMA et al. (Prop. Trading) (Feb. 2012); 

RBC; Goldman (Prop. Trading). One of these 

commenters stated that the customer-facing activity 

category of metrics, as well as other metrics, would 

be available to evaluate whether the trading unit is 

engaged in a directly customer-facing business and 

the extent to which its activities are consistent with 

the market-making exemption. See Goldman (Prop. 

Trading). 

875See Johnson & Prof. Stiglitz. See also AFR et 

al. (Feb. 2012) (noting that arbitrage, spread, or 

carry trades are a classic type of proprietary trade). 

876See Occupy. 

877See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012) (stating that permitted activities should 

include trading necessary to meet the relevant 

jurisdiction’s primary dealer and other 

requirements); JPMC (indicating that the exemption 

should cover all of a firm’s activities that are 

necessary or reasonably incidental to its acting as 

a primary dealer in a foreign government’s debt 

securities); Goldman (Prop. Trading); Banco de 

Me ́xico; IIB/EBF. See infra notes 905 to 906 and 

accompanying text (addressing these comments). 

878See Goldman (Prop. Trading). 

879See Banco de Me ́xico. 

880See JPMC; Banco de Me ́xico. These 

commenters stated that a primary dealer is required 

to assume positions in foreign sovereign debt even 

when near term customer demand is unpredictable. 

See id. 

881See Banco de Me ́xico (stating that primary 

dealers need to be able to profit from their positions 

in sovereign debt, including by holding significant 

positions in anticipation of future price movements, 

so that the primary dealer business is financially 

attractive); IIB/EBF (stating that primary dealers 

may actively seek to profit from price and interest 

rate movements based on their debt holdings, 

which governments support as providing muchneeded liquidity for securities that are otherwise 

purchased largely pursuant to buy-and-hold 

strategies of institutional investors and other 

entities seeking safe returns and liquidity buffers). 

882See Goldman (Prop. Trading). 

883See SIFMA et al. (Prop. Trading) (Feb. 2012). 

884See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); Credit Suisse (Seidel); JPMC; Goldman (Prop. 

Trading); SIFMA (Asset Mgmt.) (Feb. 2012). This 

issue is addressed in Part VI.A.3.c.1.c.iii., supra, 

and Part VI.A.3.c.2.c.iii., infra. 

stated that certain types of arbitrage 

activity should be permitted under the 

market-making exemption.863 For 

example, some commenters stated that a 

banking entity’s arbitrage activity 

should be considered market making to 

the extent the activity is driven by 

creating markets for customers tied to 

the price differential (e.g., ‘‘box’’ 

strategies, ‘‘calendar spreads,’’ merger 

arbitrage, ‘‘Cash and Carry,’’ or basis 

trading) 864 or to the extent that demand 

is predicated on specific price 

relationships between instruments (e.g., 

ETFs, ADRs) that market makers must 

maintain.865 Similarly, another 

commenter suggested that arbitrage 

activity that aligns prices should be 

permitted, such as index arbitrage, ETF 

arbitrage, and event arbitrage.866 One 

commenter noted that many markets, 

such as futures and options markets, 

rely on arbitrage activities of market 

makers for liquidity purposes and to 

maintain convergence with underlying 

instruments for cash-settled options, 

futures, and index-based products.867

Commenters stated that arbitrage trading 

provides certain market benefits, 

including enhanced price 

transparency,868 increased market 

efficiency,869 greater market 

liquidity,870 and general benefits to 

customers.871 A few commenters noted 

that certain types of hedging activity 

may appear to have characteristics of 

arbitrage trading.872

Commenters suggested certain 

methods for permitting and monitoring 

arbitrage trading under the exemption. 

For example, one commenter suggested 

a framework for permitting certain 

arbitrage within the market-making 

exemption, with requirements such as: 

(i) Common personnel with marketmaking activity; (ii) policies that cover 

the timing and appropriateness of 

arbitrage positions; (iii) time limits on 

arbitrage positions; and (iv) 

compensation that does not reward 

successful arbitrage, but instead pools 

any such revenues with market-making 

profits and losses.873 A few commenters 

represented that, if permitted under the 

rule, the Agencies would be able to 

monitor arbitrage activities for patterns 

of impermissible proprietary trading 

through the use of metrics, as well as 

compliance and examination tools.874

Other commenters stated that the 

exemption should not permit certain 

types of arbitrage. One commenter 

stated that the rule should ensure that 

relative value and complex arbitrage 

strategies cannot be conducted.875

Another commenter expressed the view 

that the market-making exemption 

should not permit any type of arbitrage 

transactions. This commenter stated 

that, in the event that liquidity or 

transparency is inhibited by a lack of 

arbitrage trading, a market maker should 

be able to find a customer who would 

seek to benefit from it.876

ix. Primary Dealer Activities 

A number of commenters requested 

that the market-making exemption 

permit banking entities to meet their 

primary dealer obligations in foreign 

jurisdictions, particularly if trading in 

foreign sovereign debt is not separately 

exempted in the final rule.877 According 

to commenters, a banking entity may be 

obligated to perform the following 

activities in its capacity as a primary 

dealer: undertaking to maintain an 

orderly market, preventing or correcting 

any price dislocations,878 and bidding 

on each issuance of the relevant 

jurisdiction’s sovereign debt.879

Commenters expressed concern that a 

banking entity’s trading activity as 

primary dealer may not comply with the 

proposed near term customer demand 

requirement 880 or the proposed source 

of revenue requirement.881 To address 

the first issue, one commenter stated 

that the final rule should clarify that a 

banking entity acting as a primary 

dealer of foreign sovereign debt is 

engaged in primary dealer activity in 

response to the near term demands of 

the sovereign, which should be 

considered a client, customer, or 

counterparty of the banking entity.882

Another commenter suggested that the 

Agencies permit primary dealer 

activities through commentary stating 

that fulfilling primary dealer obligations 

will not be included in determinations 

of whether the market-making 

exemption applies to a trading unit.883

x. New or Bespoke Products or 

Customized Hedging Contracts 

Several commenters indicated that the 

proposed exemption does not 

adequately address market making in 

new or bespoke products, including 

structured, customer-driven 

transactions, and requested that the rule 

be modified to clearly permit such 

activity.884 Many of these commenters 


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885See Credit Suisse (Seidel); Goldman (Prop. 

Trading); SIFMA (Asset Mgmt.) (Feb. 2012). 

886See Goldman (Prop. Trading); SIFMA (Asset 

Mgmt.) (Feb. 2012). 

887See SIFMA (Asset Mgmt.) (Feb. 2012). 

888See AFR et al. (Feb. 2012); Public Citizen. 

889See AFR et al. (Feb. 2012). 

890See Public Citizen. 

891The final rule includes certain refinements to 

the proposed standard, which would have required 

that the market making-related activities of the 

trading desk or other organizational unit that 

conducts the purchase or sale are, with respect to 

the financial instrument, designed not to exceed the 

reasonably expected near term demands of clients, 

customers, or counterparties. See proposed rule 

§ 75.4(b)(2)(iii). 

892See supra Part VI.A.3.c.1.c.ii.; final rule 

§ 75.4(b)(5). 

893See infra Part VI.A.3.c.3. (discussing the 

compliance program requirements); final rule 

§ 75.4(b)(2)(iii). 

894See supra Part VI.A.3.c.2.b.i. 

895This language has been added to the final rule 

to respond to commenters’ concerns that the 

proposed near term demand requirement would be 

unworkable in less liquid markets or would 

otherwise restrict a market maker’s ability to hold 

and manage its inventory in less liquid markets. See 

supra Part VI.A.3.c.2.b.ii. In addition, this provision 

is substantially similar to one commenter’s 

suggested approach of adding the phrase ‘‘based on 

the characteristics of the relevant market and asset 

class’’ to the proposed requirement, but the 

Agencies have added more specificity about the 

relevant characteristics that should be taken into 

consideration. See Morgan Stanley. 

896See infra Part VI.A.3.c.3. 

emphasized the role such transactions 

play in helping customers hedge the 

unique risks they face.885 Commenters 

stated that, as a result, limiting a 

banking entity’s ability to conduct such 

transactions would subject customers to 

increased risks and greater transaction 

costs.886 One commenter suggested that 

the Agencies explicitly state that a 

banking entity’s general willingness to 

engage in bespoke transactions is 

sufficient to make it a market maker in 

unique products for purposes of the 

rule.887

Other commenters stated that banking 

entities should be limited in their ability 

to rely on the market-making exemption 

to conduct transactions in bespoke or 

customized derivatives.888 For example, 

one commenter suggested that a banking 

entity be required to disaggregate such 

derivatives into liquid risk elements and 

illiquid risk elements, with liquid risk 

elements qualifying for the marketmaking exemption and illiquid risk 

elements having to be conducted on a 

riskless principal basis under 

§ 75.6(b)(1)(ii) of the proposed rule. 

According to this commenter, such an 

approach would not impact the end user 

customer.889 Another commenter stated 

that a banking entity making a market in 

bespoke instruments should be required 

both to hold itself out in accordance 

with § 75.4(b)(2)(ii) of the proposed rule 

and to demonstrate the purchase and 

the sale of such an instrument.890

c. Final Near Term Customer Demand 

Requirement 

Consistent with the statute, 

§ 75.4(b)(2)(ii) of the final rule’s marketmaking exemption requires that the 

amount, types, and risks of the financial 

instruments in the trading desk’s 

market-maker inventory be designed not 

to exceed, on an ongoing basis, the 

reasonably expected near term demands 

of clients, customers, or counterparties, 

based on certain market factors and 

analysis.891 As discussed above in Part 

VI.A.3.c.1.c.ii., the trading desk’s 

market-maker inventory consists of 

positions in financial instruments in 

which the trading desk stands ready to 

purchase and sell consistent with the 

final rule.892 The final rule requires the 

financial instruments to be identified in 

the trading desk’s compliance program. 

Thus, this requirement focuses on a 

trading desk’s positions in financial 

instruments for which it acts as market 

maker. These positions of a trading desk 

are more directly related to the demands 

of customers than positions in financial 

instruments used for risk management 

purposes, but in which the trading desk 

does not make a market. As noted 

above, a position or exposure that is 

included in a trading desk’s marketmaker inventory will remain in its 

market-maker inventory for as long as 

the position or exposure is managed by 

the trading desk. As a result, the trading 

desk must continue to account for that 

position or exposure, together with 

other positions and exposures in its 

market-maker inventory, in determining 

whether the amount, types, and risks of 

its market-maker inventory are designed 

not to exceed, on an ongoing basis, the 

reasonably expected near term demands 

of customers. 

While the near term customer demand 

requirement directly applies only to the 

trading desk’s market-maker inventory, 

this does not mean a trading desk may 

establish other positions, outside its 

market-maker inventory, that exceed 

what is needed to manage the risks of 

the trading desk’s market makingrelated activities and inventory. Instead, 

a trading desk must have limits on its 

market-maker inventory, the products, 

instruments, and exposures the trading 

desk may use for risk management 

purposes, and its aggregate financial 

exposure that are based on the factors 

set forth in the near term customer 

demand requirement, as well as other 

relevant considerations regarding the 

nature and amount of the trading desk’s 

market making-related activities. A 

banking entity must establish, 

implement, maintain, and enforce a 

limit structure, as well as other 

compliance program elements (e.g., 

those specifying the instruments a 

trading desk trades as a market maker or 

may use for risk management purposes 

and providing for specific risk 

management procedures), for each 

trading desk that are designed to 

prevent the trading desk from engaging 

in trading activity that is unrelated to 

making a market in a particular type of 

financial instrument or managing the 

risks associated with making a market in 

that type of financial instrument.893

To clarify the application of this 

standard in response to comments,894

the final rule provides two factors for 

assessing whether the amount, types, 

and risks of the financial instruments in 

the trading desk’s market-maker 

inventory are designed not to exceed, on 

an ongoing basis, the reasonably 

expected near term demands of clients, 

customers, or counterparties. 

Specifically, the following must be 

considered under the revised standard: 

(i) The liquidity, maturity, and depth of 

the market for the relevant type of 

financial instrument(s),895 and (ii) 

demonstrable analysis of historical 

customer demand, current inventory of 

financial instruments, and market and 

other factors regarding the amount, 

types, and risks of or associated with 

positions in financial instruments in 

which the trading desk makes a market, 

including through block trades. Under 

the final rule, a banking entity must 

account for these considerations when 

establishing risk and inventory limits 

for each trading desk.896

For purposes of this provision, 

‘‘demonstrable analysis’’ means that the 

analysis for determining the amount, 

types, and risks of financial instruments 

a trading desk may manage in its 

market-maker inventory, in accordance 

with the near term demand requirement, 

must be based on factors that can be 

demonstrated in a way that makes the 

analysis reviewable. This may include, 

among other things, the normal trading 

records of the trading desk and market 

information that is readily available and 

retrievable. If the analysis cannot be 

supported by the banking entity’s books 

and records and available market data, 

on their own, then the other factors 

utilized must be identified and 

documented and the analysis of those 

factors together with the facts gathered 

from the trading and market records 

must be identified in a way that makes 

it possible to test the analysis. 


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897As discussed further below, acquiring a 

position in a financial instrument in response to 

reasonably expected customer demand would not 

include creating a structured product for which 

there is no current customer demand and, instead, 

soliciting customer demand during or after its 

creation. See infra note 938 and accompanying text; 

Sens. Merkley & Levin (Feb. 2012). 

898The formation of structured finance products 

and securitizations is discussed in detail in Part 

VI.B.2.b. of this SUPPLEMENTARY INFORMATION. 

899See final rule § 75.4(b)(2)(iii)(B), (C). 

900This natural hedge with futures would 

introduce basis risk which, like other risks of the 

trading desk, must be managed within the desk’s 

limits. 

901See SIFMA (Asset Mgmt.) (Feb. 2012); T. Rowe 

Price; CIEBA; ICI (Feb. 2012) RBC. 

902See Japanese Bankers Ass’n.; Credit Suisse 

(Seidel); Occupy; AFR et al. (Feb. 2012); Public 

Citizen. 

Importantly, a determination of 

whether a trading desk’s market-maker 

inventory is appropriate under this 

requirement will take into account 

reasonably expected near term customer 

demand, including historical levels of 

customer demand, expectations based 

on market factors, and current demand. 

For example, at any particular time, a 

trading desk may acquire a position in 

a financial instrument in response to a 

customer’s request to sell the financial 

instrument or in response to reasonably 

expected customer buying interest for 

such instrument in the near term.897 In 

addition, as discussed below, this 

requirement is not intended to impede 

a trading desk’s ability to engage in 

certain market making-related activities 

that are consistent with and needed to 

facilitate permissible trading with its 

clients, customers, or counterparties, 

such as inventory management and 

interdealer trading. These activities 

must, however, be consistent with the 

analysis conducted under the final rule 

and the trading desk’s limits discussed 

below.898 Moreover, as explained below, 

the banking entity must also have in 

place escalation procedures to address, 

analyze, and document trades made in 

response to customer requests that 

would exceed one of a trading desk’s 

limits. 

The near term demand requirement is 

an ongoing requirement that applies to 

the amount, types, and risks of the 

financial instruments in the trading 

desk’s market-maker inventory. For 

instance, a trading desk may acquire 

exposures as a result of entering into 

market-making transactions with 

customers that are within the desk’s 

market-marker inventory and financial 

exposure limits. Even if the trading desk 

is appropriately managing the risks of 

its market-maker inventory, its marketmaker inventory still must be consistent 

with the analysis of the reasonably 

expected near term demands of clients, 

customers, and counterparties and the 

liquidity, maturity and depth of the 

market for the relevant instruments in 

the inventory. Moreover, the trading 

desk must take action to ensure that its 

financial exposure does not exceed its 

financial exposure limits.899 A trading 

desk may not maintain an exposure in 

its market-maker inventory, irrespective 

of customer demand, simply because 

the exposure is hedged and the resulting 

financial exposure is below the desk’s 

financial exposure limit. In addition, the 

amount, types, and risks of financial 

instruments in a trading desk’s marketmaker inventory would not be 

consistent with permitted marketmaking activities if, for example, the 

trading desk has a pattern or practice of 

retaining exposures in its market-maker 

inventory, while refusing to engage in 

customer transactions when there is 

customer demand for those exposures at 

commercially reasonable prices. 

The following is an example of the 

interplay between a trading desk’s 

market-maker inventory and financial 

exposure. An airline company customer 

may seek to hedge its long-term 

exposure to price fluctuations in jet fuel 

by asking a banking entity to create a 

structured ten-year, $1 billion jet fuel 

swap for which there is no liquid 

market. A trading desk that makes a 

market in energy swaps may service its 

customer’s needs by executing a custom 

jet fuel swap with the customer and 

holding the swap in its market-maker 

inventory, if the resulting transaction 

does not cause the trading desk to 

exceed its market-maker inventory limit 

on the applicable class of instrument, or 

the trading desk has received approval 

to increase the limit in accordance with 

the authorization and escalation 

procedures under paragraph 

(b)(2)(iii)(E). In keeping with the marketmaking exemption as provided in the 

final rule, the trading desk would be 

required to hedge the risk from this 

swap, either individually or as part of a 

set of aggregated positions, if the trade 

would result in a financial exposure that 

exceeds the desk’s financial exposure 

limits. The trading desk may hedge the 

risk of the swap, for example, by 

entering into one or more futures or 

swap positions that are identified as 

permissible hedging products, 

instruments, or exposures in the trading 

desk’s compliance program and that 

analysis, including correlation analysis 

as appropriate, indicates would 

demonstrably reduce or otherwise 

significantly mitigate risks associated 

with the financial exposure from its 

market-making activities. Alternatively, 

if the trading desk also acts as a market 

maker in crude oil futures, then the 

desk’s exposures arising from its 

market-making activities may naturally 

hedge the jet fuel swap (i.e., it may 

reduce its financial exposure levels 

resulting from such instruments).900 The 

trading desk must continue to 

appropriately manage risks of its 

financial exposure over time in 

accordance with its financial exposure 

limits. 

As discussed above, several 

commenters expressed concern that the 

near-term customer demand 

requirement is too restrictive and that it 

could impede a market maker’s ability 

to build or retain inventory, particularly 

in less liquid markets where demand is 

intermittent.901 Because customer 

demand in illiquid markets can be 

difficult to predict with precision, 

market-maker inventory may not closely 

track customer order flow. The Agencies 

acknowledge that market makers will 

face costs associated with demonstrating 

that market-maker inventory is designed 

not to exceed, on an ongoing basis, the 

reasonably expected near term demands 

of customers, as required by the statute 

and the final rule because this is an 

analysis that banking entities may not 

currently undertake. However, the final 

rule includes certain modifications to 

the proposed rule that are intended to 

reduce the negative impacts cited by 

commenters, such as limitations on 

inventory management activity and 

potential restrictions on market making 

in less liquid instruments, which the 

Agencies believe should reduce the 

perceived burdens of the proposed near 

term demand requirement. For example, 

the final rule recognizes that liquidity, 

maturity, and depth of the market vary 

across asset classes. The Agencies 

expect that the express recognition of 

these differences in the rule should 

avoid unduly impeding a market 

maker’s ability to build or retain 

inventory. More specifically, the 

Agencies recognize the relationship 

between market-maker inventory and 

customer order flow can vary across 

asset classes and that an inflexible 

standard for demonstrating that 

inventory does not exceed reasonably 

expected near term demand could 

provide an incentive to stop making 

markets in illiquid asset classes. 

i. Definition of ‘‘client,’’ ‘‘customer,’’ 

and ‘‘counterparty’’ 

In response to comments requesting 

further definition of the terms ‘‘client,’’ 

‘‘customer,’’ and ‘‘counterparty’’ for 

purposes of this standard,902 the 

Agencies have defined these terms in 

the final rule. In particular, the final 


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903Final rule § 75.4(b)(3). 

904See final rule § 75.4(b)(3)(i). The Agencies are 

using a $50 billion threshold for these purposes in 

recognition that firms engaged in substantial trading 

activity do not typically act as customers to other 

market makers, while smaller regional firms may 

seek liquidity from larger firms as part of their 

market making-related activities. 

905See final rule § 75.4(b)(3)(i)(A), (B). In 

Appendix C of the proposed rule, a trading unit 

engaged in market making-related activities would 

have been required to describe how it identifies its 

customers for purposes of the Customer-Facing 

Trading Ratio, if applicable, including 

documentation explaining when, how, and why a 

broker-dealer, swap dealer, security-based swap 

dealer, or any other entity engaged in market 

making-related activities, or any affiliate thereof, is 

considered to be a customer of the trading unit. See 

Joint Proposal, 76 FR at 68964. While the proposed 

approach would not have necessarily prevented any 

of these entities from being considered a customer 

of the trading desk, it would have required 

enhanced documentation and justification for 

treating any of these entities as a customer. The 

final rule’s exclusion from the definition of client, 

customer, and counterparty is similar to the 

proposed approach, but is more narrowly focused 

on firms that have $50 billion or more trading assets 

and liabilities because, as noted above, the Agencies 

believe firms engaged in such substantial trading 

activity are less likely to act as customers to market 

makers than smaller regional firms. 

906See Joint Proposal, 76 FR at 68960; CFTC 

Proposal, 77 FR at 8439. 

907See, e.g., Goldman (Prop. Trading) (explaining 

generally how exchange-based market makers 

operate). 

908See ISDA (Feb. 2012). In addition, a number 

of commenters suggested that the rule should not 

limit broker-dealers from being customers of a 

market maker. See SIFMA et al. (Prop. Trading) 

(Feb. 2012); Credit Suisse (Seidel); RBC; Comm. on 

Capital Markets Regulation. 

909See AFR et al. (Feb. 2012); Occupy; Public 

Citizen. 

910A primary dealer is a firm that trades a 

sovereign government’s obligations directly with 

the sovereign (in many cases, with the sovereign’s 

central bank) as well as with other customers 

through market making. The sovereign government 

may impose conditions on a primary dealer or 

require that it engage in certain trading in the 

relevant government obligations (e.g., participate in 

auctions for the government obligation or maintain 

a liquid secondary market in the government 

obligations). Further, a sovereign government may 

limit the number of primary dealers that are 

authorized to trade with the sovereign. A number 

of countries use a primary dealer system, including 

Australia, Brazil, Canada, China-Hong Kong, 

France, Germany, Greece, India, Indonesia, Ireland, 

Italy, Japan, Mexico, Netherlands, Portugal, South 

Africa, South Korea, Spain, Turkey, the U.K., and 

the U.S. See, e.g., Oliver Wyman (Feb. 2012). The 

Agencies note that this standard would similarly 

apply to the relationship between a banking entity 

and a sovereign that does not have a formal primary 

dealer system, provided the sovereign’s process 

functions like a primary dealer framework. 

911See Goldman (Prop. Trading). See also supra 

Part VI.A.3.c.2.b.ix. (discussing commenters’ 

concerns regarding primary dealer activity). Each 

suggestion regarding the treatment of primary 

dealer activity has not been incorporated into the 

Continued 

rule defines ‘‘client,’’ ‘‘customer,’’ and 

‘‘counterparty’’ as, on a collective or 

individual basis, ‘‘market participants 

that make use of the banking entity’s 

market making-related services by 

obtaining such services, responding to 

quotations, or entering into a continuing 

relationship with respect to such 

services.’’ 903 However, for purposes of 

the analysis supporting the marketmaker inventory held to meet the 

reasonably expected near-term demands 

of clients, customer and counterparties, 

a client, customer, or counterparty of 

the trading desk does not include a 

trading desk or other organizational unit 

of another entity if that entity has $50 

billion or more in total trading assets 

and liabilities, measured in accordance 

with § 75.20(d)(1),904 unless the trading 

desk documents how and why such 

trading desk or other organizational unit 

should be treated as a customer or the 

transactions are conducted 

anonymously on an exchange or similar 

trading facility that permits trading on 

behalf of a broad range of market 

participants.905

The Agencies believe this definition is 

generally consistent with the proposed 

interpretation of ‘‘customer’’ in the 

proposal. The proposal generally 

provided that, for purposes of market 

making on an exchange or other 

organized trading facility, a customer is 

any person on behalf of whom a buy or 

sell order has been submitted. In the 

context of the over-the-counter market, 

a customer was generally considered to 

be a market participant that makes use 

of the market maker’s intermediation 

services, either by requesting such 

services or entering into a continuing 

relationship for such services.906 The 

definition of client, customer, and 

counterparty in the final rule recognizes 

that, in the context of market making in 

a financial instrument that is executed 

on an exchange or other organized 

trading facility, a client, customer, or 

counterparty would be any person 

whose buy or sell order executes against 

the banking entity’s quotation posted on 

the exchange or other organized trading 

facility.907 Under these circumstances, 

the person would be trading with the 

banking entity in response to the 

banking entity’s quotations and 

obtaining the banking entity’s market 

making-related services. In the context 

of market making in a financial 

instrument in the OTC market, a client, 

customer, or counterparty generally 

would be a person that makes use of the 

banking entity’s intermediation services, 

either by requesting such services 

(possibly via a request-for-quote on an 

established trading facility) or entering 

into a continuing relationship with the 

banking entity with respect to such 

services. For purposes of determining 

the reasonably expected near-term 

demands of customers, a client, 

customer, or counterparty generally 

would not include a trading desk or 

other organizational unit of another 

entity that has $50 billion or more in 

total trading assets except if the trading 

desk has a documented reason for 

treating the trading desk or other 

organizational unit of such entity as a 

customer or the trading desk’s 

transactions are executed anonymously 

on an exchange or similar trading 

facility that permits trading on behalf of 

a broad range of market participants. 

The Agencies believe that this exclusion 

balances commenters’ suggested 

alternatives of either defining as a 

client, customer, or counterparty anyone 

who is on the other side of a market 

maker’s trade 908 or preventing any 

banking entity from being a client, 

customer, or counterparty.909 The 

Agencies believe that the first 

alternative is overly broad and would 

not meaningfully distinguish between 

permitted market making-related 

activity and impermissible proprietary 

trading. For example, the Agencies are 

concerned that such an approach would 

allow a trading desk to maintain an 

outsized inventory and to justify such 

inventory levels as being tangentially 

related to expected market-wide 

demand. On the other hand, preventing 

any banking entity from being a client, 

customer, or counterparty under the 

final rule would result in an overly 

narrow definition that would 

significantly impact banking entities’ 

ability to provide and access market 

making-related services. For example, 

most banks look to market makers to 

provide liquidity in connection with 

their investment portfolios. 

The Agencies further note that, with 

respect to a banking entity that acts as 

a primary dealer (or functional 

equivalent) for a sovereign government, 

the sovereign government and its central 

bank are each a client, customer, or 

counterparty for purposes of the marketmaking exemption as well as the 

underwriting exemption.910 The 

Agencies believe this interpretation, 

together with the modifications in the 

rule that eliminate the requirement to 

distinguish between revenues from 

spreads and price appreciation and the 

recognition that the market-making 

exemption extends to market makingrelated activities appropriately captures 

the unique relationship between a 

primary dealer and the sovereign 

government. Thus, generally a banking 

entity may rely on the market-making 

exemption for its activities as primary 

dealer (or functional equivalent) to the 

extent those activities are outside of the 

underwriting exemption.911


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rule. Specifically, the exemption for market making 

as applied to a primary dealer does not extend 

without limitation to primary dealer activities that 

are not conducted under the conditions of one of 

the exemptions. These interpretations would be 

inconsistent with Congressional intent for the 

statute, to limit permissible market- making activity 

through the statute’s near term demand requirement 

and, thus, does not permit trading without 

limitation. See SIFMA et al. (Prop. Trading) (Feb. 

2012) (stating that permitted activities should 

include trading necessary to meet the relevant 

jurisdiction’s primary dealer and other 

requirements); JPMC (indicating that the exemption 

should cover all of a firm’s activities that are 

necessary or reasonably incidental to its acting as 

a primary dealer in a foreign government’s debt 

securities); Goldman (Prop. Trading); Banco de 

Me ́xico; IIB/EBF. Rather, recognizing that market 

making by primary dealers is a key function, the 

limits and other conditions of the rule are flexible 

enough to permit necessary market making-related 

activities. 

912ETF sponsors enter into relationships with one 

or more financial institutions that become APs for 

the ETF. Only APs are permitted to purchase and 

redeem shares directly from the ETF, and they can 

do so only in large aggregations or blocks that are 

commonly called ‘‘creation units.’’ In response to a 

question in the proposal, a number of commenters 

expressed concern that the proposed market-making 

exemption may not permit certain AP and market 

maker activities in ETFs and requested clarification 

that these activities would be permitted under the 

market-making exemption. See Joint Proposal, 76 

FR at 68873 (question 91) (‘‘Do particular markets 

or instruments, such as the market for exchangetraded funds, raise particular issues that are not 

adequately or appropriately addressed in the 

proposal? If so, how could the proposal better 

address those instruments, markets or market 

features?’’); CFTC Proposal, 77 FR at 8359 (question 

91); supra Part VI.A.3.c.2.b.vii. (discussing 

comments on this issue). 

913This is consistent with two commenters’ 

request that an ETF issuer be considered a 

‘‘counterparty’’ of the banking entity when it trades 

directly with the ETF issuer as an AP. See ICI 

Global; ICI (Feb. 2012). Further, this approach is 

intended to address commenters’ concerns that the 

near term demand requirement may limit a banking 

entity’s ability to act as AP for an ETF. See BoA; 

Vanguard. The Agencies believe that one 

commenter’s concern about the impact of the 

proposed source of revenue requirement on AP 

activity should be addressed by the replacement of 

this proposed requirement with a metric-based 

focus on when a trading desk generates revenue 

from its trading activity. See BoA; infra Part 

VI.A.3.c.7.c. (discussing the new approach to 

assessing a trading desk’s pattern of profit and loss). 

914This does not imply that the AP must perfectly 

predict future customer demand, but rather that 

there is a demonstrable, statistical, or historical 

basis for the size of the inventory held, as more 

fully discussed below. Consider, for example, a 

fixed-income ETF with $500 million in assets. If, on 

a typical day, an AP generates requests for $10 to 

$20 million of creations or redemptions, then an 

inventory of $10 to $20 million in bonds upon 

which the ETF is based (or some small multiple 

thereof) could be construed as consistent with 

reasonably expected near term customer demand. 

On the other hand, if under the same circumstances 

an AP holds $1 billion of these bonds solely in its 

capacity as an AP for this ETF, it would be more 

difficult to justify this as needed for reasonably 

expected near term customer demand and may be 

indicative of an AP engaging in prohibited 

proprietary trading. 

915 In ETF loan transactions (also referred to as 

‘‘create-to-lend’’ transactions), an AP borrows the 

underlying instruments that form the creation 

basket of an ETF, submits the borrowed instruments 

to the ETF agent in exchange for a creation unit of 

ETF shares, and lends the resulting ETF shares to 

a customer that wants to borrow the ETF. At the 

end of the ETF loan, the borrower returns the ETF 

shares to the AP, and the AP redeems the ETF 

shares with the ETF agent in exchange for the 

underlying instruments that form the creation 

basket. The AP may return the underlying 

instruments to the parties from whom it borrowed 

them or may use them for another loan, as long as 

the AP is not obligated to return them at that time. 

For the term of the ETF loan transaction, the AP 

hedges against market risk arising from any 

rebalancing of the ETF, which would change the 

amount or type of underlying instruments the AP 

would receive in exchange for the ETF compared 

to the underlying instruments the AP borrowed and 

submitted to the ETF agent to create the ETF shares. 

See David J. Abner, ‘‘The ETF Handbook,’’ Ch. 12 

(2010); Jean M. McLoughlin, Davis Polk & Wardwell 

LLP, to Division of Corporation Finance, U.S. 

Securities and Exchange Commission, dated Jan. 23, 

2013, available at http://www.sec.gov/divisions/

corpfin/cf-noaction/2013/davis-polk-wardwell-llp012813-16a.pdf. 

916See SSgA (Feb. 2012). 

917A number of commenters expressed concern 

that the proposed rule would limit market making 

or AP activity in ETFs because market makers and 

APs engage in trading to maintain a price 

relationship between ETFs and their underlying 

components, which promotes ETF market 

efficiency. See Vanguard; RBC; Goldman (Prop. 

Trading); JPMC; SIFMA et al. (Prop. Trading) (Feb. 

2012); SSgA (Feb. 2012); Credit Suisse (Prop. 

Trading). 

918Some commenters suggested that a range of 

arbitrage trading should be permitted under the 

market-making exemption. See, e.g., Goldman 

(Prop. Trading); RBC; SIFMA et al. (Prop. Trading) 

(Feb. 2012); JPMC. Other commenters, however, 

stated that arbitrage trading should be prohibited 

under the final rule. See AFR et al. (Feb. 2012); 

Volcker; Occupy. In response to commenters 

representing that it would be difficult to comply 

with this standard because it requires a trading desk 

to determine the proportionality of its activities in 

response to customer demand compared to its 

activities that are not in response to customer 

demand, the Agencies believe that the statute 

requires a banking entity to distinguish between 

market making-related activities that are designed 

not to exceed the reasonably expected near term 

demands of customers and impermissible 

proprietary trading. See Goldman (Prop. Trading); 

RBC. 

For exchange-traded funds (‘‘ETFs’’) 

(and related structures), Authorized 

Participants (‘‘APs’’) are generally the 

conduit for market participants seeking 

to create or redeem shares of the fund 

(or equivalent structure).912 For 

example, an AP may buy ETF shares 

from market participants who would 

like to redeem those shares for cash or 

a basket of instruments upon which the 

ETF is based. To provide this service, 

the AP may in turn redeem these shares 

from the ETF itself. Similarly, an AP 

may receive cash or financial 

instruments from a market participant 

seeking to purchase ETF shares, in 

which case the AP may use that cash or 

set of financial instruments to create 

shares from the ETF. In either case, for 

the purpose of the market-making 

exemption, such market participants as 

well as the ETF itself would be 

considered clients, customers, or 

counterparties of the AP.913 The 

inventory of ETF shares or underlying 

instruments held by the AP can 

therefore be evaluated under the criteria 

of the market-making exemption, such 

as how these holdings relate to 

reasonably expected near term customer 

demand.914 These criteria can be 

similarly applied to other activities of 

the AP, such as building inventory to 

‘‘seed’’ a new ETF or engaging in ETFloan related transactions.915 The 

Agencies recognize that banking entities 

currently conduct a substantial amount 

of AP creation and redemption activity 

in the ETF market and, thus, if the rule 

were to prevent or restrict a banking 

entity from acting as an AP for an ETF, 

then the rule would impact the 

functioning of the ETF market.916

Some firms, whether or not an AP in 

a given ETF, may also actively engage in 

buying and selling shares of an ETF and 

its underlying instruments in the market 

to maintain price continuity between 

the ETF and its underlying instruments, 

which are exchangeable for one another. 

Sometimes these firms will register as 

market makers on an exchange for a 

given ETF, but other times they may not 

register as market maker. Regardless of 

whether or not the firm is registered as 

a market maker on any given exchange, 

this activity not only provides liquidity 

for ETFs, but also, and very importantly, 

helps keep the market price of an ETF 

in line with the NAV of the fund. The 

market-making exemption can be used 

to evaluate trading that is intended to 

maintain price continuity between these 

exchangeable instruments by 

considering how the firm quotes, 

maintains risk and exposure limits, 

manages its inventory and risk, and, in 

the case of APs, exercises its ability to 

create and redeem shares from the fund. 

Because customers take positions in 

ETFs with an expectation that the price 

relationship will be maintained, such 

trading can be considered to be market 

making-related activity.917

After considering comments, the 

Agencies continue to take the view that 

a trading desk would not qualify for the 

market-making exemption if it is wholly 

or principally engaged in arbitrage 

trading or other trading that is not in 

response to, or driven by, the demands 

of clients, customers, or 

counterparties.918 The Agencies believe 

this activity, which is not in response to 

or driven by customer demand, is 

inconsistent with the Congressional 

intent that market making-related 

activity be designed not to exceed the 

reasonably expected near term demands 


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919See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); JPMC. 

920See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); JPMC; Credit Suisse (Seidel). For example, 

customers have an expectation of general price 

alignment under these circumstances, both at the 

time they decide to invest in the instrument and for 

the remaining time they hold the instrument. To the 

contrary, general statistical arbitrage does not 

maintain a price relationship between related 

instruments that is expected and relied upon by 

customers and, thus, is not permitted under the 

market-making exemption. Firms engage in general 

statistical arbitrage to profit from differences in 

market prices between instruments, assets, or price 

or risk elements associated with instruments or 

assets that are thought to be statistically related, but 

which do not have a direct relationship of being 

exchangeable, convertible, or exercisable for the 

other. 

921See MetLife; ACLI (Feb. 2012); Goldman 

(Prop. Trading); Morgan Stanley; Chamber (Feb. 

2012); Prof. Duffie; Oliver Wyman (Dec. 2011); 

Oliver Wyman (Feb. 2012). 

922A number of commenters requested that the 

rule be modified to clearly recognize interdealer 

trading as a component of permitted market 

making-related activity. See MetLife; SIFMA et al. 

(Prop. Trading) (Feb. 2012); RBC; Credit Suisse 

(Seidel); JPMC; BoA; ACLI (Feb. 2012); AFR et al. 

(Feb. 2012); ISDA (Feb. 2012); Goldman (Prop. 

Trading); Oliver Wyman (Feb. 2012). One of these 

commenters analyzed the potential market impact 

of preventing interdealer trading, combined with 

inventory limits. See Oliver Wyman (Feb. 2012). 

Because the final rule does not prohibit interdealer 

trading or limit inventory in the manner this 

commenter assumed for purposes of its analysis, the 

Agencies do not believe the final rule will have the 

market impact cited by this commenter. 

923See AFR et al. (Feb. 2012) (recognizing that 

the ability to manage inventory through interdealer 

transactions should be accommodated in the rule, 

but recommending that this activity be conditioned 

on a market maker having an appropriate level of 

inventory after an interdealer transaction). 

924Provided it is consistent with the requirements 

of the market-making exemption, including the near 

term customer demand requirement, a trading desk 

may trade for purposes of determining how to price 

a financial instrument a customer seeks to trade 

with the trading desk or to determine the depth of 

the market for a financial instrument a customer 

seeks to trade with the trading desk. See Goldman 

(Prop. Trading). 

925See CIEBA (stating that, absent a different 

interpretation for illiquid instruments, market 

makers will err on the side of holding less inventory 

to avoid sanctions for violating the rule); Morgan 

Stanley; RBC; ICI (Feb. 2012) ISDA (Feb. 2012); 

Comm. on Capital Markets Regulation; Alfred 

Brock. 

926See supra Part VI.A.3.c.2.b.ii. (discussing 

comments on this issue). 

927See final rule § 75.4(b)(2)(ii)(A). 

928The final rule does not impose additional 

capital requirements on aged inventory to 

discourage a trading desk from retaining positions 

in inventory, as suggested by some commenters. See 

CalPERS; Vanguard. The Agencies believe the final 

rule already limit a trading desk’s ability to hold 

inventory over an extended period and do not see 

a need at this time to include additional capital 

requirements in the final rule. For example, a 

trading desk must have written policies and 

procedures relating to its inventory and must be 

able to demonstrate, as needed, its analysis of why 

the levels of its market-maker inventory are 

necessary to meet, or is a result of meeting, 

customer demand. See final rule § 75.4(b)(2)(ii), 

(iii)(C). 

of clients, customers, or counterparties. 

For example, a trading desk would not 

be permitted to engage in general 

statistical arbitrage trading between 

instruments that have some degree of 

correlation but where neither 

instrument has the capability of being 

exchanged, converted, or exercised for 

or into the other instrument. A trading 

desk may, however, act as market maker 

to a customer engaged in a statistical 

arbitrage trading strategy. Furthermore 

as suggested by some commenters,919

trading activity used by a market maker 

to maintain a price relationship that is 

expected and relied upon by clients, 

customers, and counterparties is 

permitted as it is related to the demands 

of clients, customers, or counterparties 

because the relevant instrument has the 

capability of being exchanged, 

converted, or exercised for or into 

another instrument.920

The Agencies recognize that a trading 

desk, in anticipating and responding to 

customer needs, may engage in 

interdealer trading as part of its 

inventory management activities and 

that interdealer trading provides certain 

market benefits, such as more efficient 

matching of customer order flow, greater 

hedging options to reduce risk, and 

enhanced ability to accumulate or exit 

customer-related positions.921 The final 

rule does not prohibit a trading desk 

from using the market-making 

exemption to engage in interdealer 

trading that is consistent with and 

related to facilitating permissible 

trading with the trading desk’s clients, 

customers, or counterparties.922

However, in determining the reasonably 

expected near term demands of clients, 

customers, or counterparties, a trading 

desk generally may not account for the 

expected trading interests of a trading 

desk or other organizational unit of an 

entity with aggregate trading assets and 

liabilities of $50 billion or greater 

(except if the trading desk documents 

why and how a particular trading desk 

or other organizational unit at such a 

firm should be considered a customer or 

the trading desk or conduct marketmaking activity anonymously on an 

exchange or similar trading facility that 

permits trading on behalf of a broad 

range of market participants).923

A trading desk may engage in 

interdealer trading to: Establish or 

acquire a position to meet the 

reasonably expected near term demands 

of its clients, customers, or 

counterparties, including current 

demand; unwind or sell positions 

acquired from clients, customers, or 

counterparties; or engage in riskmitigating or inventory management 

transactions.924 The Agencies believe 

that allowing a trading desk to continue 

to engage in customer-related 

interdealer trading is appropriate 

because it can help a trading desk 

appropriately manage its inventory and 

risk levels and can effectively allow 

clients, customers, or counterparties to 

access a larger pool of liquidity. While 

the Agencies recognize that effective 

intermediation of client, customer, or 

counterparty trading may require a 

trading desk to engage in a certain 

amount of interdealer trading, this is an 

activity that will bear some scrutiny by 

the Agencies and should be monitored 

by banking entities to ensure it reflects 

market-making activities and not 

impermissible proprietary trading. 

ii. Impact of the Liquidity, Maturity, and 

Depth of the Market on the Analysis 

Several commenters expressed 

concern about the potential impact of 

the proposed near term demand 

requirement on market making in less 

liquid markets and requested that the 

Agencies recognize that near term 

customer demand may vary across 

different markets and asset classes.925

The Agencies understand that 

reasonably expected near term customer 

demand may vary based on the 

liquidity, maturity, and depth of the 

market for the relevant type of financial 

instrument(s) in which the trading desk 

acts as market maker.926 As a result, the 

final rule recognizes that these factors 

impact the analysis of reasonably 

expected near term demands of clients, 

customers, or counterparties and the 

amount, types, and risks of marketmaker inventory needed to meet such 

demand.927 In particular, customer 

demand is likely to be more frequent in 

more liquid markets than in less liquid 

or illiquid markets. As a result, market 

makers in more liquid cash-based 

markets, such as liquid equity 

securities, should generally have higher 

rates of inventory turnover and less aged 

inventory than market makers in less 

liquid or illiquid markets.928 Market 

makers in less liquid cash-based 

markets are more likely to hold a 

particular position for a longer period of 

time due to intermittent customer 

demand. In the derivatives markets, 

market makers carry open positions and 

manage various risk factors, such as 

exposure to different points on a yield 

curve. These exposures are analogous to 

inventory in the cash-based markets. 

Further, it may be more difficult to 

reasonably predict near term customer 

demand in less mature markets due to, 


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929The Agencies agree, as suggested by one 

commenter, it may be appropriate for a market 

maker in a new asset class or market to look to 

reasonably expected future developments on the 

basis of the trading desk’s customer relationships. 

See Morgan Stanley. As discussed further below, 

the Agencies recognize that a trading desk could 

encounter similar issues if it is a new entrant in an 

existing market. 

930See Joint Proposal, 76 FR at 68871; CFTC 

Proposal, 77 FR at 8356–8357. 

931See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); Goldman (Prop. Trading); Chamber (Feb. 

2012); Comm. on Capital Markets Regulation. See 

also Morgan Stanley; SIFMA (Asset Mgmt.) (Feb. 

2012). 

932See SIFMA et al. (Prop. Trading) (Feb. 2012); 

MetLife; Chamber (Feb. 2012); RBC; CIEBA; 

Wellington; ICI (Feb. 2012) Alfred Brock. 

933See SIFMA et al. (Prop. Trading) (Feb. 2012). 

934See CIEBA. 

935To determine an appropriate historical dataset, 

a banking entity should assess the relation between 

current or reasonably expected near term conditions 

and demand and those of prior market cycles. 

936This analysis may, where appropriate, take 

into account prior and/or anticipated cyclicality to 

the demands of clients, customers, or 

counterparties, which may cause variations in the 

amounts, types, and risks of financial instruments 

needed to provide intermediation services at 

different points in a cycle. For example, the final 

rule recognizes that a trading desk may need to 

accumulate a larger-than-average amount of 

inventory in anticipation of an index rebalance. See 

supra note 843 (discussing a comment on this 

issue). The Agencies are aware that a trading desk 

engaged in block positioning activity may have a 

less consistent pattern of inventory because of the 

need to take on large block positions at the request 

of customers. See supra note 761 and 

accompanying text (discussing comments on this 

issue). 

Because the final rule does not prevent banking 

entities from providing direct liquidity for 

rebalance trades, the Agencies do not believe that 

the final rule will cause the market impacts that one 

commenter predicted would occur were such a 

restriction adopted. See Oliver Wyman (Feb. 2012) 

(estimating that if market makers are not able to 

provide direct liquidity for rebalance trades, 

investors tracking these indices could potentially 

pay incremental costs of $600 million to $1.8 

billion every year). 

937 In addition, the Agencies recognize that a new 

entrant to a particular market or asset class may not 

have knowledge of historical customer demand in 

that market or asset class at the outset. See supra 

note 924 and accompanying text (discussing factors 

that may be relevant to new market entrants for 

purposes of determining the reasonably expected 

near term demands of clients, customers, or 

counterparties). 

938One commenter suggested an approach that 

would allow market makers to build inventory in 

products where they believe customer demand will 

exist, regardless of whether inventory can be tied 

to a particular customer in the near term or to 

historical trends in customer demand. See Credit 

Suisse (Seidel). The Agencies believe an approach 

that does not provide for any consideration of 

historical trends could result in a heightened risk 

of evasion. At the same time, as discussed above, 

the Agencies recognize that historical trends may 

not always determine the amount of inventory a 

trading desk may need to meet reasonably expected 

near term demand and it may under certain 

circumstances be appropriate to build inventory in 

anticipation of a reasonably expected near term 

event that would likely impact customer demand. 

While the Agencies are not requiring that marketmaker inventory be tied to a particular customer, 

the Agencies are requiring that a banking entity 

analyze and support its expectations for near term 

customer demand. 

939The Agencies recognize that a trading desk 

could acquire either a long or short position in 

among other things, a lack of historical 

experience with client, customer, or 

counterparty demands for the relevant 

product. Under these circumstances, the 

Agencies encourage banking entities to 

consider their experience with similar 

products or other relevant factors.929

iii. Demonstrable Analysis of Certain 

Factors 

In the proposal, the Agencies stated 

that permitted market making includes 

taking positions in securities in 

anticipation of customer demand, so 

long as any anticipatory buying or 

selling activity is reasonable and related 

to clear, demonstrable trading interest of 

clients, customers, or counterparties.930

A number of commenters expressed 

concern about this proposed 

interpretation’s impact on market 

makers’ inventory management activity 

and represented that it was inconsistent 

with the statute’s near term demand 

standard, which permits market-making 

activity that is ‘‘designed’’ not to exceed 

the ‘‘reasonably expected’’ near term 

demands of customers.931 In response to 

comments, the Agencies are permitting 

a trading desk to take positions in 

reasonable expectation of customer 

demand in the near term based on a 

demonstrable analysis that the amount, 

types, and risks of the financial 

instruments in the trading desk’s 

market-maker inventory are designed 

not to exceed, on an ongoing basis, the 

reasonably expected near term demands 

of customers. 

The proposal also stated that a 

banking entity’s determination of near 

term customer demand should generally 

be based on the unique customer base 

of a specific market-making business 

line (and not merely an expectation of 

future price appreciation). Several 

commenters stated that it was unclear 

how such determinations should be 

made and expressed concern that near 

term customer demand cannot always 

be accurately predicted,932 particularly 

in markets where trades occur 

infrequently and customer demand is 

hard to predict 933 or when a banking 

entity is entering a new market.934 To 

address these comments, the Agencies 

are providing additional information 

about how a banking entity can comply 

with the statute’s near term customer 

demand requirement, including a new 

requirement that a banking entity 

conduct a demonstrable assessment of 

reasonably expected near term customer 

demand and several examples of factors 

that may be relevant for conducting 

such an assessment. The Agencies 

believe it is important to require such 

demonstrable analysis to allow 

determinations of reasonably expected 

near term demand and associated 

inventory levels to be monitored and 

tested to ensure compliance with the 

statute and the final rule. 

The final rule provides that, to help 

determine the appropriate amount, 

types, and risks of the financial 

instruments in the trading desk’s 

market-maker inventory and to ensure 

that such inventory is designed not to 

exceed, on an ongoing basis, the 

reasonably expected near term demands 

of client, customers, or counterparties, a 

banking entity must conduct 

demonstrable analysis of historical 

customer demand, current inventory of 

financial instruments, and market and 

other factors regarding the amount, 

types, and risks of or associated with 

financial instruments in which the 

trading desk makes a market, including 

through block trades. This analysis 

should not be static or fixed solely on 

current market or other factors. Instead, 

an appropriately conducted analysis 

under this provision will be both 

backward- and forward-looking by 

taking into account relevant historical 

trends in customer demand 935 and any 

events that are reasonably expected to 

occur in the near term that would likely 

impact demand.936 Depending on the 

facts and circumstances, it may be 

proper for a banking entity to weigh 

these factors differently when 

conducting an analysis under this 

provision. For example, historical 

trends in customer demand may be less 

relevant when a trading desk is 

experiencing or expects to experience a 

change in the pattern of customer needs 

(e.g., requests for block positioning), 

adjustments to its business model (e.g., 

efforts to expand or contract its market 

shares), or changes in market 

conditions.937 On the other hand, absent 

these types of current or anticipated 

events, the amount, types, and risks of 

the financial instruments in the trading 

desk’s market-maker inventory should 

be relatively consistent with such 

trading desk’s historical profile of 

market-maker inventory.938

Moreover, the demonstrable analysis 

required under § 75.4(b)(2)(ii)(B) should 

account for, among other things, how 

the market factors discussed in 

§ 75.4(b)(2)(ii)(A) impact the amount, 

types, and risks of market-maker 

inventory the trading desk may need to 

facilitate reasonably expected near term 

demands of clients, customers, or 

counterparties.939 Other potential 


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reasonable anticipation of near term demands of 

clients, customers, or counterparties. In particular, 

if it is expected that customers will want to buy an 

instrument in the near term, it may be appropriate 

for the desk to acquire a long position in such 

instrument. If it is expected that customers will 

want to sell the instrument, acquiring a short 

position may be appropriate under certain 

circumstances. 

940See supra Part VI.A.3.c.2.b.iii. See FTN; 

Morgan Stanley (suggesting a standard that would 

require a position to be ‘‘reasonably consistent with 

observable customer demand patterns’’). 

941Complex structured products can contain a 

combination of several different types of risks, 

including, among others, market risk, credit risk, 

volatility risk, and prepayment risk. 

942 In contrast, a trading desk may respond to 

requests for customized transactions, such as 

custom swaps, provided that the trading desk is a 

market maker in the risk exposures underlying the 

swap or can hedge the underlying risk exposures, 

consistent with its financial exposure and hedging 

limits, and otherwise meets the requirements of the 

market-making exemption. For example, a trading 

desk may routinely make markets in underlying 

exposures and, thus, would meet the requirements 

for engaging in transactions in derivatives that 

reflect the same exposures. Alternatively, a trading 

desk might meet the requirements by routinely 

trading in the derivative and hedging in the 

underlying exposures. See supra Part 

VI.A.3.c.1.c.iii. 

943See, e.g., Sens. Merkley & Levin (Feb. 2012). 

944The Agencies are clarifying this point in 

response to commenters who expressed concern 

that the proposal would prevent an exchange 

market maker from using market or marketable limit 

orders under these circumstances. See, e.g., NYSE 

Euronext; SIFMA et al. (Prop. Trading) (Feb. 2012); 

Goldman (Prop. Trading); RBC. 

945See supra notes 774 to 779 and accompanying 

text (discussing commenters’ response to statements 

in the proposal requiring exchange registration as 

a market maker under certain circumstances). 

Similarly, the final rule does not establish a 

presumption of compliance with the market-making 

exemption based on registration as a market maker 

with an exchange, as requested by a few 

commenters. See supra note 777 and accompanying 

text. As noted above, activity that is considered 

market making for purposes of this rule may not be 

considered market making for purposes of other 

rules, including self-regulatory organization rules, 

and vice versa. In addition, exchange requirements 

for registered market makers are subject to change 

without consideration of the impact on this rule. 

Although a banking entity is not required to be an 

exchange-registered market maker under the final 

rule, a banking entity must be licensed or registered 

to engage in market making-related activities in 

accordance with applicable law. For example, a 

banking entity would be required to be an SECregistered broker-dealer to engage in market 

making-related activities in securities in the U.S. 

unless the banking entity is exempt from 

registration or excluded from regulation as a dealer 

under the Exchange Act. See infra Part VI.A.3.c.6.; 

final rule § 75.4(b)(2)(vi). 

946See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Goldman (Prop. Trading) (noting that there are more 

than 12 exchanges and 40 alternative trading 

systems currently trading U.S. equities). 

factors that could be used to assess 

reasonably expected near term customer 

demand and the appropriate amount, 

types, and risks of financial instruments 

in the trading desk’s market-maker 

inventory include, among others: (i) 

Recent trading volumes and customer 

trends; (ii) trading patterns of specific 

customers or other observable customer 

demand patterns; (iii) analysis of the 

banking entity’s business plan and 

ability to win new customer business; 

(iv) evaluation of expected demand 

under current market conditions 

compared to prior similar periods; (v) 

schedule of maturities in customers’ 

existing portfolios; and (vi) expected 

market events, such as an index 

rebalancing, and announcements. The 

Agencies believe that some banking 

entities already analyze these and other 

relevant factors as part of their overall 

risk management processes.940

With respect to the creation and 

distribution of complex structured 

products, a trading desk may be able to 

use the market-making exemption to 

acquire some or all of the risk exposures 

associated with the product if the 

trading desk has evidence of customer 

demand for each of the significant risks 

associated with the product.941 To have 

evidence of customer demand under 

these circumstances, there must be prior 

express interest from customers in the 

specific risk exposures of the product. 

Without such express interest, a trading 

desk would not have sufficient 

information to support the required 

demonstrable analysis (e.g., information 

about historical customer demand or 

other relevant factors).942 The Agencies 

are concerned that, absent express 

interest in each significant risk 

associated with the product, a trading 

desk could evade the market-making 

exemption by structuring a deal with 

certain risk exposures, or amounts of 

risk exposures, for which there is no 

customer demand and that would be 

retained in the trading desk’s inventory, 

potentially for speculative purposes. 

Thus, a trading desk would not be 

engaged in permitted market makingrelated activity if, for example, it 

structured a product solely to acquire a 

desired exposure and not to respond to 

customer demand.943 When a trading 

desk acquires risk exposures in these 

circumstances, the trading desk would 

be expected to enter into appropriate 

hedging transactions or otherwise 

mitigate the risks of these exposures, 

consistent with its hedging policies and 

procedures and risk limits. 

With regard to a trading desk that 

conducts its market-making activities on 

an exchange or other similar anonymous 

trading facility, the Agencies continue 

to believe that market-making activities 

are generally consistent with reasonably 

expected near term customer demand 

when such activities involve passively 

providing liquidity by submitting 

resting orders that interact with the 

orders of others in a non-directional or 

market-neutral trading strategy or by 

regularly responding to requests for 

quotes in markets where resting orders 

are not generally provided. This ensures 

that the trading desk has a pattern of 

providing, rather than taking, liquidity. 

However, this does not mean that a 

trading desk acting as a market maker 

on an exchange or other similar 

anonymous trading facility is only 

permitted to use these types of orders in 

connection with its market makingrelated activities. The Agencies 

recognize that it may be appropriate for 

a trading desk to enter market or 

marketable limit orders on an exchange 

or other similar anonymous trading 

facility, or to request quotes from other 

market participants, in connection with 

its market making-related activities for a 

variety of purposes including, among 

others, inventory management, 

addressing order imbalances on an 

exchange, and hedging.944 In response 

to comments, the Agencies are not 

requiring a banking entity to be 

registered as a market maker on an 

exchange or other similar anonymous 

trading facility, if the exchange or other 

similar anonymous trading facility 

registers market makers, for purposes of 

the final rule.945 The Agencies 

recognize, as noted by commenters, that 

there are a large number of exchanges 

and organized trading facilities on 

which market makers may need to trade 

to maintain liquidity across the markets 

and to provide customers with favorable 

prices and that requiring registration 

with each exchange or other trading 

facility may unnecessarily restrict or 

impose burdens on exchange marketmaking activities.946

A banking entity is not required to 

conduct the demonstrable analysis 

under § 75.4(b)(2)(B) of the final rule on 

an instrument-by-instrument basis. The 

Agencies recognize that, in certain 

cases, customer demand may be for a 

particular type of exposure, and a 

customer may be willing to trade any 

one of a number of instruments that 

would provide the demanded exposure. 

Thus, an assessment of the amount, 

types, and risks of financial instruments 

that the trading desk may hold in 

market-maker inventory and that would 

be designed not to exceed, on an 

ongoing basis, the reasonably expected 

near term demands of clients, 

customers, or counterparties does not 

need to be made for each financial 

instrument in which the trading desk 

acts as market maker. Instead, the 

amount and types of financial 

instruments in the trading desk’s 

market-maker inventory should be 


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947See RBC; CIEBA; Wellington; ICI (Feb. 2012) 

Invesco. 

948See Appendix A. 

949The Agencies recognize that for some types of 

positions or trading strategies, the use of ‘‘Risk 

Factor Sensitivities’’ and ‘‘Value-at-Risk and Stress 

Value-at-Risk’’ metrics may be ineffective and 

accordingly limits do not need to be set for those 

metrics if such ineffectiveness is demonstrated by 

the banking entity. 

950See final rule § 75.4(b)(2)(iii); infra Part 

VI.A.3.c.3.c. (discussing the meaning of 

‘‘independent’’ review for purposes of this 

requirement). 

951See proposed rule § 75.4(b)(2)(i); Joint 

Proposal, 76 FR at 68870; CFTC Proposal, 77 FR at 

8355. 

952See Flynn & Fusselman; Morgan Stanley. 

953See Flynn & Fusselman. 

954See Occupy. 

955See ICI (Feb. 2012). 

956The independent testing standard is discussed 

in more detail in Part VI.C., which discusses the 

compliance program requirement in § 75.20 of the 

final rule. 

consistent with the types of financial 

instruments in which the desk makes a 

market and the amount and types of 

such instruments that the desk’s 

customers are reasonably expected to be 

interested in trading. 

In response to commenters’ concern 

that banking entities may be subject to 

regulatory sanctions if reasonably 

expected customer demand does not 

materialize,947 the Agencies recognize 

that predicting the reasonably expected 

near term demands of clients, 

customers, or counterparties is 

inherently subject to changes based on 

market and other factors that are 

difficult to predict with certainty. Thus, 

there may at times be differences 

between predicted demand and actual 

demand from clients, customers, or 

counterparties. However, assessments of 

expected near term demand may not be 

reasonable if, in the aggregate and over 

longer periods of time, a trading desk 

exhibits a repeated pattern or practice of 

significant variation in the amount, 

types, and risks of financial instruments 

in its market-maker inventory in excess 

of what is needed to facilitate near term 

customer demand. 

iv. Relationship to Required Limits 

As discussed further below, a banking 

entity must establish limits for each 

trading desk on the amount, types, and 

risks of its market-maker inventory, 

level of exposures to relevant risk 

factors arising from its financial 

exposure, and period of time a financial 

instrument may be held by a trading 

desk. These limits must be reasonably 

designed to ensure compliance with the 

market-making exemption, including 

the near term customer demand 

requirement, and must take into account 

the nature and amount of the trading 

desk’s market making-related activities. 

Thus, the limits should account for and 

generally be consistent with the 

historical near term demands of the 

desk’s clients, customers, or 

counterparties and the amount, types, 

and risks of financial instruments that 

the trading desk has historically held in 

market-maker inventory to meet such 

demands. In addition to the limits that 

a trading desk selects in managing its 

positions to ensure compliance with the 

market-making exemption set out in 

§ 75.4(b), the Agencies are requiring, for 

banking entities that must report metrics 

in Appendix A, such limits include, at 

a minimum, ‘‘Risk Factor Sensitivities’’ 

and ‘‘Value-at-Risk and Stress Value-atRisk’’ metrics as limits, except to the 

extent any of the ‘‘Risk Factor 

Sensitivities’’ or ‘‘Value-at-Risk and 

Stress Value-at-Risk’’ metrics are 

demonstrably ineffective for measuring 

and monitoring the risks of a trading 

desk based on the types of positions 

traded by, and risk exposures of, that 

desk.948 The Agencies believe that these 

metrics can be useful for measuring and 

managing many types of positions and 

trading activities and therefore can be 

useful in establishing a minimum set of 

metrics for which limits should be 

applied.949

As this requirement applies on an 

ongoing basis, a trade in excess of one 

or more limits set for a trading desk 

should not be permitted simply because 

it responds to customer demand. Rather, 

a banking entity’s compliance program 

must include escalation procedures that 

require review and approval of any 

trade that would exceed one or more of 

a trading desk’s limits, demonstrable 

analysis that the basis for any temporary 

or permanent increase to one or more of 

a trading desk’s limits is consistent with 

the requirements of this near term 

demand requirement and with the 

prudent management of risk by the 

banking entity, and independent review 

of such demonstrable analysis and 

approval.950 The Agencies expect that a 

trading desk’s escalation procedures 

will generally explain the circumstances 

under which a trading desk’s limits can 

be increased, either temporarily or 

permanently, and that such increases 

must be consistent with reasonably 

expected near term demands of the 

desk’s clients, customers, or 

counterparties and the amount and type 

of risks to which the trading desk is 

authorized to be exposed. 

3. Compliance Program Requirement 

a. Proposed Compliance Program 

Requirement 

To ensure that a banking entity 

relying on the market-making 

exemption had an appropriate 

framework in place to support its 

compliance with the exemption, 

§ 75.4(b)(2)(i) of the proposed rule 

required a banking entity to establish an 

internal compliance program, as 

required by subpart D of the proposal, 

designed to ensure compliance with the 

requirements of the market-making 

exemption.951

b. Comments on the Proposed 

Compliance Program Requirement 

A few commenters supported the 

proposed requirement that a banking 

entity establish a compliance program 

under § 75.20 of the proposed rule as 

effective.952 For example, one 

commenter stated that the requirement 

‘‘keeps a strong focus on the bank’s own 

workings and allows banks to selfmonitor.’’ 953 One commenter indicated 

that a comprehensive compliance 

program is a ‘‘cornerstone of effective 

corporate governance,’’ but cautioned 

against placing ‘‘undue reliance’’ on 

compliance programs.954 As discussed 

further below in Parts VI.C.1. and 

VI.C.3., many commenters expressed 

concern about the potential burdens of 

the proposed rule’s compliance program 

requirement, as well as the proposed 

requirement regarding quantitative 

measurements. According to one 

commenter, the compliance burdens 

associated with these requirements may 

dissuade a banking entity from 

attempting to comply with the marketmaking exemption.955

c. Final Compliance Program 

Requirement 

Similar to the proposed exemption, 

the market-making exemption adopted 

in the final rule requires that a banking 

entity establish and implement, 

maintain, and enforce an internal 

compliance program required by 

subpart D that is reasonably designed to 

ensure the banking entity’s compliance 

with the requirements of the marketmaking exemption, including 

reasonably designed written policies 

and procedures, internal controls, 

analysis, and independent testing.956

This provision further requires that the 

compliance program include particular 

written policies and procedures, 

internal controls, analysis, and 

independent testing identifying and 

addressing: 

• The financial instruments each 

trading desk stands ready to purchase 

and sell as a market maker; 

• The actions the trading desk will 

take to demonstrably reduce or 


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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 5885 

957See final rule § 75.4(b)(2)(iii). 

958The Agencies note that a number of 

commenters requested that the Agencies place a 

greater emphasis on inventory limits and risk limits 

in the final exemption. See, e.g., Citigroup 

(suggesting that the market-making exemption 

utilize risk limits that would be set for each trading 

unit based on expected levels of customer trading— 

estimated by looking to historical results, target 

product and customer lists, and target market 

share—and an appropriate amount of required 

inventory to support that level of customer trading); 

Prof. Colesanti et al. (suggesting that the exemption 

include, among other things, a bright-line threshold 

of the amount of risk that can be retained (which 

cannot be in excess of the size and type required 

for market making), positions limits, and limits on 

holding periods); Sens. Merkley & Levin (Feb. 2012) 

(suggesting the use of specific parameters for 

inventory levels, along with a number of other 

criteria, to establish a safe harbor); SIFMA et al. 

(Prop. Trading) (Feb. 2012) (recommending the use 

of risk limits in combination with a guidance-based 

approach); Japanese Bankers Ass’n. (suggesting that 

the rule set risk allowances for market makingrelated activities based on required capital for such 

activities). The Agencies are not establishing 

specific limits in the final rule, as some commenters 

appeared to recommend, in recognition of the fact 

that appropriate limits will differ based on a 

number of factors, including the size of the marketmaking operation and the liquidity, depth, and 

maturity of the market for the particular type(s) of 

financial instruments in which the trading desk is 

permitted to trade. See Sens. Merkley & Levin (Feb. 

2012); Prof. Colesanti et al. However, banking 

entities relying on the market-making exemption 

must set limits and demonstrate how the specific 

limits and limit methodologies they have chosen 

are reasonably designed to limit the amount, types, 

and risks of the financial instruments in a trading 

desk’s market-maker inventory consistent with the 

reasonably expected near term demands of the 

banking entity’s clients, customers, and 

counterparties, subject to the market and conditions 

discussed above, and to commensurately control 

the desk’s overall financial exposure. 

959See final rule § 75.4(b)(2)(iii)(A) (requiring 

written policies and procedures, internal controls, 

analysis, and independent testing regarding the 

financial instruments each trading desk stands 

ready to purchase and sell in accordance with 

§ 75.4(b)(2)(i) of the final rule); final rule 

§ 75.4(b)(2)(iii)(B) (requiring written policies and 

procedures, internal controls, analysis, and 

independent testing regarding the products, 

instruments, or exposures each trading desk may 

use for risk management purposes). 

960This standard addresses issues raised by 

commenters concerning: certain language in 

proposed Appendix B regarding market makingrelated risk management; the market making-related 

hedging provision in § 75.4(b)(3) of the proposed 

rule; and, to some extent, the proposed source of 

revenue requirement in § 75.4(b)(2)(v) of the 

proposed rule. See Joint Proposal, 76 FR at 68960; 

CFTC Proposal, 77 FR at 8439–8440; proposed rule 

§ 75.4(b)(3); Joint Proposal, 76 FR at 68873; CFTC 

Proposal, 77 FR at 8358; Wellington; Credit Suisse 

(Seidel); Morgan Stanley; PUC Texas; CIEBA; SSgA 

(Feb. 2012); AllianceBernstein; Investure; Invesco; 

Japanese Bankers Ass’n.; SIFMA et al. (Prop. 

Trading) (Feb. 2012); FTN; RBC; NYSE Euronext; 

MFA. As discussed in more detail above, a number 

of commenters emphasized that market makingrelated activities necessarily involve a certain 

amount of risk-taking to provide ‘‘immediacy’’ to 

customers. See, e.g., Prof. Duffie; Morgan Stanley; 

SIFMA et al. (Prop. Trading) (Feb. 2012). 

Commenters also represented that the amount of 

risk a market maker needs to retain may differ 

across asset classes and markets. See, e.g., Morgan 

Stanley; Credit Suisse (Seidel). The Agencies 

believe that the requirement we are adopting better 

recognizes that appropriate risk management will 

tailor acceptable position, risk and inventory limits 

based on the type(s) of financial instruments in 

which the trading desk is permitted to trade and the 

liquidity, maturity, and depth of the market for the 

relevant type of financial instrument. 

otherwise significantly mitigate 

promptly the risks of its financial 

exposure consistent with the required 

limits; the products, instruments, and 

exposures each trading desk may use for 

risk management purposes; the 

techniques and strategies each trading 

desk may use to manage the risks of its 

market making-related activities and 

inventory; and the process, strategies, 

and personnel responsible for ensuring 

that the actions taken by the trading 

desk to mitigate these risks are and 

continue to be effective; 

• Limits for each trading desk, based 

on the nature and amount of the trading 

desk’s market making-related activities, 

that address the factors prescribed by 

the near term customer demand 

requirement of the final rule, on: 

Æ The amount, types, and risks of its 

market-maker inventory; 

Æ The amount, types, and risks of the 

products, instruments, and exposures 

the trading desk uses for risk 

management purposes; 

Æ Level of exposures to relevant risk 

factors arising from its financial 

exposure; and 

Æ Period of time a financial 

instrument may be held; 

• Internal controls and ongoing 

monitoring and analysis of each trading 

desk’s compliance with its required 

limits; and 

• Authorization procedures, 

including escalation procedures that 

require review and approval of any 

trade that would exceed a trading desk’s 

limit(s), demonstrable analysis that the 

basis for any temporary or permanent 

increase to a trading desk’s limit(s) is 

consistent with the requirements of 

§ 75.4(b)(2)(ii) of the final rule, and 

independent review (i.e., by risk 

managers and compliance officers at the 

appropriate level independent of the 

trading desk) of such demonstrable 

analysis and approval.957

The compliance program requirement 

in the proposed market-making 

exemption did not include specific 

references to all the compliance 

program elements now listed in the final 

rule. Instead, these elements were 

generally included in the compliance 

requirements of Appendix C of the 

proposed rule. The Agencies are moving 

certain of these requirements into the 

market-making exemption to ensure that 

critical components are made part of the 

compliance program for market makingrelated activities. Further, placing these 

requirements within the market-making 

exemption emphasizes the important 

role they play in overall compliance 

with the exemption.958 Banking entities 

should note that these compliance 

procedures must be established, 

implemented, maintained, and enforced 

for each trading desk engaged in market 

making-related activities under the final 

rule. Each of the requirements in 

paragraphs (b)(2)(iii)(A) through (E) 

must be appropriately tailored to the 

individual trading activities and 

strategies of each trading desk on an 

ongoing basis. 

As a threshold issue, the compliance 

program must identify the products, 

instruments, and exposures the trading 

desk may trade as market maker or for 

risk management purposes.959

Identifying the relevant instruments in 

which a trading desk is permitted to 

trade will facilitate monitoring and 

oversight of compliance with the 

exemption by preventing an individual 

trader on a market-making desk from 

establishing positions in instruments 

that are unrelated to the desk’s marketmaking function. Further, this 

identification of instruments helps form 

the basis for the specific types of 

inventory and risk limits that the 

banking entity must establish and is 

relevant to considerations throughout 

the exemption regarding the liquidity, 

depth, and maturity of the market for 

the relevant type of financial 

instrument. The Agencies note that a 

banking entity should be able to 

demonstrate the relationship between 

the instruments in which a trading desk 

may act as market maker and the 

instruments the desk may use to manage 

the risk of its market making-related 

activities and inventory and why the 

instruments the desk may use to manage 

its risk appropriately and effectively 

mitigate the risk of its market makingrelated activities without generating an 

entirely new set of risks that outweigh 

the risks that are being hedged. 

The final rule provides that a banking 

entity must establish an appropriate risk 

management framework for each of its 

trading desks that rely on the marketmaking exemption.960 This includes not 

only the techniques and strategies that 

a trading desk may use to manage its 

risk exposures, but also the actions the 

trading desk will take to demonstrably 

reduce or otherwise significantly 

mitigate promptly the risks of its 

financial exposures consistent with its 

required limits, which are discussed in 

more detail below. While the Agencies 

do not expect a trading desk to hedge all 

of the risks that arise from its market 


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5886 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

961 It may be more efficient for a banking entity 

to manage some risks at a higher organizational 

level than the trading desk level. As a result, a 

banking entity’s written policies and procedures 

may delegate the responsibility to mitigate specific 

risks of the trading desk’s financial exposure to an 

entity other than the trading desk, including 

another organizational unit of the banking entity or 

of an affiliate, provided that such organizational 

unit of the banking entity or of an affiliate is 

identified in the banking entity’s written policies 

and procedures. Under these circumstances, the 

other organizational unit of the banking entity or of 

an affiliate must conduct such hedging activity in 

accordance with the requirements of the hedging 

exemption in § 75.5 of the final rule, including the 

documentation requirement in § 75.5(c). As 

recognized in Part VI.A.4.d.4., hedging activity 

conducted by a different organizational unit than 

the unit responsible for the positions being hedged 

presents a greater risk of evasion. Further, the risks 

being managed by a higher organizational level than 

the trading desk may be generated by trading desks 

engaged in market making-related activity or by 

trading desks engaged in other permitted activities. 

Thus, it would be inappropriate for such hedging 

activity to be conducted in reliance on the marketmaking exemption. 

962See supra Part VI.A.3.c.2.c. (discussing the 

final near term demand requirement). 

963See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); Credit Suisse (Seidel); Goldman (Prop. 

Trading); MFA; RBC. 

964See, e.g., BoA; SIFMA et al. (Prop. Trading) 

(Feb. 2012); Chamber (Feb. 2012). 

965See Joint Proposal, 76 FR at 68873; CFTC 

Proposal, 77 FR at 8358. 

966As discussed above, if a trading desk operating 

under the market-making exemption directs a 

different organizational unit of the banking entity 

or an affiliate to establish a hedge position on the 

desk’s behalf, then the other organizational unit 

may rely on the market-making exemption to 

establish the hedge position as long as: (i) The other 

organizational unit’s hedging activity is consistent 

with the trading desk’s risk management policies 

and procedures (e.g., the hedge instrument, 

technique, and strategy are consistent with those 

identified in the trading desk’s policies and 

procedures); and (ii) the hedge position is attributed 

to the financial exposure of the trading desk and is 

included in the trading desk’s daily profit and loss. 

If a different organizational unit of the banking 

entity or of an affiliate establishes a hedge for the 

trading desk’s financial exposure based on its own 

determination, or if such position was not 

established in accordance with the trading desk’s 

required procedures or was included in that other 

organizational unit’s financial exposure and/or 

daily profit and loss, then that hedge position must 

be established in compliance with the hedging 

exemption in § 75.5 of the rule, including the 

documentation requirement in § 75.5(c). See supra 

Part VI.A.3.c.1.c.ii. 

967For example, this may occur if a U.S. 

corporate bond trading desk acquires a $100 million 

long position in the corporate bonds of one issuer 

from clients, customers, or counterparties and 

separately acquires a $50 million short position in 

another issuer in the same market sector in 

reasonable expectation of near term demand of 

clients, customers, or counterparties. Although both 

positions were acquired to facilitate customer 

demand, the positions may also naturally hedge 

each other, to some extent. 

968See Joint Proposal, 76 FR at 68875; CFTC 

Proposal, 77 FR at 8361. 

969Two commenters recommended that banking 

entities be permitted to establish hedges prior to 

acquiring the underlying risk exposure under these 

circumstances. See Credit Suisse (Seidel); BoA. 

making-related activities, the Agencies 

do expect each trading desk to take 

appropriate steps consistent with 

market-making activities to contain and 

limit risk exposures (such as by 

unwinding unneeded positions) and to 

follow reasonable procedures to monitor 

the trading desk’s risk exposures (i.e., its 

financial exposure) and hedge risks of 

its financial exposure to remain within 

its relevant risk limits.961

As discussed in Part VI.A.3.c.4.c., 

managing the risks associated with 

maintaining a market-maker inventory 

that is appropriate to meet the 

reasonably expected near-term demands 

of customers is an important part of 

market making.962 The Agencies 

understand that, in the context of 

market-making activities, inventory 

management includes adjustment of the 

amount and types of market-maker 

inventory to meet the reasonably 

expected near term demands of 

customers.963 Adjustments of the size 

and types of a financial exposure are 

also made to reduce or mitigate the risks 

associated with financial instruments 

held as part of a trading desk’s marketmaker inventory. A common strategy in 

market making is to establish marketmaker inventory in anticipation of 

reasonably expected customer needs 

and then to reduce that market-maker 

inventory over time as customer 

demand materializes.964 If customer 

demand does not materialize, the 

market maker addresses the risks 

associated with its market-maker 

inventory by adjusting the amount or 

types of financial instruments in its 

inventory as well as taking steps 

otherwise to mitigate the risk associated 

with its inventory. 

The Agencies recognize that, to 

provide effective intermediation 

services, a trading desk engaged in 

permitted market making-related 

activities retains a certain amount of 

risk arising from the positions it holds 

in inventory and may hedge certain 

aspects of that risk. The requirements in 

the final rule establish controls around 

a trading desk’s risk management 

activities, yet still recognize that a 

trading desk engaged in market makingrelated activities may retain a certain 

amount of risk in meeting the 

reasonably expected near term demands 

of clients, customers, or counterparties. 

As the Agencies noted in the proposal, 

where the purpose of a transaction is to 

hedge a market making-related position, 

it would appear to be market makingrelated activity of the type described in 

section 13(d)(1)(B) of the BHC Act.965

The Agencies emphasize that the only 

risk management activities that qualify 

for the market-making exemption—and 

that are not subject to the hedging 

exemption—are risk management 

activities conducted or directed by the 

trading desk in connection with its 

market making-related activities and in 

conformance with the trading desk’s 

risk management policies and 

procedures.966 A trading desk engaged 

in market making-related activities 

would be required to comply with the 

hedging exemption or another available 

exemption for any risk management or 

other activity that is not in conformance 

with the trading desk’s required marketmaking risk management policies and 

procedures. 

A banking entity’s written policies 

and procedures, internal controls, 

analysis, and independent testing 

identifying and addressing the products, 

instruments, or exposures and the 

techniques and strategies that may be 

used by each trading desk to manage the 

risks of its market making-related 

activities and inventory must cover both 

how the trading desk may establish 

hedges and how such hedges are 

removed once the risk they were 

mitigating is unwound. With respect to 

establishing positions that hedge or 

otherwise mitigate the risk(s) of market 

making-related positions held by the 

trading desk, the written policies and 

procedures may consider the natural 

hedging and diversification that occurs 

in an aggregation of long and short 

positions in financial instruments for 

which the trading desk is a market 

maker,967 as it documents its specific 

risk-mitigating strategies that use 

instruments for which the desk is a 

market maker or instruments for which 

the desk is not a market maker. Further, 

the written policies and procedures 

identifying and addressing permissible 

hedging techniques and strategies must 

address the circumstances under which 

the trading desk may be permitted to 

engage in anticipatory hedging. Like the 

proposed rule’s hedging exemption, a 

trading desk may establish an 

anticipatory hedge position before it 

becomes exposed to a risk that it is 

highly likely to become exposed to, 

provided there is a sound risk 

management rationale for establishing 

such an anticipatory hedge position.968

For example, a trading desk may hedge 

against specific positions promised to 

customers, such as volume-weighted 

average price (‘‘VWAP’’) orders or large 

block trades, to facilitate the customer 

trade.969 The amount of time that an 

anticipatory hedge may precede the 

establishment of the position to be 

hedged will depend on market factors, 


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970See final rule § 75.4(b)(2)(iii)(B). 

971See final rule § 75.4(b)(2)(iii)(C). 

972See, e.g., Citigroup (Feb. 2012) (noting that its 

suggested approach to implementing the marketmaking exemption, which would focus on risk 

limits and risk architecture, would build on existing 

risk limits and risk management systems already 

present in institutions). 

973See final rule § 75.4(b)(2)(iv). 

such as the liquidity of the hedging 

position. 

Written policies and procedures, 

internal controls, analysis, and 

independent testing established 

pursuant to the final rule identifying 

and addressing permissible hedging 

techniques and strategies should be 

designed to prevent a trading desk from 

over-hedging its market-maker 

inventory or financial exposure. Overhedging would occur if, for example, a 

trading desk established a position in a 

financial instrument for the purported 

purpose of reducing a risk associated 

with one or more market-making 

positions when, in fact, that risk had 

already been mitigated to the full extent 

possible. Over-hedging results in a new 

risk exposure that is unrelated to 

market-making activities and, thus, is 

not permitted under the market-making 

exemption. 

A trading desk’s financial exposure 

generally would not be considered to be 

consistent with market making-related 

activities to the extent the trading desk 

is engaged in hedging activities that are 

inconsistent with the management of 

identifiable risks in its market-maker 

inventory or maintains significant hedge 

positions after the underlying risk(s) of 

the market-maker inventory have been 

unwound. A banking entity’s written 

policies and procedures, internal 

controls, analysis, and independent 

testing regarding the trading desk’s 

permissible hedging techniques and 

strategies must be designed to prevent a 

trading desk from engaging in overhedging or maintaining hedge positions 

after they are no longer needed.970

Further, the compliance program must 

provide for the process and personnel 

responsible for ensuring that the actions 

taken by the trading desk to mitigate the 

risks of its market making-related 

activities are and continue to be 

effective, which would include 

monitoring for and addressing any 

scenarios where a trading desk may be 

engaged in over-hedging or maintaining 

unnecessary hedge positions or new 

significant risks have been introduced 

by the hedging activity. 

As a result of these limitations, the 

size and risks of the trading desk’s 

hedging positions are naturally 

constrained by the size and risks of its 

market-maker inventory, which must be 

designed not to exceed the reasonably 

expected near term demands of clients, 

customers, or counterparties, as well as 

by the risk limits and controls 

established under the final rule. This 

ultimately constrains a trading desk’s 

overall financial exposure since such 

position can only contain positions, 

risks, and exposures related to the 

market-maker inventory that are 

designed to meet current or near term 

customer demand and positions, risks 

and exposures designed to mitigate the 

risks in accordance with the limits 

previously established for the trading 

desk. 

The written policies and procedures 

identifying and addressing a trading 

desk’s hedging techniques and strategies 

also must describe how and under what 

timeframe a trading desk must remove 

hedge positions once the underlying 

risk exposure is unwound. Similarly, 

the compliance program established by 

the banking entity to specify and control 

the trading desk’s hedging activities in 

accordance with the final rule must be 

designed to prevent a trading desk from 

purposefully or inadvertently 

transforming its positions taken to 

manage the risk of its market-maker 

inventory under the exemption into 

what would otherwise be considered 

prohibited proprietary trading. 

Moreover, the compliance program 

must provide for the process and 

personnel responsible for ensuring that 

the actions taken by the trading desk to 

mitigate the risks of its market makingrelated activities and inventory— 

including the instruments, techniques, 

and strategies used for risk management 

purposes—are and continue to be 

effective. This includes ensuring that 

hedges taken in the context of market 

making-related activities continue to be 

effective and that positions taken to 

manage the risks of the trading desk’s 

market-maker inventory are not 

purposefully or inadvertently 

transformed into what would otherwise 

be considered prohibited proprietary 

trading. If a banking entity’s monitoring 

procedures find that a trading desk’s 

risk management procedures are not 

effective, such deficiencies must be 

promptly escalated and remedied in 

accordance with the banking entity’s 

escalation procedures. A banking 

entity’s written policies and procedures 

must set forth the process for 

determining the circumstances under 

which a trading desk’s risk management 

strategies may be modified. In addition, 

risk management techniques and 

strategies developed and used by a 

trading desk must be independently 

tested or verified by management 

separate from the trading desk. 

To control and limit the amount and 

types of financial instruments and risks 

that a trading desk may hold in 

connection with its market makingrelated activities, a banking entity must 

establish, implement, maintain, and 

enforce reasonably designed written 

policies and procedures, internal 

controls, analysis, and independent 

testing identifying and addressing 

specific limits on a trading desk’s 

market-maker inventory, risk 

management positions, and financial 

exposure. In particular, the compliance 

program must establish limits for each 

trading desk, based on the nature and 

amount of its market making-related 

activities (including the factors 

prescribed by the near term customer 

demand requirement), on the amount, 

types, and risks of its market-maker 

inventory, the amount, types, and risks 

of the products, instruments, and 

exposures the trading desk may use for 

risk management purposes, the level of 

exposures to relevant risk factors arising 

from its financial exposure, and the 

period of time a financial instrument 

may be held.971 The limits would be set, 

as appropriate, and supported by an 

analysis for specific types of financial 

instruments, levels of risk, and duration 

of holdings, which would also be 

required by the compliance appendix. 

This approach will build on existing 

risk management infrastructure for 

market-making activities that subject 

traders to a variety of internal, 

predefined limits.972 Each of these 

limits is independent of the others, and 

a trading desk must maintain its 

aggregated market-making position 

within each of these limits, including by 

taking action to bring the trading desk 

into compliance with the limits as 

promptly as possible after the limit is 

exceeded.973 For example, if changing 

market conditions cause an increase in 

one or more risks within the trading 

desk’s financial exposure and that 

increased risk causes the desk to exceed 

one or more of its limits, the trading 

desk must take prompt action to reduce 

its risk exposure (either by hedging the 

risk or unwinding its existing positions) 

or receive approval of a temporary or 

permanent increase to its limit through 

the required escalation procedures. 

The Agencies recognize that trading 

desks’ limits will differ across asset 

classes and acknowledge that trading 

desks engaged in market making-related 

activities in less liquid asset classes, 

such as corporate bonds, certain 

derivatives, and securitized products, 

may require different inventory, risk 

exposure, and holding period limits 

than trading desks engaged in market 


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5888 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

974See final rule § 75.4(b)(2)(iii)(C). 

975For example, if a U.S. corporate bond trading 

desk has a prescribed limit of $200 million net 

exposure to any single sector of related issuers, the 

desk’s limits may permit it to acquire a net 

economic exposure of $400 million long to issuer 

ABC and a net economic exposure of $300 million 

short to issuer XYZ, where ABC and XYZ are in the 

same sector. This is because the trading desk’s net 

exposure to the sector would only be $100 million, 

which is within its limits. Even though the net 

exposure to this sector is within the trading desk’s 

prescribed limits, the desk would still need to be 

able to demonstrate how its net exposure of $400 

million long to issuer ABC and $300 million short 

to issuer XYZ is related to customer demand. 

976See final rule § 75.4(b)(2)(iii)(D). 

977For example, a banking entity may determine 

to permit temporary, short-term increases to a 

trading desk’s risk limits due to an increase in 

short-term credit spreads or in response to volatility 

in instruments in which the trading desk makes a 

market, provided the increased limit is consistent 

with the reasonably expected near term demands of 

clients, customers, or counterparties. As noted 

above, other potential circumstances that could 

warrant changes to a trading desk’s limits include: 

A change in the pattern of customer needs, 

adjustments to the market maker’s business model 

(e.g., new entrants or existing market makers trying 

to expand or contract their market share), or 

changes in market conditions. See supra note 937 

and accompanying text. 

978See final rule § 75.4(b)(2)(iii)(E). 

979See ICI (Feb. 2012). 

making-related activities in more liquid 

financial instruments, such as certain 

listed equity securities. Moreover, the 

types of risk factors for which limits are 

established should not be limited solely 

to market risk factors. Instead, such 

limits should also account for all risk 

factors that arise from the types of 

financial instruments in which the 

trading desk is permitted to trade. In 

addition, these limits should be 

sufficiently granular and focused on the 

particular types of financial instruments 

in which the desk may trade. For 

example, a trading desk that makes a 

market in derivatives would have 

exposures to counterparty risk, among 

others, and would need to have 

appropriate limits on such risk. Other 

types of limits that may be relevant for 

a trading desk include, among others, 

position limits, sector limits, and 

geographic limits. 

A banking entity must have a 

reasonable basis for the limits it 

establishes for a trading desk and must 

have a robust procedure for analyzing, 

establishing, and monitoring limits, as 

well as appropriate escalation 

procedures.974 Among other things, the 

banking entity’s compliance program 

must provide for: (i) Written policies 

and procedures and internal controls 

establishing and monitoring specific 

limits for each trading desk; and (ii) 

analysis regarding how and why these 

limits are determined to be appropriate 

and consistent with the nature and 

amount of the desk’s market makingrelated activities, including 

considerations related to the near term 

customer demand requirement. In 

making these determinations, a banking 

entity should take into account and be 

consistent with the type(s) of financial 

instruments the desk is permitted to 

trade, the desk’s trading and risk 

management activities and strategies, 

the history and experience of the desk, 

and the historical profile of the desk’s 

near term customer demand and market 

and other factors that may impact the 

reasonably expected near term demands 

of customers. 

The limits established by a banking 

entity should generally reflect the 

amount and types of inventory and risk 

that a trading desk holds to meet the 

reasonably expected near term demands 

of clients, customers, or counterparties. 

As discussed above, while the trading 

desk’s market-maker inventory is 

directly limited by the reasonably 

expected near term demands of 

customers, the positions managed by the 

trading desk outside of its market-maker 

inventory are similarly constrained by 

the near term demand requirement 

because they must be designed to 

manage the risks of the market-maker 

inventory in accordance with the desk’s 

risk management procedures. As a 

result, the trading desk’s risk 

management positions and aggregate 

financial exposure are also limited by 

the current and reasonably expected 

near term demands of customers. A 

trading desk’s market-maker inventory, 

risk management positions, or financial 

exposure would not, however, be 

permissible under the market-making 

exemption merely because the marketmaker inventory, risk management 

positions, or financial exposure happens 

to be within the desk’s prescribed 

limits.975

In addition, a banking entity must 

establish internal controls and ongoing 

monitoring and analysis of each trading 

desk’s compliance with its limits, 

including the frequency, nature, and 

extent of a trading desk exceeding its 

limits and patterns regarding the 

portions of the trading desk’s limits that 

are accounted for by the trading desk’s 

activity.976 This may include the use of 

management and exception reports. 

Moreover, the compliance program must 

set forth a process for determining the 

circumstances under which a trading 

desk’s limits may be modified on a 

temporary or permanent basis (e.g., due 

to market changes or modifications to 

the trading desk’s strategy).977 This 

process must cover potential scenarios 

when a trading desk’s limits should be 

raised, as well as potential scenarios 

when a trading desk’s limits should be 

lowered. For example, if a trading desk 

experiences reduced customer demand 

over a period of time, that trading desk’s 

limits should be decreased to address 

the factors prescribed by the near term 

demand requirement. 

A banking entity’s compliance 

program must also include escalation 

procedures that require review and 

approval of any trade that would exceed 

one or more of a trading desk’s limits, 

demonstrable analysis that the basis for 

any temporary or permanent increase to 

one or more of a trading desk’s limits is 

consistent with the near term customer 

demand requirement, and independent 

review of such demonstrable analysis 

and approval of any increase to one or 

more of a trading desk’s limits.978 Thus, 

in order to increase a limit of a trading 

desk—on either a temporary or 

permanent basis—there must be an 

analysis of why such increase would be 

appropriate based on the reasonably 

expected near term demands of clients, 

customers, or counterparties, including 

the factors identified in § 75.4(b)(2)(ii) of 

the final rule, which must be 

independently reviewed. A banking 

entity also must maintain 

documentation and records with respect 

to these elements, consistent with the 

requirement of § 75.20(b)(6). 

As already discussed, commenters 

have represented that the compliance 

costs associated with the proposed rule, 

including the compliance program and 

metrics requirements, may be significant 

and ‘‘may dissuade a banking entity 

from attempting to comply with the 

market making-related activities 

exemption.’’ 979 The Agencies believe 

that a robust compliance program is 

necessary to ensure adherence to the 

rule and to prevent evasion, although, as 

discussed in Part VI.C.3., the Agencies 

are adopting a more tailored set of 

quantitative measurements to better 

focus on those that are most germane to 

evaluating market making-related 

activity. The Agencies acknowledge that 

the compliance program requirements 

for the market-making exemption, 

including reasonably designed written 

policies and procedures, internal 

controls, analysis, and independent 

testing, represent a new regulatory 

requirement for banking entities and the 

Agencies have thus been mindful that it 

may impose significant costs and may 

cause a banking entity to reconsider 

whether to conduct market makingrelated activities. Despite the potential 

costs of the compliance program, the 

Agencies believe they are warranted to 

ensure that the goals of the rule and 

statute will be met, such as promoting 


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980See Joint Proposal, 76 FR at 68873; CFTC 

Proposal, 77 FR at 8358. 

981See proposed rule § 75.4(b)(3); Joint Proposal, 

76 FR at 68873; CFTC Proposal, 77 FR at 8358. 

982See Joint Proposal, 76 FR at 68870 n.146; 

CFTC Proposal, 77 FR at 8356 n.152. 

983See, e.g., Japanese Bankers Ass’n.; SIFMA et 

al. (Prop. Trading) (Feb. 2012); Credit Suisse 

(Seidel); FTN; RBC; NYSE Euronext; MFA. These 

comments are addressed in Part VI.A.3.c.4.c., infra. 

984See SIFMA et al. (Prop. Trading) (Feb. 2012); 

RBC. See also FTN (stating that the principal 

requirement for such hedges should be that they 

reduce the risk of market making). 

985See NYSE Euronext (stating that the best 

hedge sometimes involves a variety of complex and 

dynamic transactions over the time in which an 

asset is held, which may fall outside the parameters 

of the exemption); MFA; JPMC. 

986See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Credit Suisse (Seidel); NYSE Euronext; MFA; 

Japanese Bankers Ass’n.; RBC. 

987RBC. 

988See BoA; SIFMA (Asset Mgmt.) (Feb. 2012). 

989See Goldman (Prop. Trading). 

990See BoA. 

991See SIFMA (Asset Mgmt.) (Feb. 2012). 

992See Alfred Brock. 

993See Occupy. 

994See infra notes 1073 to 1075 and 

accompanying text. 

995See Public Citizen. 

996See, e.g., Japanese Bankers Ass’n.; SIFMA et 

al. (Prop. Trading) (Feb. 2012); Credit Suisse 

(Seidel); FTN; RBC; NYSE Euronext; MFA. 

997See final rule § 75.4(b)(2)(iii)(B); supra Part 

VI.A.3.c.3.c. 

the safety and soundness of banking 

entities and the financial stability of the 

United States. 

4. Market Making-Related Hedging 

a. Proposed Treatment of Market 

Making-Related Hedging 

In the proposal, certain hedging 

transactions related to market making 

were considered to be made in 

connection with a banking entity’s 

market making-related activity for 

purposes of the market-making 

exemption. The Agencies explained that 

where the purpose of a transaction is to 

hedge a market making-related position, 

it would appear to be market makingrelated activity of the type described in 

section 13(d)(1)(B) of the BHC Act.980

To qualify for the market-making 

exemption, a hedging transaction would 

have been required to meet certain 

requirements under § 75.4(b)(3) of the 

proposed rule. This provision required 

that the purchase or sale of a financial 

instrument: (i) Be conducted to reduce 

the specific risks to the banking entity 

in connection with and related to 

individual or aggregated positions, 

contracts, or other holdings acquired 

pursuant to the market-making 

exemption; and (ii) meet the criteria 

specified in § 75.5(b) of the proposed 

hedging exemption and, where 

applicable, § 75.5(c) of the proposal.981

In the proposal, the Agencies noted that 

a market maker may often make a 

market in one type of financial 

instrument and hedge its activities using 

different financial instruments in which 

it does not make a market. The Agencies 

stated that this type of hedging 

transaction would meet the terms of the 

market-making exemption if the hedging 

transaction met the requirements of 

§ 75.4(b)(3) of the proposed rule.982

b. Comments on the Proposed 

Treatment of Market Making-Related 

Hedging 

Several commenters recommended 

that the proposed market-making 

exemption be modified to establish a 

more permissive standard for market 

maker hedging.983 A few of these 

commenters stated that, rather than 

applying the standards of the riskmitigating hedging exemption to market 

maker hedging, a market maker’s hedge 

position should be permitted as long as 

it is designed to mitigate the risk 

associated with positions acquired 

through permitted market makingrelated activities.984 Other commenters 

emphasized the need for flexibility to 

permit a market maker to choose the 

most effective hedge.985 In general, 

these commenters expressed concern 

that limitations on hedging market 

making-related positions may cause a 

reduction in liquidity, wider spreads, or 

increased risk and trading costs for 

market makers.986 For example, one 

commenter stated that ‘‘[t]he ability of 

market makers to freely offset or hedge 

positions is what, in most cases, makes 

them willing to buy and sell [financial 

instruments] to and from customers, 

clients or counterparties,’’ so ‘‘[a]ny 

impediment to hedging market makingrelated positions will decrease the 

willingness of banking entities to make 

markets and, accordingly, reduce 

liquidity in the marketplace.’’ 987

In addition, some commenters 

expressed concern that certain 

requirements in the proposed hedging 

exemption may result in a reduction in 

market-making activities under certain 

circumstances.988 For example, one 

commenter expressed concern that the 

proposed hedging exemption would 

require a banking entity to identify and 

tag hedging transactions when hedges in 

a particular asset class take place 

alongside a trading desk’s customer flow 

trading and inventory management in 

that same asset class.989 Further, a few 

commenters represented that the 

proposed reasonable correlation 

requirement in the hedging exemption 

could impact market making by 

discouraging market makers from 

entering into customer transactions that 

do not have a direct hedge 990 or making 

it more difficult for market makers to 

cost-effectively hedge the fixed income 

securities they hold in inventory, 

including hedging such inventory 

positions on a portfolio basis.991

One commenter, however, stated that 

the proposed approach is effective.992

Another commenter indicated that it is 

confusing to include hedging within the 

market-making exemption and 

suggested that a market maker be 

required to rely on the hedging 

exemption under § 75.5 of the proposed 

rule for its hedging activity.993

As noted above in the discussion of 

comments on the proposed source of 

revenue requirement, a number of 

commenters expressed concern that the 

proposed rule assumed that there are 

effective, or perfect, hedges for all 

market making-related positions.994

Another commenter stated that market 

makers should be required to hedge 

whenever an inventory imbalance 

arises, and the absence of a hedge in 

such circumstances may evidence 

prohibited proprietary trading.995

c. Treatment of Market Making-Related 

Hedging in the Final Rule 

Unlike the proposed rule, the final 

rule does not require that market 

making-related hedging activities 

separately comply with the 

requirements found in the riskmitigating hedging exemption if 

conducted or directed by the same 

trading desk conducting the marketmaking activity. Instead, the Agencies 

are including requirements for market 

making-related hedging activities within 

the market-making exemption in 

response to comments.996 As discussed 

above, a trading desk’s compliance 

program must include written policies 

and procedures, internal controls, 

independent testing and analysis 

identifying and addressing the products, 

instruments, exposures, techniques, and 

strategies a trading desk may use to 

manage the risks of its market makingrelated activities, as well as the actions 

the trading desk will take to 

demonstrably reduce or otherwise 

significant mitigate the risks of its 

financial exposure consistent with its 

required limits.997 The Agencies believe 

this approach addresses commenters’ 

concerns that limitations on hedging 

market making-related positions may 

cause a reduction in liquidity, wider 

spreads, or increased risk and trading 

costs for market makers because it 

allows banking entities to determine 


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5890 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

998See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Credit Suisse (Seidel); NYSE Euronext; MFA; 

Japanese Bankers Ass’n.; RBC. 

999See BoA; SIFMA (Asset Mgmt.) (Feb. 2012); 

Goldman (Prop. Trading). 

1000See Joint Proposal, 76 FR at 68961. 

1001See, e.g., letter from JPMC (stating that, to 

minimize risk management costs, firms commonly 

organize their market-making activities so that risks 

delivered to client-facing desks are aggregated and 

passed by means of internal transactions to a single 

utility desk and suggesting this be recognized as 

permitted market making-related behavior). 

1002See final rule § 75.5(c). 

1003See proposed rule § 75.4(b)(2)(vii). 

1004See Joint Proposal, 76 FR at 68872; CFTC 

Proposal, 77 FR at 8358. 

1005See Prof. Duffie; SIFMA et al. (Prop. Trading) 

(Feb. 2012); John Reed; Credit Suisse (Seidel); 

JPMC; Morgan Stanley; Better Markets (Feb. 2012); 

Johnson & Prof. Stiglitz; Occupy; AFR et al. (Feb. 

2012); Public Citizen. 

1006See FTN; Alfred Brock. 

1007See Japanese Bankers Ass’n. 

1008See Occupy. 

1009See Occupy; Goldman (Prop. Trading). 

1010See AllianceBernstein; Prof. Duffie; Investure; 

STANY; Chamber (Dec. 2011). 

1011See Better Markets (Feb. 2012); Public 

Citizen; AFR et al. (Feb. 2012); Occupy; John Reed; 

AFR et al. (Feb. 2012); Johnson & Prof. Stiglitz; Prof. 

Duffie; Sens. Merkley & Levin (Feb. 2012). These 

comments are addressed in note 1032, infra. 

1012See Better Markets (Feb. 2012); Public 

Citizen. 

1013See AFR et al. (Feb. 2012) 

1014See Occupy. 

1015See John Reed; AFR et al. (Feb. 2012); 

Johnson & Prof. Stiglitz; Prof. Duffie (‘‘A trader’s 

incentives for risk taking can be held in check by 

vesting incentive-based compensation over a 

substantial period of time. Pending compensation 

can thus be forfeited if a trader’s negligence causes 

substantial losses or if his or her employer fails.’’); 

Sens. Merkley & Levin (Feb. 2012). 

1016See John Reed. 

1017See Johnson & Prof. Stiglitz; John Reed; Sens. 

Merkley & Levin (Feb. 2012). 

how best to manage the risks of trading 

desks’ market making-related activities 

through reasonable policies and 

procedures, internal controls, 

independent testing, and analysis, 

rather than requiring compliance with 

the specific requirements of the hedging 

exemption.998 Further, this approach 

addresses commenters’ concerns about 

the impact of certain requirements of 

the hedging exemption on market 

making-related activities.999

The Agencies believe it is consistent 

with the statute’s reference to ‘‘market 

making-related’’ activities to permit 

market making-related hedging 

activities under this exemption. In 

addition, the Agencies believe it is 

appropriate to require a trading desk to 

appropriately manage its risks, 

consistent with its risk management 

procedures and limits, because 

management of risk is a key factor that 

distinguishes permitted market makingrelated activity from impermissible 

proprietary trading. As noted in the 

proposal, while ‘‘a market maker 

attempts to eliminate some [of the risks 

arising from] its retained principal 

positions and risks by hedging or 

otherwise managing those risks [ ], a 

proprietary trader seeks to capitalize on 

those risks, and generally only hedges or 

manages a portion of those risks when 

doing so would improve the potential 

profitability of the risk it retains.’’ 1000

The Agencies recognize that some 

banking entities may manage the risks 

associated with market making at a 

different level than the individual 

trading desk.1001 While this risk 

management activity is not permitted 

under the market-making exemption, it 

may be permitted under the hedging 

exemption, provided the requirements 

of that exemption are met. Thus, the 

Agencies believe banking entities will 

continue to have options available that 

allow them to efficiently hedge the risks 

arising from their market-making 

operations. Nevertheless, the Agencies 

understand that this rule will result in 

additional documentation or other 

potential burdens for market makingrelated hedging activity that is not 

conducted by the trading desk 

responsible for the market-making 

positions being hedged.1002 As 

discussed in Part VI.A.4.d.4., hedging 

conducted by a different organizational 

unit than the trading desk that is 

responsible for the underlying positions 

presents an increased risk of evasion, so 

the Agencies believe it is appropriate for 

such hedging activity to be required to 

comply with the hedging exemption, 

including the associated documentation 

requirement. 

5. Compensation Requirement 

a. Proposed Compensation Requirement 

Section 75.4(b)(2)(vii) of the proposed 

market-making exemption would have 

required that the compensation 

arrangements of persons performing 

market making-related activities at the 

banking entity be designed not to 

reward proprietary risk-taking.1003 In 

the proposal, the Agencies noted that 

activities for which a banking entity has 

established a compensation incentive 

structure that rewards speculation in, 

and appreciation of, the market value of 

a financial instrument position held in 

inventory, rather than success in 

providing effective and timely 

intermediation and liquidity services to 

customers, would be inconsistent with 

the proposed market-making exemption. 

The Agencies stated that under the 

proposed rule, a banking entity relying 

on the market-making exemption should 

provide compensation incentives that 

primarily reward customer revenues 

and effective customer service, not 

proprietary risk-taking. However, the 

Agencies noted that a banking entity 

relying on the proposed market-making 

exemption would be able to 

appropriately take into account 

revenues resulting from movements in 

the price of principal positions to the 

extent that such revenues reflect the 

effectiveness with which personnel 

have managed principal risk 

retained.1004

b. Comments Regarding the Proposed 

Compensation Requirement 

Several commenters recommended 

certain revisions to the proposed 

compensation requirement.1005 Two 

commenters stated that the proposed 

requirement is effective,1006 while one 

commenter stated that it should be 

removed from the rule.1007 Moreover, in 

addressing this proposed requirement, 

commenters provided views on: 

identifiable characteristics of 

compensation arrangements that 

incentivize prohibited proprietary 

trading,1008 methods of monitoring 

compliance with this requirement,1009

and potential negative incentives or 

outcomes this requirement could 

cause.1010

With respect to suggested 

modifications to this requirement, a few 

commenters suggested that a market 

maker’s compensation should be subject 

to additional limitations.1011 For 

example, two commenters stated that 

compensation should be restricted to 

particular sources, such as fees, 

commissions, and spreads.1012 One 

commenter suggested that compensation 

should not be symmetrical between 

gains and losses and, further, that 

trading gains reflecting an unusually 

high variance in position values should 

either not be reflected in compensation 

and bonuses or should be less reflected 

than other gains and losses.1013 Another 

commenter recommended that the 

Agencies remove ‘‘designed’’ from the 

rule text and provide greater clarity 

about how a banking entity’s 

compensation regime must be 

structured.1014 Moreover, a number of 

commenters stated that compensation 

should be vested for a period of time, 

such as until the trader’s market making 

positions have been fully unwound and 

are no longer in the banking entity’s 

inventory.1015 As one commenter 

explained, such a requirement would 

discourage traders from carrying 

inventory and encourage them to get out 

of positions as soon as possible.1016

Some commenters also recommended 

that compensation be risk adjusted.1017


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1018See SIFMA et al. (Prop. Trading) (Feb. 2012); 

JPMC; Morgan Stanley. 

1019See SIFMA et al. (Prop. Trading) (Feb. 2012); 

JPMC. 

1020See Morgan Stanley; SIFMA et al. (Prop. 

Trading) (Feb. 2012). The Agencies respond to these 

comments in note 1026 and its accompanying text, 

infra. 

1021See Occupy; Alfred Brock. 

1022See Occupy. The Agencies respond to this 

comment in Part VI.A.3.c.5.c., infra. 

1023See Goldman (Prop. Trading). 

1024See Occupy. 

1025See AllianceBernstein; Investure; Prof. Duffie; 

STANY. This issue is addressed in note 1032, infra. 

1026See AllianceBernstein; Investure. 1027See Prof. Duffie. 1028See STANY. 1029See Chamber (Dec. 2011). 1030See final rule § 75.4(b)(2)(v). 1031See Morgan Stanley; SIFMA et al. (Prop. 

Trading) (Feb. 2012). 

1032Because the Agencies are not limiting a 

market maker’s compensation to specific sources, 

such as fees, commissions, and bid-ask spreads, as 

recommended by a few commenters, the Agencies 

do not believe the compensation requirement in the 

final rule will incentivize market makers to widen 

their quoted spreads or charge higher fees and 

commissions, as suggested by certain other 

commenters. See Better Markets (Feb. 2012); Public 

Citizen; AllianceBernstein; Investure. In addition, 

the Agencies note that an approach requiring 

revenue from fees, commissions, and bid-ask 

spreads to be fully distinguished from revenue from 

price appreciation can raise certain practical 

difficulties, as discussed in Part VI.A.3.c.7. The 

Agencies also are not requiring compensation to be 

vested for a period of time, as recommended by 

some commenters to reduce traders’ incentives for 

undue risk-taking. The Agencies believe the final 

rule includes sufficient controls around risk-taking 

activity without a compensation vesting 

requirement. See John Reed; AFR et al. (Feb. 2012); 

Johnson & Prof. Stiglitz; Prof. Duffie; Sens. Merkley 

& Levin (Feb. 2012). 

1033See proposed rule § 75.4(b)(2)(iv); Joint 

Proposal, 76 FR at 68872; CFTC Proposal, 77 FR at 

8357–8358. 

1034See Occupy; Alfred Brock. 

1035See SIFMA et al. (Prop. Trading) (Feb. 2012) 

(stating that if the requirement is not removed from 

Continued 

A few commenters indicated that the 

proposed approach may be too 

restrictive.1018 Two of these commenters 

stated that the compensation 

requirement should instead be set forth 

as guidance in Appendix B.1019 In 

addition, two commenters requested 

that the Agencies clarify that 

compensation arrangements must be 

designed not to reward prohibited 

proprietary risk-taking. These 

commenters were concerned the 

proposed approach may restrict a 

banking entity’s ability to provide 

compensation for permitted activities, 

which also involve proprietary 

trading.1020

Two commenters discussed 

identifiable characteristics of 

compensation arrangements that clearly 

incentivize prohibited proprietary 

trading.1021 For example, one 

commenter stated that rewarding pure 

profit and loss, without consideration 

for the risk that was assumed to capture 

it, is an identifiable characteristic of an 

arrangement that incentivizes 

proprietary risk-taking.1022 For purposes 

of monitoring and ensuring compliance 

with this requirement, one commenter 

noted that existing Board regulations for 

systemically important banking entities 

require comprehensive firm-wide 

policies that determine compensation. 

This commenter stated that those 

regulations, along with appropriately 

calibrated metrics, should ensure that 

compensation arrangements are not 

designed to reward prohibited 

proprietary risk-taking.1023 For similar 

purposes, another commenter suggested 

that compensation incentives should be 

based on a metric that meaningfully 

accounts for the risk underlying 

profitability.1024

Certain commenters expressed 

concern that the proposed 

compensation requirement could 

incentivize market makers to act in a 

way that would not be beneficial to 

customers or market liquidity.1025 For 

example, two commenters expressed 

concern that the requirement could 

cause market makers to widen their 

spreads or charge higher fees because 

their personal compensation depends 

on these factors.1026 One commenter 

stated that the proposed requirement 

could dampen traders’ incentives and 

discretion and may make market makers 

less likely to accept trades involving 

significant increases in risk or profit.1027

Another commenter expressed the view 

that profitability-based compensation 

arrangements encourage traders to 

exercise due care because such 

arrangements create incentives to avoid 

losses.1028 Finally, one commenter 

stated that compliance with the 

proposed requirement may be difficult 

or impossible if the Agencies do not 

take into account the incentive-based 

compensation rulemaking.1029

c. Final Compensation Requirement 

Similar to the proposed rule, the 

market-making exemption requires that 

the compensation arrangements of 

persons performing the banking entity’s 

market making-related activities, as 

described in the exemption, are 

designed not to reward or incentivize 

prohibited proprietary trading.1030 The 

language of the final compensation 

requirement has been modified in 

response to comments expressing 

concern about the proposed language 

regarding ‘‘proprietary risk-taking.’’ 1031

The Agencies note that the Agencies do 

not intend to preclude an employee of 

a market-making desk from being 

compensated for successful market 

making, which involves some risktaking. 

The Agencies continue to hold the 

view that activities for which a banking 

entity has established a compensation 

incentive structure that rewards 

speculation in, and appreciation of, the 

market value of a position held in 

inventory, rather than use of that 

inventory to successfully provide 

effective and timely intermediation and 

liquidity services to customers, are 

inconsistent with permitted market 

making-related activities. Although a 

banking entity relying on the marketmaking exemption may appropriately 

take into account revenues resulting 

from movements in the price of 

principal positions to the extent that 

such revenues reflect the effectiveness 

with which personnel have managed 

retained principal risk, a banking entity 

relying on the market-making 

exemption should provide 

compensation incentives that primarily 

reward customer revenues and effective 

customer service, not prohibited 

proprietary trading.1032 For example, a 

compensation plan based purely on net 

profit and loss with no consideration for 

inventory control or risk undertaken to 

achieve those profits would not be 

consistent with the market-making 

exemption. 

6. Registration Requirement 

a. Proposed Registration Requirement 

Under § 75.4(b)(2)(iv) of the proposed 

rule, a banking entity relying on the 

market-making exemption with respect 

to trading in securities or certain 

derivatives would be required to be 

appropriately registered as a securities 

dealer, swap dealer, or security-based 

swap dealer, or exempt from registration 

or excluded from regulation as such 

type of dealer, under applicable 

securities or commodities laws. Further, 

if the banking entity was engaged in the 

business of a securities dealer, swap 

dealer, or security-based swap dealer 

outside the United States in a manner 

for which no U.S. registration is 

required, the banking entity would be 

required to be subject to substantive 

regulation of its dealing business in the 

jurisdiction in which the business is 

located.1033

b. Comments on the Proposed 

Registration Requirement 

A few commenters stated that the 

proposed dealer registration 

requirement is effective.1034 However, a 

number of commenters opposed the 

proposed dealer registration 

requirement in whole or in part.1035


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the rule, then it should only be an indicative factor 

of market making); Morgan Stanley; Goldman (Prop. 

Trading); ISDA (Feb. 2012). 

1036See Goldman (Prop. Trading); Morgan 

Stanley; RBC; SIFMA et al. (Prop. Trading) (Feb. 

2012); ISDA (Feb. 2012); JPMC. This issue is 

addressed in note 1044 and its accompanying text, 

infra. 

1037See Goldman (Prop. Trading); RBC; SIFMA et 

al. (Prop. Trading) (Feb. 2012). 

1038See JPMC; Goldman (Prop. Trading). 

1039See Goldman (Prop. Trading); RBC; SIFMA et 

al. (Prop. Trading) (Feb. 2012). See also Morgan 

Stanley (requesting the addition of the phrase ‘‘to 

the extent it is legally required to be subject to such 

regulation’’ to the non-U.S. dealer provisions). 

1040See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Goldman (Prop. Trading); Morgan Stanley; ISDA 

(Feb. 2012). Rather than remove the requirement 

entirely, one commenter recommended that the 

Agencies move the dealer registration requirement 

to proposed Appendix B, which would allow the 

Agencies to take into account the facts and 

circumstances of a particular trading activity. See 

JPMC. 

1041See SIFMA et al. (Prop. Trading) (Feb. 2012). 

1042See Goldman (Prop. Trading). 

1043See CME Group. 

1044See ISDA (Feb. 2012); SIFMA et al. (Prop. 

Trading) (Feb. 2012). 

1045See ISDA (Feb. 2012). 

1046See SIFMA et al. (Prop. Trading) (Feb. 2012). 

1047See final rule § 75.4(b)(2)(vi). 

1048See supra Part VI.A.3.c.5.b. One commenter 

expressed concern that the instruments listed in 

§ 75.4(b)(2)(iv) of the proposed rule could be 

interpreted as limiting the availability of the 

market-making exemption to other instruments, 

such as exchange-traded futures and options. In 

response to this comment, the Agencies note that 

the reference to particular instruments in 

§ 75.4(b)(2)(iv) was intended to reflect that trading 

in certain types of instruments gives rise to dealer 

registration requirements. This provision was not 

intended to limit the availability of the marketmaking exemption to certain types of financial 

instruments. See CME Group. 

1049See Goldman (Prop. Trading); RBC; SIFMA et 

al. (Prop. Trading) (Feb. 2012); Morgan Stanley. 

1050 In response to commenters who stated that 

the dealer registration requirement should be 

removed from the rule because, among other things, 

registration as a dealer does not distinguish 

between permitted market making and 

impermissible proprietary trading, the Agencies 

recognize that acting as a registered dealer does not 

ensure that a banking entity is engaged in permitted 

market making-related activity. See SIFMA et al. 

(Prop. Trading) (Feb. 2012); Goldman (Prop. 

Trading); Morgan Stanley; ISDA (Feb. 2012). 

However, this requirement recognizes that 

registration as a dealer is an indicator of market 

making-related activities in the circumstances in 

which a person is legally obligated to be a registered 

dealer to act as a market maker. 

1051A banking entity relying on the marketmaking exemption for transactions in securitybased swaps would generally be required to be a 

registered security-based swap dealer and would 

not be required to be a registered securities dealer. 

However, a banking entity may be required to be 

a registered securities dealer if it engages in marketmaking transactions involving security-based swaps 

with persons that are not eligible contract 

participants. The definition of ‘‘dealer’’ in section 

3(a)(5) of the Exchange Act generally includes ‘‘any 

person engaged in the business of buying and 

selling securities (not including security-based 

swaps, other than security-based swaps with or for 

persons that are not eligible contract participants), 

for such person’s own account.’’ 15 U.S.C. 78c(a)(5). 

To the extent, if any, that a banking entity relies 

on the market-making exemption for its trading in 

municipal securities or government securities, 

rather than the exemption in § 75.6(a) of the final 

rule, this provision may require the banking entity 

to be registered or licensed as a municipal securities 

dealer or government securities dealer. 

1052As noted above, under certain circumstances, 

a banking entity acting as market maker in securityCommenters’ primary concern with the 

requirement appeared to be its 

application to market making-related 

activities outside of the United States 

for which no U.S. registration is 

required.1036 For example, several 

commenters stated that many non-U.S. 

markets do not provide substantive 

regulation of dealers for all asset 

classes.1037 In addition, two 

commenters stated that booking entities 

may be able to rely on intra-group 

exemptions under local law rather than 

carrying dealer registrations, or a 

banking entity may execute customer 

trades through an international dealer 

but book the position in a non-dealer 

entity for capital adequacy and risk 

management purposes.1038 Several of 

these commenters requested, at a 

minimum, that the dealer registration 

requirement not apply to dealers in nonU.S. jurisdictions.1039

In addition, with respect to the 

provisions that would generally require 

a banking entity to be a form of SEC- or 

CFTC-registered dealer for marketmaking activities in securities or 

derivatives in the United States, a few 

commenters stated that these provisions 

should be removed from the rule.1040

These commenters represented that 

removing these provisions would be 

appropriate for several reasons. For 

example, one commenter stated that 

dealer registration does not help 

distinguish between market making and 

speculative trading.1041 Another 

commenter indicated that effective 

market making often requires a banking 

entity to trade on several exchange and 

platforms in a variety of markets, 

including through legal entities other 

than SEC- or CFTC-registered dealer 

entities.1042 One commenter expressed 

general concern that the proposed 

requirement may result in the marketmaking exemption being unavailable for 

market making in exchange-traded 

futures and options because those 

markets do not have a corollary to 

dealer registration requirements in 

securities, swaps, and security-based 

swaps markets.1043

Some commenters expressed 

particular concern about the provisions 

that would generally require registration 

as a swap dealer or a security-based 

swap dealer.1044 For example, one 

commenter expressed concern that these 

provisions may require banking 

regulators to redundantly enforce CFTC 

and SEC registration requirements. 

Moreover, according to this commenter, 

the proposed definitions of ‘‘swap 

dealer’’ and ‘‘security-based swap 

dealer’’ do not focus on the market 

making core of the swap dealing 

business.1045 Another commenter stated 

that incorporating the proposed 

definitions of ‘‘swap dealer’’ and 

‘‘security-based swap dealer’’ is contrary 

to the Administrative Procedure Act.1046

c. Final Registration Requirement 

The final requirement of the marketmaking exemption provides that the 

banking entity must be licensed or 

registered to engage in market makingrelated activity in accordance with 

applicable law.1047 The Agencies have 

considered comments regarding the 

dealer registration requirement in the 

proposed rule.1048 In response to 

comments, the Agencies have narrowed 

the scope of the proposed requirement’s 

application to banking entities engaged 

in market making-related activity in 

foreign jurisdictions.1049 Rather than 

requiring these banking entities to be 

subject to substantive regulation of their 

dealing business in the relevant foreign 

jurisdiction, the final rule only require 

a banking entity to be a registered dealer 

in a foreign jurisdiction to the extent 

required by applicable foreign law. The 

Agencies have also simplified the 

language of the proposed requirement, 

although the Agencies have not 

modified the scope of the requirement 

with respect to U.S. dealer registration 

requirements. 

This provision is not intended to 

expand the scope of licensing or 

registration requirements under relevant 

U.S. or foreign law that are applicable 

to a banking entity engaged in marketmaking activities. Instead, this provision 

recognizes that compliance with 

applicable law is an essential indicator 

that a banking entity is engaged in 

market-making activities.1050 For 

example, a U.S. banking entity would be 

expected to be an SEC-registered dealer 

to rely on the market-making exemption 

for trading in securities—other than 

exempted securities, security-based 

swaps, commercial paper, bankers 

acceptances, or commercial bills— 

unless the banking entity is exempt 

from registration or excluded from 

regulation as a dealer.1051 Similarly, a 

U.S. banking entity is expected to be a 

CFTC-registered swap dealer or SECregistered security-based swap dealer to 

rely on the market-making exemption 

for trading in swaps or security-based 

swaps, respectively,1052 unless the 


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based swaps may be required to be a registered 

securities dealer. See supra note 1051. 

1053For example, a banking entity meeting the 

conditions of the de minimis exception in SEC Rule 

3a71–2 under the Exchange Act would not need to 

be a registered security-based swap dealer to act as 

a market maker in security-based swaps. See 17 

CFR 240.3a71–2. 

1054See ISDA (Feb. 2012); SIFMA et al. (Prop. 

Trading) (Feb. 2012). 

1055See 7 U.S.C. 1a(49)(A); 15 U.S.C. 

78c(a)(71)(A). 

1056See Goldman (Prop. Trading); RBC; SIFMA et 

al. (Prop. Trading) (Feb. 2012); Morgan Stanley. 

This is consistent with one commenter’s suggestion 

that the Agencies add ‘‘to the extent it is legally 

required to be subject to such regulation’’ to the 

non-U.S. dealer provisions. See Morgan Stanley. 

1057See proposed rule § 75.4(b)(2)(v). 

1058See Joint Proposal, 76 FR at 68872; CFTC 

Proposal, 77 FR at 8358. 

1059These concerns are addressed in Part 

VI.A.3.c.7.c., infra. 

1060See infra note 1103 (responding to these 

comments). 

1061See, e.g., NYSE Euronext; SIFMA et al. (Prop. 

Trading) (Feb. 2012); Morgan Stanley; Goldman 

(Prop. Trading); BoA; Citigroup (Feb. 2012); 

STANY; BlackRock; SIFMA (Asset Mgmt.) (Feb. 

2012); ACLI (Feb. 2012); T. Rowe Price; PUC Texas; 

SSgA (Feb. 2012); ICI (Feb. 2012) Invesco; MetLife; 

MFA. 

1062See, e.g., Morgan Stanley; BoA; BlackRock; T. 

Rowe Price; Goldman (Prop. Trading); NYSE 

Euronext (suggesting that principal trading by 

market makers in large sizes is essential in some 

securities, such as an AP’s trading in ETFs); Prof. 

Duffie; SSgA (Feb. 2012); CIEBA; SIFMA et al. 

(Prop. Trading) (Feb. 2012); MFA. To explain its 

concern, one commenter stated that bid-ask spreads 

are useful to capture the concept of market-making 

revenues when a market maker is intermediating on 

a close to real-time basis between balanced 

customer buying and selling interest for the same 

instrument, but such close-in-time intermediation 

does not occur in many large or illiquid assets, 

where demand gaps may be present for days, weeks, 

or months. See Morgan Stanley. 

1063See Capital Group. 

1064See NYSE Euronext; CIEBA (stating that if the 

rule discourages market makers from holding 

inventory, there will be reduced liquidity for 

investors and issuers). 

1065See NYSE Euronext. For a more in-depth 

discussion of comments regarding the benefits of 

permitting market makers to hold and manage 

inventory, see Part VI.A.3.c.2.b.vi., infra. 

1066See, e.g., Wellington; CIEBA; MetLife; ACLI 

(Feb. 2012); SSgA (Feb. 2012); PUC Texas; ICI (Feb. 

2012) BoA. 

1067See MetLife; ACLI (Feb. 2012); ICI (Feb. 2012) 

SSgA (Feb. 2012). 

banking entity is exempt from 

registration or excluded from regulation 

as a swap dealer or security-based swap 

dealer.1053 In response to comments on 

whether this provision should generally 

require registration as a swap dealer or 

security-based swap dealer to make a 

market in swaps or security-based 

swaps,1054 the Agencies continue to 

believe that this requirement is 

appropriate. In general, a person that is 

engaged in making a market in swaps or 

security-based swaps or other activity 

causing oneself to be commonly known 

in the trade as a market maker in swaps 

or security-based swaps is required to be 

a registered swap dealer or registered 

security-based swap dealer, unless 

exempt from registration or excluded 

from regulation as such.1055 As noted 

above, compliance with applicable law 

is an essential indicator that a banking 

entity is engaged in market-making 

activities. 

As noted above, the Agencies have 

determined that, rather than require a 

banking entity engaged in the business 

of a securities dealer, swap dealer, or 

security-based swap dealer outside the 

United States to be subject to 

substantive regulation of its dealing 

business in the foreign jurisdiction in 

which the business is located, a banking 

entity’s dealing activity outside the U.S. 

should only be subject to licensing or 

registration requirements under 

applicable foreign law (provided no U.S. 

registration or licensing requirements 

apply to the banking entity’s activities). 

As a result, this requirement will not 

impact a banking entity’s ability to 

engage in permitted market makingrelated activities in a foreign 

jurisdiction that does not provide for 

substantive regulation of dealers.1056

7. Source of Revenue Analysis 

a. Proposed Source of Revenue 

Requirement 

To qualify for the market-making 

exemption, the proposed rule required 

that the market making-related activities 

of the trading desk or other 

organizational unit be designed to 

generate revenues primarily from fees, 

commissions, bid/ask spreads or other 

income not attributable to appreciation 

in the value of financial instrument 

positions it holds in trading accounts or 

the hedging of such positions.1057 This 

proposed requirement was intended to 

ensure that activities conducted in 

reliance on the market-making 

exemption demonstrate patterns of 

revenue generation and profitability 

consistent with, and related to, the 

intermediation and liquidity services a 

market maker provides to its customers, 

rather than changes in the market value 

of the positions or risks held in 

inventory.1058

b. Comments Regarding the Proposed 

Source of Revenue Requirement 

As discussed in more detail below, 

many commenters expressed concern 

about the proposed source of revenue 

requirement. These commenters raised a 

number of concerns including, among 

others, the proposed requirement’s 

potential impact on a market maker’s 

inventory or on costs to customers, the 

difficulty of differentiating revenues 

from spreads and revenues from price 

appreciation in certain markets, and the 

need for market makers to be 

compensated for providing 

intermediation services.1059 Several of 

these commenters requested that the 

proposed source of revenue requirement 

be removed from the rule or modified in 

certain ways. Some commenters, 

however, expressed support for the 

proposed requirement or requested that 

the Agencies place greater restrictions 

on a banking entity’s permissible 

sources of revenue under the marketmaking exemption.1060

i. Potential Restrictions on Inventory, 

Increased Costs for Customers, and 

Other Changes to Market-Making 

Services 

Many commenters stated that the 

proposed source of revenue requirement 

may limit a market maker’s ability to 

hold sufficient inventory to facilitate 

customer demand.1061 Several of these 

commenters expressed particular 

concern about applying this 

requirement to less liquid markets or to 

facilitating large customer positions, 

where a market maker is more likely to 

hold inventory for a longer period of 

time and has increased risk of potential 

price appreciation (or depreciation).1062

Further, another commenter questioned 

how the proposed requirement would 

apply when unforeseen market pressure 

or disappearance of customer demand 

results in a market maker holding a 

particular position in inventory for 

longer than expected.1063 In response to 

this proposed requirement, a few 

commenters stated that it is important 

for market makers to be able to hold a 

certain amount of inventory to: provide 

liquidity (particularly in the face of 

order imbalances and market 

volatility),1064 facilitate large trades, and 

hedge positions acquired in the course 

of market making.1065

Several commenters expressed 

concern that the proposed source of 

revenue requirement may incentivize a 

market maker to widen its quoted 

spreads or otherwise impose higher fees 

to the detriment of its customers.1066

For example, some commenters stated 

that the proposed requirement could 

result in a market maker having to sell 

a position in its inventory within an 

artificially prescribed period of time 

and, as a result, the market maker would 

pay less to initially acquire the position 

from a customer.1067 Other commenters 

represented that the proposed source of 

revenue requirement would compel 

market makers to hedge their exposure 


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1068See SSgA (Feb. 2012); PUC Texas. 

1069See ICI (Feb. 2012) SSgA (Feb. 2012); SIFMA 

(Asset Mgmt.) (Feb. 2012); BoA. 

1070See CIEBA (arguing that banking entities may 

be reluctant to provide liquidity when markets are 

declining and there are more sellers than buyers 

because it would be necessary to hold positions in 

inventory to avoid losses). 

1071See Credit Suisse (Seidel) (arguing that 

banking entities are likely to cease being market 

makers if they are: (i) Unable to take into account 

the likely direction of a financial instrument, or (ii) 

forced to take losses if a financial instrument moves 

against them, but cannot take gains if the 

instrument’s price moves in their favor); STANY 

(contending that banking entities cannot afford to 

maintain unprofitable or marginally profitable 

operations in highly competitive markets, so this 

requirement would cause banking entities to 

eliminate a majority of their market-making 

functions). 

1072See IR&M (arguing that domestic corporate 

and securitized credit markets are too large and 

heterogeneous to be served appropriately by a 

primarily agency-based trading model). 

1073See Wellington; Credit Suisse (Seidel); 

Morgan Stanley; PUC Texas (contending that it is 

impossible to predict the behavior of even the most 

highly correlated hedge in comparison to the 

underlying position); CIEBA; SSgA (Feb. 2012); 

AllianceBernstein; Investure; Invesco. 

1074See Morgan Stanley; Credit Suisse (Seidel); 

SSgA (Feb. 2012); PUC Texas; Wellington; 

AllianceBernstein; Investure. 

1075See Wellington. Moreover, one commenter 

stated that, as a general matter, market makers need 

to be compensated for bearing risk related to 

providing immediacy to a customer. This 

commenter stated that ‘‘[t]he greater the inventory 

risk faced by the market maker, the higher the 

expected return (compensation) that the market 

maker needs,’’ to compensate the market maker for 

bearing the risk and reward its specialization skills 

in that market (e.g., its knowledge about market 

conditions and early indicators that may imply 

future price movements in a particular direction). 

This commenter did not, however, discuss the 

source of revenue requirement in the proposed rule. 

See Thakor Study. 

1076See Capital Group; Prof. Duffie; Investure; 

SIFMA et al. (Prop. Trading) (Feb. 2012); STANY; 

SIFMA (Asset Mgmt.) (Feb. 2012); RBC; PNC. 

1077See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); Goldman (Prop. Trading); BoA; Citigroup 

(Feb. 2012); Japanese Bankers Ass’n.; Sumitomo 

Trust; Morgan Stanley; Barclays; RBC; Capital 

Group. 

1078See SIFMA et al. (Prop. Trading) (Feb. 2012). 

1079See Citigroup (Feb. 2012). See also Barclays 

(arguing that a bid-ask spread cannot be defined on 

a consistent basis with respect to many 

instruments). 

1080See Goldman (Prop. Trading); BoA; Morgan 

Stanley (‘‘Observable, actionable, bid/ask spreads 

exist in only a small subset of institutional products 

and markets. Indicative bid/ask spreads may be 

observable for certain products, but this pricing 

would typically be specific to small size standard 

lot trades and would not represent a spread 

applicable to larger and/or more illiquid trades. 

End-of-day valuations for assets are calculated, but 

they are not an effective proxy for real-time bid/ask 

spreads because of intra-day price movements.’’); 

RBC; Capital Group (arguing that bid-ask spreads in 

fixed-income markets are not always quantifiable or 

well defined and can fluctuate widely within a 

trading day because of small or odd lot trades, price 

discovery activity, a lack of availability to cover 

shorts, or external factors not directly related to the 

security being traded). 

1081See Capital Group; CIEBA; SIFMA et al. 

(Prop. Trading) (Feb. 2012); SSgA (Feb. 2012). 

These commenters stated that the requirement may 

be problematic for the fixed-income markets 

because, for example, market makers must hold 

inventory in these markets for a longer period of 

time than in more liquid markets. See id. 

1082See SIFMA et al. (Prop. Trading) (Feb. 2012) 

(stating that these markets are characterized by even 

less liquidity and less frequent trading than the U.S. 

corporate bond market). This commenter also stated 

that in markets where trades are large and less 

frequent, such as the market for customized 

securitized products, appreciation in price of one 

position may be a predominate contributor to the 

overall profit and loss of the trading unit. See id. 

1083See BoA. According to this commenter, the 

distinction between capturing a spread and price 

appreciation is fundamentally flawed in some 

markets, like equity derivatives, because the market 

does not trade based on movements of a particular 

security or underlying instrument. This commenter 

indicated that expected returns are instead based on 

the bid-ask spread the market maker charges for 

implied volatility as reflected in options premiums 

and hedging of the positions. See id. 

1084See CIEBA (stating that because it would be 

difficult for a market maker to enter promptly into 

an offsetting swap, the market maker would not be 

able to generate income from the spread). 

1085See SIFMA et al. (Prop. Trading) (Feb. 2012). 

This commenter questioned whether proposed 

Appendix B’s reference to ‘‘unexpected market 

disruptions’’ as an explanatory fact and 

circumstance was intended to permit such market 

making. See id. 

to price movements, which would likely 

increase the cost of intermediation.1068

Some commenters stated that the 

proposed source of revenue requirement 

may make a banking entity less willing 

to make markets in instruments that it 

may not be able to resell immediately or 

in the short term.1069 One commenter 

indicated that this concern may be 

heightened in times of market stress.1070

Further, a few commenters expressed 

the view that the proposed requirement 

would cause banking entities to exit the 

market-making business due to 

restrictions on their ability to make a 

profit from market-making activities.1071

Moreover, in one commenter’s opinion, 

the proposed requirement would 

effectively compel market makers to 

trade on an agency basis.1072

ii. Certain Price Appreciation-Related 

Profits Are an Inevitable or Important 

Component of Market Making 

A number of commenters indicated 

that market makers will inevitably make 

some profit from price appreciation of 

certain inventory positions because 

changes in market values cannot be 

precisely predicted or hedged.1073 In 

particular, several commenters 

emphasized that matched or perfect 

hedges are generally unavailable for 

most types of positions.1074 According 

to one commenter, a provision that 

effectively requires a market-making 

business to hedge all of its principal 

positions would discourage essential 

market-making activity. The commenter 

explained that effective hedges may be 

unavailable in less liquid markets and 

hedging can be costly, especially in 

relation to the relative risk of a trade 

and hedge effectiveness.1075 A few 

commenters further indicated that 

making some profit from price 

appreciation is a natural part of market 

making or is necessary to compensate a 

market maker for its willingness to take 

a position, and its associated risk (e.g., 

the risk of market changes or decreased 

value), from a customer.1076

iii. Concerns Regarding the Workability 

of the Proposed Standard in Certain 

Markets or Asset Classes 

Some commenters represented that it 

would be difficult or burdensome to 

identify revenue attributable to the bidask spread versus revenue arising from 

price appreciation, either as a general 

matter or for specific markets.1077 For 

example, one commenter expressed the 

opinion that the difference between the 

bid-ask spread and price appreciation is 

‘‘metaphysical’’ in some sense,1078

while another stated that it is almost 

impossible to objectively identify a bidask spread or to capture profit and loss 

solely from a bid-ask spread in most 

markets.1079 Other commenters 

represented that it is particularly 

difficult to make this distinction when 

trades occur infrequently or where 

prices are not transparent, such as in the 

fixed-income market where no spread is 

published.1080

Many commenters expressed 

particular concern about the proposed 

requirement’s application to specific 

markets, including: The fixed-income 

markets; 1081 the markets for 

commodities, derivatives, securitized 

products, and emerging market 

securities; 1082 equity and physical 

commodity derivatives markets; 1083 and 

customized swaps used by customers of 

banking entities for hedging 

purposes.1084 Another commenter 

expressed general concern about 

extremely volatile markets, where 

market makers often see large upward or 

downward price swings over time.1085

Two commenters emphasized that the 

revenues a market maker generates from 

hedging the positions it holds in 

inventory are equivalent to spreads in 

many markets. These commenters 

explained that, under these 

circumstances, a market maker 

generates revenue from the difference 

between the customer price for the 

position and the banking entity’s price 

for the hedge. The commenters noted 

that proposed Appendix B expressly 

recognizes this in the case of derivatives 

and recommended that Appendix B’s 


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1086See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Goldman (Prop. Trading). In its discussion of 

‘‘customer revenues,’’ Appendix B states: ‘‘In the 

case of a derivative contract, these revenues reflect 

the difference between the cost of entering into the 

derivative contract and the cost of hedging 

incremental, residual risks arising from the 

contract.’’ Joint Proposal, 76 FR at 68960; CFTC 

Proposal, 77 FR at 8440. See also RBC (requesting 

clarification on how the proposed standard would 

apply if a market maker took an offsetting position 

in a different instrument (e.g., a different bond) and 

inquiring whether, if the trader took the offsetting 

position, its revenue gain is attributable to price 

appreciation of the two offsetting positions or from 

the bid-ask spread in the respective bonds). 

1087See Prof. Duffie; NYSE Euronext; Capital 

Group; RBC; Goldman (Prop. Trading). See also 

Thakor Study (discussing market makers’ role of 

providing ‘‘immediacy’’ in general). 

1088See CIEBA. 

1089See, e.g., JPMC; Barclays; Goldman (Prop. 

Trading); BoA; CFA Inst.; ICI (Feb. 2012) Flynn & 

Fusselman. 

1090See, e.g., CIEBA; SIFMA et al. (Prop. Trading) 

(Feb. 2012); Morgan Stanley; Goldman (Prop. 

Trading); Capital Group; RBC. In addition to the 

concerns discussed above, one commenter stated 

that the proposed requirement may set limits on the 

values of certain metrics, and it would be 

inappropriate to prejudge the appropriate results of 

such metrics at this time. See SIFMA et al. (Prop. 

Trading) (Feb. 2012). 

1091See, e.g., Barclays. This commenter provided 

alternative rule text stating that ‘‘market makingrelated activity is conducted by each trading unit 

such that its activities are reasonably designed to 

generate revenues primarily from fees, 

commissions, bid-ask spreads, or other income 

attributable to satisfying reasonably expected 

customer demand.’’ See id. 

1092See Goldman (Prop. Trading) (suggesting that 

the Agencies use a metrics-based approach to focus 

on customer revenues, as measured by Spread Profit 

and Loss (when it is feasible to calculate) or other 

metrics, especially because a proprietary trading 

desk would not be expected to earn any revenues 

this way). This commenter also indicated that the 

‘‘primarily’’ standard in the proposed rule is 

problematic and can be read to mean ‘‘more than 

50%,’’ which is different from Appendix B’s 

acknowledgment that the proportion of customer 

revenues relative to total revenues will vary by asset 

class. See id. 

1093See BoA (recommending that the guidance 

state that the Agencies would consider the design 

and mix of such revenues as an indicator of 

potentially prohibited proprietary trading, but only 

for those markets for which revenues are 

quantifiable based on publicly available data, such 

as segments of certain highly liquid equity markets). 

1094See CFA Inst. 

1095See ICI (Feb. 2012). 

1096See Sens. Merkley & Levin (Feb. 2012); Better 

Markets (Feb. 2012); FTN; Public Citizen; Occupy; 

Alfred Brock. 

1097See Better Markets (Feb. 2012). See also 

Public Citizen (arguing that the imperfection of a 

hedge should signal potential disqualification of the 

underlying position from the market-making 

exemption). 

1098See Sens. Merkley & Levin (Feb. 2012). This 

commenter further suggested that the rule identify 

certain red flags and metrics that could be used to 

monitor this requirement, such as: (i) Failure to 

obtain relatively low ratios of revenue-to-risk, low 

volatility, and relatively high turnover; (ii) 

significant revenues from price appreciation 

relative to the value of securities being traded; (iii) 

volatile revenues from price appreciation; or (iv) 

revenue from price appreciation growing out of 

proportion to the risk undertaken with the security. 

See id. 

1099See AFR et al. (Feb. 2012). 

1100See Occupy; Better Markets (Feb. 2012). See 

supra note 1108 (addressing these comments). 

1101See Occupy. 

1102See Occupy; Public Citizen. 

1103See proposed rule § 75.4(b)(2)(v). 

1104See infra Part VI.A.3.c.7.b. 

guidance on this point apply equally to 

certain non-derivative positions.1086

A few commenters questioned how 

this requirement would work in the 

context of block trading or otherwise 

facilitating large trades, where a market 

maker may charge a premium or 

discount for taking on a large position 

to provide ‘‘immediacy’’ to its 

customer.1087 One commenter further 

explained that explicitly quoted bid-ask 

spreads are only valid for indicated 

trade sizes that are modest enough to 

have negligible market impact, and such 

spreads cannot be used for purposes of 

a significantly larger trade.1088

iv. Suggested Modifications to the 

Proposed Requirement 

To address some or all of the concerns 

discussed above, many commenters 

recommended that the source of 

revenue requirement be modified 1089 or 

removed from the rule entirely.1090 With 

respect to suggested changes, some 

commenters stated that the Agencies 

should modify the rule text,1091 use a 

metrics-based approach to focus on 

customer revenues,1092 or replace the 

proposed requirement with 

guidance.1093 Some commenters 

requested that the Agencies modify the 

focus of the requirement so that, for 

example, dealers’ market-making 

activities in illiquid securities can 

function as close to normal as 

possible 1094 or market makers can take 

short-term positions that may ultimately 

result in a profit or loss.1095 As 

discussed below, some commenters 

stated that the Agencies should modify 

the proposed requirement to place 

greater restrictions on market maker 

revenue. 

v. General Support for the Proposed 

Requirement or for Placing Greater 

Restrictions on a Market Maker’s 

Sources of Revenue 

Some commenters expressed support 

for the proposed source of revenue 

requirement or stated that the 

requirement should be more 

restrictive.1096 For example, one of these 

commenters stated that a real market 

maker’s trading book should be fully 

hedged, so it should not generate profits 

in excess of fees and commissions 

except in times of rare and 

extraordinary market conditions.1097

According to another commenter, the 

final rule should make it clear that 

banking entities seeking to rely on the 

market-making exemption may not 

generally seek to profit from price 

movements in their inventories, 

although their activities may give rise to 

modest and relatively stable profits 

arising from their limited inventory.1098

One commenter recommended that the 

proposed requirement be interpreted to 

limit market making in illiquid 

positions because a banking entity 

cannot have the required revenue 

motivation when it enters into a 

position for which there is no readily 

discernible exit price.1099

Further, some commenters suggested 

that the Agencies remove the word 

‘‘primarily’’ from the provision to limit 

banking entities to specified sources of 

revenue.1100 In addition, one of these 

commenters requested that the Agencies 

restrict a market maker’s revenue to fees 

and commissions and remove the 

allowance for revenue from bid-ask 

spreads because generating bid-ask 

revenues relies exclusively on changes 

in market values of positions held in 

inventory.1101 For enforcement 

purposes, a few commenters suggested 

that the Agencies require banking 

entities to disgorge any profit obtained 

from price appreciation.1102

c. Final Rule’s Approach To Assessing 

Revenues 

Unlike the proposed rule, the final 

rule does not include a requirement that 

a trading desk’s market making-related 

activity be designed to generate revenue 

primarily from fees, commissions, bidask spreads, or other income not 

attributable to appreciation in the value 

of a financial instrument or hedging.1103

The revenue requirement was one of the 

most commented upon aspects of the 

market-making exemption in the 

proposal.1104

The Agencies believe that an analysis 

of patterns of revenue generation and 

profitability can help inform a judgment 

regarding whether trading activity is 

consistent with the intermediation and 

liquidity services that a market maker 

provides to its customers in the context 

of the liquidity, maturity, and depth of 

the relevant market, as opposed to 

prohibited proprietary trading activities. 

To facilitate this type of analysis, the 

Agencies have included a metrics data 

reporting requirement that is refined 

from the proposed metric regarding 

profits and losses. The Comprehensive 

Profit and Loss Attribution metric 

collects information regarding the daily 

fluctuation in the value of a trading 

desk’s positions to various sources, 

along with its volatility, including: (i) 


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1105See Appendix A of the final rule (describing 

the Comprehensive Profit and Loss Attribution 

metric). This approach is generally consistent with 

one commenter’s suggested metrics-based approach 

to focus on customer-related revenues. See 

Goldman (Prop. Trading); see also Sens. Merkley & 

Levin (Feb. 2012) (suggesting the use of metrics to 

monitor a firm’s source of revenue); proposed 

Appendix A. 

1106See supra Part VI.A.3.c.7. and infra Part 

VI.C.3. 

1107The Agencies understand that some 

commenters interpreted the proposed requirement 

as requiring that both the bid-ask spread for a 

financial instrument and the revenue a market 

maker acquired from such bid-ask spread through 

a customer trade be identifiable on a close-to-realtime basis and readily distinguishable from any 

additional revenue gained from price appreciation 

(both on the day of the transaction and for the rest 

of the holding period). See, e.g., SIFMA et al. (Prop. 

Trading) (Feb. 2012); Goldman (Prop. Trading); 

BoA; Citigroup (Feb. 2012); Japanese Bankers 

Ass’n.; Sumitomo Trust; Morgan Stanley; Barclays; 

RBC; Capital Group. We recognize that such a 

requirement would be unduly burdensome. In fact, 

the proposal noted that bid-ask spreads or similar 

spreads may not be widely disseminated on a 

consistent basis or otherwise reasonably 

ascertainable in certain asset classes for purposes of 

the proposed Spread Profit and Loss metric in 

Appendix A of the proposal. See Joint Proposal, 76 

FR at 68958–68959; CFTC Proposal, 77 FR at 8438. 

Moreover, the burden associated with the proposed 

requirement should be further reduced because we 

are not adopting a stand-alone requirement 

regarding a trading desk’s source of revenue. 

Instead, when and how a trading desk generates 

profit and loss from its trading activities is a factor 

that must be considered for purposes of the near 

term customer demand requirement. It is not a 

dispositive factor for determining compliance with 

the exemption. 

Further, some commenters expressed concern 

that the proposed requirement suggested market 

makers were not permitted to profit from price 

appreciation, but rather only from observable 

spreads or explicit fees or commissions. See, e.g., 

Wellington, Credit Suisse (Seidel); Morgan Stanley; 

PUC Texas; CIEBA; SSgA (Feb. 2012); 

AllianceBernstein; Investure; Invesco. The Agencies 

confirm that the intent of the market-making 

exemption is not to preclude a trading desk from 

generating any revenue from price appreciation. 

Because this approach clarifies that a trading desk’s 

source of revenue is not limited to its quoted 

spread, the Agencies believe this quantitative 

measurement will address commenters concerns 

that the proposed source of revenue requirement 

could create incentives for market makers to widen 

their spreads, result in higher transaction costs, 

require market makers to hedge any exposure to 

price movements, or discourage a trading desk from 

making a market in instruments that it may not be 

able to sell immediately. See Wellington; CIEBA; 

MetLife; ACLI (Feb. 2012); SSgA (Feb. 2012); PUC 

Texas; ICI (Feb. 2012) BoA; SIFMA (Asset Mgmt.) 

(Feb. 2012). The modifications to this provision are 

designed to better reflect when, on average and 

across many transactions, profits are gained rather 

than how they are gained, similar to the way some 

firms measure their profit and loss today. See, e.g., 

Goldman (Prop. Trading). 

1108See, e.g., Wellington; CIEBA; MetLife; ACLI 

(Feb. 2012); SSgA (Feb. 2012); PUC Texas; ICI (Feb. 

2012) BoA. The Agencies are not adopting an 

approach that limits a market maker to specified 

revenue sources (e.g., fees, commissions, and 

spreads), as suggested by some commenters, due to 

the considerations discussed above. See Occupy; 

Better Markets (Feb. 2012). In response to the 

proposed source of revenue requirement, some 

commenters noted that a market maker may charge 

a premium or discount for taking on a large position 

from a customer. See Prof. Duffie; NYSE Euronext; 

Capital Group; RBC; Goldman (Prop. Trading). 

1109See proposed rule § 75.4(b)(2)(vi). 

1110See Joint Proposal, 76 FR at 68873, 68960– 

68961; CFTC Proposal, 77 FR at 8358, 8439–8440. 

Profit and loss attributable to current 

positions that were also held by the 

banking entity as of the end of the prior 

day (‘‘existing positions); (ii) profit and 

loss attributable to new positions 

resulting from the current day’s trading 

activity (‘‘new positions’’); and (iii) 

residual profit and loss that cannot be 

specifically attributed to existing 

positions or new positions.1105

This quantitative measurement has 

certain conceptual similarities to the 

proposed source of revenue requirement 

in § 75.4(b)(2)(v) of the proposed rule 

and certain of the proposed quantitative 

measurements.1106 However, in 

response to comments on those 

provisions, the Agencies have 

determined to modify the focus from 

particular revenue sources (e.g., fees, 

commissions, bid-ask spreads, and price 

appreciation) to when the trading desk 

generates revenue from its positions. 

The Agencies recognize that when the 

trading desk is engaged in market 

making-related activities, the day one 

profit and loss component of the 

Comprehensive Profit and Loss 

Attribution metric may reflect customergenerated revenues, like fees, 

commissions, and spreads (including 

embedded premiums or discounts), as 

well as that day’s changes in market 

value. Thereafter, profit and loss 

associated with the position carried in 

the trading desk’s book may reflect 

changes in market price until the 

position is sold or unwound. The 

Agencies also recognize that the metric 

contains a residual component for profit 

and loss that cannot be specifically 

attributed to existing positions or new 

positions. 

The Agencies believe that evaluation 

of the Comprehensive Profit and Loss 

Attribution metric could provide 

valuable information regarding patterns 

of revenue generation by market-making 

trading desks involved in marketmaking activities that may warrant 

further review of the desk’s activities, 

while eliminating the requirement from 

the proposal that the trading desk 

demonstrate that its primary source of 

revenue, under all circumstances, is 

fees, commissions and bid/ask spreads. 

This modified focus will reduce the 

burden associated with the proposed 

source of revenue requirement and 

better account for the varying depth and 

liquidity of markets.1107 In addition, the 

Agencies believe these modifications 

appropriately address commenters’ 

concerns about the proposed source of 

revenue requirement and reduce the 

potential for negative market impacts of 

the proposed requirement cited by 

commenters, such as incentives to 

widen spreads or disincentives to 

engage in market making in less liquid 

markets.1108

The Agencies recognize that this 

analysis is only informative over time, 

and should not be determinative of an 

analysis of whether the amount, types, 

and risks of the financial instruments in 

the trading desk’s market-maker 

inventory are designed not to exceed the 

reasonably expected near term demands 

of clients, customers, or counterparties. 

The Agencies believe this quantitative 

measurement provides appropriate 

flexibility to obtain information on 

market-maker revenues, which is 

designed to address commenters’ 

concerns about the proposal’s source of 

revenue requirement (e.g., the burdens 

associated with differentiating spread 

revenue from price appreciation 

revenue) while also helping assess 

patterns of revenue generation that may 

be informative over time about whether 

a market maker’s activities are designed 

to facilitate and provide customer 

intermediation. 

8. Appendix B of the Proposed Rule 

a. Proposed Appendix B Requirement 

The proposed market-making 

exemption would have required that the 

market making-related activities of the 

trading desk or other organizational unit 

of the banking entity be consistent with 

the commentary in proposed Appendix 

B.1109 In this proposed Appendix, the 

Agencies provided overviews of 

permitted market making-related 

activity and prohibited proprietary 

trading activity.1110

The proposed Appendix also set forth 

various factors that the Agencies 

proposed to use to help distinguish 

prohibited proprietary trading from 

permitted market making-related 

activity. More specifically, proposed 

Appendix B set forth six factors that, 

absent explanatory facts and 

circumstances, would cause particular 

trading activity to be considered 

prohibited proprietary trading activity 

and not permitted market makingrelated activity. The proposed factors 

focused on: (i) Retaining risk in excess 

of the size and type required to provide 

intermediation services to customers 

(‘‘risk management factor’’); (ii) 

primarily generating revenues from 

price movements of retained principal 

positions and risks, rather than 

customer revenues (‘‘source of revenues 

factor’’); (iii) generating only very small 


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1111See Joint Proposal, 76 FR at 68873, 68961– 

68963; CFTC Proposal, 77 FR at 8358, 8440–8442. 

1112See MetLife; ACLI (Feb. 2012). 

1113See Alfred Brock. But see, e.g., Occupy 

(stating that the proposed commentary only 

accounts for the most liquid and transparent 

markets and fails to accurately describe market 

making in most illiquid or OTC markets). 

1114See Morgan Stanley; IIF; Sumitomo Trust; 

ISDA (Apr. 2012); BDA (Feb. 2012) (Oct. 2012) 

(stating that proposed Appendix B places too great 

of a focus on derivatives trading and does not 

reflect how principal trading operations in equity 

and fixed income markets are structured). One of 

these commenters requested that the appendix be 

modified to account for certain activities conducted 

in connection with market making in swaps. This 

commenter indicated that a swap dealer may not 

regularly enjoy a dominant flow of customer 

revenues and may consistently need to make 

revenue from its book management. In addition, the 

commenter stated that the appendix should 

recognize that making a two-way market may be a 

dominant theme, but there are certain to be frequent 

occasions when, as a matter of market or internal 

circumstances, a market maker is unavailable to 

trade. See ISDA (Apr. 2012). 

1115See SIFMA et al. (Prop. Trading) (Feb. 2012). 

1116See Sens. Merkley & Levin (Feb. 2012). This 

commenter stated that, for example, Appendix B 

could deem market making involving widely-traded 

stocks and bonds issued by well-established 

corporations, government securities, or highly 

liquid asset-backed securities as the type of plain 

vanilla, low risk capital activities that are 

presumptively permitted, provided the activity is 

within certain, specified parameters for inventory 

levels, revenue-to-risk metrics, volatility, and 

hedging. See id. 

1117See Morgan Stanley; Flynn & Fusselman. 

1118See JPMC. In support of such an approach, 

the commenter argued that sometimes proposed 

§ 75.4(b) and Appendix B addressed the same topic 

and, when this occurs, it is unclear whether 

compliance with Appendix B constitutes 

compliance with § 75.4(b) or if additional 

compliance steps are required. See id. 

1119See Morgan Stanley. 

1120See NYSE Euronext; Morgan Stanley. 

1121See IAA. 

1122See Wellington; Goldman (Prop. Trading); 

SIFMA (Asset Mgmt.) (Feb. 2012). 

1123See Morgan Stanley; Chamber (Feb. 2012); 

Goldman (Prop. Trading). 

1124See Japanese Bankers Ass’n.; Credit Suisse 

(Seidel); Chamber (Feb. 2012); ICFR; Morgan 

Stanley; Goldman (Prop. Trading); Occupy; Oliver 

Wyman (Feb. 2012); Oliver Wyman (Dec. 2011); 

Public Citizen; NYSE Euronext. But see Alfred 

Brock (stating that the proposed factors are 

effective). 

1125See Wellington; Goldman (Prop. Trading); 

SIFMA (Asset Mgmt.) (Feb. 2012). In particular, 

proposed Appendix B provided that ‘‘The particular 

types of trading activity described in this appendix 

may involve the aggregate trading activities of a 

single trading unit, a significant number or series 

of transactions occurring at one or more trading 

units, or a single significant transaction, among 

other potential scenarios.’’ Joint Proposal, 76 FR at 

68961; CFTC Proposal, 77 FR at 8441. The Agencies 

address commenters’ trade-by-trade concerns in 

Part VI.A.3.c.1.c.ii., infra. 

1126See Goldman (Prop. Trading). 

1127See Morgan Stanley; Goldman (Prop. 

Trading); Chamber (Feb. 2012). Specifically, 

commenters cited statements in proposed Appendix 

B indicating that market makers ‘‘typically only 

engage in transactions with non-customers to the 

extent that these transactions directly facilitate or 

support customer transactions.’’ On this issue, the 

appendix further stated that ‘‘a market maker 

generally only transacts with non-customers to the 

extent necessary to hedge or otherwise manage the 

risks of its market making-related activities, 

including managing its risk with respect to 

movements of the price of retained principal 

positions and risks, to acquire positions in amounts 

consistent with reasonably expected near term 

demand of its customers, or to sell positions 

acquired from its customers.’’ The appendix 

recognized, however, that the ‘‘appropriate 

proportion of a market maker’s transactions that are 

with customers versus non-customers varies 

depending on the type of positions involved and 

the extent to which the positions are typically 

hedged in non-customer transactions.’’ Joint 

Proposal, 76 FR at 68961; CFTC Proposal, 77 FR at 

8440. Commenters’ concerns regarding interdealer 

trading are addressed in Part VI.A.3.c.2.c.i., infra. 

1128See Morgan Stanley; Goldman (Prop. 

Trading). 

1129See Morgan Stanley; Goldman (Prop. 

Trading); Chamber (Feb. 2012). 

or very large amounts of revenue per 

unit of risk, not demonstrating 

consistent profitability, or 

demonstrating high earnings volatility 

(‘‘revenues relative to risk factor’’); (iv) 

not trading through a trading system 

that interacts with orders of others or 

primarily with customers of the banking 

entity’s market-making desk to provide 

liquidity services, or retaining principal 

positions in excess of reasonably 

expected near term customer demands 

(‘‘customer-facing activity factor’’); (v) 

routinely paying rather than earning 

fees, commissions, or spreads 

(‘‘payment of fees, commissions, and 

spreads factor’’); and (vi) providing 

compensation incentives to employees 

that primarily reward proprietary risktaking (‘‘compensation incentives 

factor’’).1111

b. Comments on Proposed Appendix B 

Commenters expressed differing 

views about the accuracy of the 

commentary in proposed Appendix B 

and the appropriateness of including 

such commentary in the rule. For 

example, some commenters stated that 

the description of market makingrelated activity in the proposed 

appendix is accurate 1112 or 

appropriately accounts for differences 

among asset classes.1113 Other 

commenters indicated that the appendix 

is too strict or narrow.1114 Some 

commenters recommended that the 

Agencies revise proposed Appendix B’s 

approach by, for example, placing 

greater focus on what market making is 

rather than what it is not,1115 providing 

presumptions of activity that will be 

treated as permitted market makingrelated activity,1116 re-formulating the 

appendix as nonbinding guidance,1117

or moving certain requirements of the 

proposed exemption to the 

appendix.1118 One commenter suggested 

the Agencies remove Appendix B from 

the rule and instead use the 

conformance period to analyze and 

develop a body of supervisory guidance 

that appropriately characterizes the 

nature of market making-related 

activity.1119

A few commenters expressed concern 

about the appendix’s facts-andcircumstances-based approach to 

distinguishing between prohibited 

proprietary trading and permitted 

market making-related activity and 

stated that such an approach will make 

it more difficult or burdensome for 

banking entities to comply with the 

proposed rule 1120 or will generate 

regulatory uncertainty.1121 As discussed 

below, other commenters opposed 

proposed Appendix B because of its 

level of granularity 1122 or due to 

perceived restrictions on interdealer 

trading or generating revenue from 

retained principal positions or risks in 

the proposed appendix.1123 A number of 

commenters expressed concern about 

the complexity or prescriptiveness of 

the six proposed factors for 

distinguishing permitted market 

making-related activity from prohibited 

proprietary trading.1124

With respect to the level of 

granularity of proposed Appendix B, a 

number of commenters expressed 

concern that the reference to a ‘‘single 

significant transaction’’ indicated that 

the Agencies will review compliance 

with the proposed market-making 

exemption on a trade-by-trade basis and 

stated that assessing compliance at the 

level of individual transactions would 

be unworkable.1125 One of these 

commenters further stated that assessing 

compliance at this level of granularity 

would reduce a market maker’s 

willingness to execute a customer sell 

order as principal due to concern that 

the market maker may not be able to 

immediately resell such position. The 

commenter noted that this chilling 

effect would be heightened in declining 

markets.1126

A few commenters interpreted certain 

statements in proposed Appendix B as 

limiting interdealer trading and 

expressed concerns regarding potential 

limitations on this activity.1127 These 

commenters emphasized that market 

makers may need to trade with noncustomers to: (i) Provide liquidity to 

other dealers and, indirectly, their 

customers, or to otherwise allow 

customers to access a larger pool of 

liquidity; 1128 (ii) conduct price 

discovery to inform the prices a market 

maker can offer to customers; 1129 (iii) 

unwind or sell positions acquired from 


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1130See Morgan Stanley; Chamber (Feb. 2012) 

(stating that market makers in the corporate bond, 

interest rate derivative, and natural gas derivative 

markets frequently trade with other dealers to work 

down a concentrated position originating with a 

customer trade). 

1131See Morgan Stanley; Chamber (Feb. 2012). 

1132See Goldman (Prop. Trading). 

1133See Chamber (Feb. 2012). 

1134See Goldman (Prop. Trading). 

1135See Morgan Stanley; SIFMA et al. (Prop. 

Trading) (Feb. 2012); Goldman (Prop. Trading). On 

this issue, Appendix B stated that certain types of 

‘‘customer revenues’’ provide the primary source of 

a market maker’s profitability and, while a market 

maker also incurs losses or generates profits as price 

movements occur in its retained principal positions 

and risks, ‘‘such losses or profits are incidental to 

customer revenues and significantly limited by the 

banking entity’s hedging activities.’’ Joint Proposal, 

76 FR at 68960; CFTC Proposal, 77 FR at 8440. The 

Agencies address commenters’ concerns about 

proposed requirements regarding a market maker’s 

source of revenue in Part VI.A.3.c.7.c., infra. 

1136See Morgan Stanley. 

1137See supra note 1086 and accompanying text. 

1138See supra note 1111 and accompanying text. 

1139See Alfred Brock. 

1140See Japanese Bankers Ass’n. 

1141Sens. Merkley & Levin (Feb. 2012). 

1142The proposed appendix stated that the 

Agencies would use certain quantitative 

measurements required in proposed Appendix A to 

help assess the extent to which a trading unit’s risks 

are potentially being retained in excess amounts, 

including VaR, Stress VaR, VaR Exceedance, and 

Risk Factor Sensitivities. See Joint Proposal, 76 FR 

at 68961–68962; CFTC Proposal, 77 FR at 8441. One 

commenter questioned whether, assuming such 

metrics are effective and the activity does not 

exceed the banking entity’s expressed risk appetite, 

it is necessary to place greater restrictions on risktaking, based on the Agencies’ judgment of the level 

of risk necessary for bona fide market making. See 

ICFR. 

1143See Chamber (Feb. 2012). 

1144See Credit Suisse (Seidel). 

1145See Goldman (Prop. Trading); Morgan 

Stanley. 

1146See Morgan Stanley. 

1147See Goldman (Prop. Trading). This 

commenter suggested that the Agencies remove any 

negative presumptions based on revenues and 

instead use revenue metrics, such as Spread Profit 

and Loss (when it is feasible to calculate) or other 

metrics for purposes of monitoring a banking 

entity’s trading activity. See id. 

1148See Occupy (stating that these factors are 

important and will provide invaluable information 

about the nature of the banking entity’s trading 

activity). 

1149See Morgan Stanley; Credit Suisse (Seidel); 

Oliver Wyman (Feb. 2012); Oliver Wyman (Dec. 

2011). 

1150See Morgan Stanley; Credit Suisse (Seidel); 

Oliver Wyman (Feb. 2012); Oliver Wyman (Dec. 

2011). For example, one commenter stated that 

because markets and trading volumes are volatile, 

consistent profitability and low earnings volatility 

are outside a market maker’s control. In support of 

this statement, the commenter indicated that: (i) 

Customer trading activity varies significantly with 

market conditions, which results in volatility in a 

market maker’s earnings and profitability; and (ii) 

a market maker will experience volatility associated 

with changes in the value of its inventory positions, 

and principal risk is a necessary feature of market 

making. See Morgan Stanley. 

1151See Oliver Wyman (Feb. 2012); Oliver 

Wyman (Dec. 2011). 

1152See Morgan Stanley; Goldman (Prop. 

Trading). 

1153See Public Citizen. 

1154See Oliver Wyman (Feb. 2012). 

customers; 1130 (iv) establish or acquire 

positions to meet reasonably expected 

near term customer demand; 1131 (v) 

hedge; 1132 and (vi) sell a financial 

instrument when there are more buyers 

than sellers for the instrument at that 

time.1133 Further, one of these 

commenters expressed the view that the 

proposed appendix’s statements are 

inconsistent with the statutory marketmaking exemption’s reference to 

‘‘counterparties.’’ 1134

In addition, a few commenters 

expressed concern about statements in 

proposed Appendix B about a market 

maker’s source of revenue.1135

According to one commenter, the 

statement that profit and loss generated 

by inventory appreciation or 

depreciation must be ‘‘incidental’’ to 

customer revenues is inconsistent with 

market making-related activity in less 

liquid assets and larger transactions 

because market makers often must 

retain principal positions for longer 

periods of time in such circumstances 

and are unable to perfectly hedge these 

positions.1136 As discussed above with 

respect to the source of revenue 

requirement in § 75.4(b)(v) of the 

proposed rule, a few commenters 

requested that Appendix B’s discussion 

of ‘‘customer revenues’’ be modified to 

state that revenues from hedging will be 

considered to be customer revenues in 

certain contexts beyond derivatives 

contracts.1137

A number of commenters discussed 

the six proposed factors in Appendix B 

that, absent explanatory facts and 

circumstances, would have caused a 

particular trading activity to be 

considered prohibited proprietary 

trading activity and not permitted 

market making-related activity.1138 With 

respect to the proposed factors, one 

commenter indicated that they are 

appropriate,1139 while another 

commenter stated that they are complex 

and their effectiveness is uncertain.1140

Another commenter expressed the view 

that ‘‘[w]hile each of the selected factors 

provides evidence of ‘proprietary 

trading,’ warrants regulatory attention, 

and justifies a shift in the burden of 

proof, some require subjective 

judgments, are subject to gaming or data 

manipulation, and invite excessive 

reliance on circumstantial evidence and 

lawyers’ opinions.’’ 1141

In response to the proposed risk 

management factor,1142 one commenter 

expressed concern that it could prevent 

a market maker from warehousing 

positions in anticipation of predictable 

but unrealized customer demands and, 

further, could penalize a market maker 

that misestimated expected demand. 

This commenter expressed the view that 

such an outcome would be contrary to 

the statute and would harm market 

liquidity.1143 Another commenter 

requested that this presumption be 

removed because in less liquid markets, 

such as markets for corporate bonds, 

equity derivatives, securitized products, 

emerging markets, foreign exchange 

forwards, and fund-linked products, a 

market maker needs to act as principal 

to facilitate client requests and, as a 

result, will be exposed to risk.1144

Two commenters expressed concern 

about the proposed source of revenue 

factor.1145 One commenter stated that 

this factor does not accurately reflect 

how market making occurs in a majority 

of markets and asset classes.1146 The 

other commenter expressed concern that 

this factor shifted the emphasis of 

§ 75.4(b)(v) of the proposed rule, which 

required that market making-related 

activities be ‘‘designed’’ to generate 

revenue primarily from certain sources, 

to the actual outcome of activities.1147

With respect to the proposed revenues 

relative to risk factor, one commenter 

supported this aspect of the 

proposal.1148 Some commenters, 

however, expressed concern about using 

these factors to differentiate permitted 

market making-related activity from 

prohibited proprietary trading.1149

These commenters stated that volatile 

risk-taking and revenue can be a natural 

result of principal market-making 

activity.1150 One commenter noted that 

customer flows are often ‘‘lumpy’’ due 

to, for example, a market maker’s 

facilitation of large trades.1151

A few commenters indicated that the 

analysis in the proposed customerfacing activity factor may not accurately 

reflect how market making occurs in 

certain markets and asset classes due to 

potential limitations on interdealer 

trading.1152 According to another 

commenter, however, a banking entity’s 

non-customer facing trades should be 

required to be matched with existing 

customer counterparties.1153 With 

respect to the near term customer 

demand component of this factor, one 

commenter expressed concern that it 

goes farther than the statute’s activitybased ‘‘design’’ test by analyzing 

whether a trading unit’s inventory has 

exceeded reasonably expected near term 

customer demand at any particular 

point in time.1154

Some commenters expressed concern 

about the payment of fees, commissions, 


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1155See NYSE Euronext; Morgan Stanley. 

1156See Public Citizen. 

1157See NYSE Euronext. 

1158See Morgan Stanley. 

1159See Public Citizen. 

1160See Occupy. This commenter also stated that 

the commentary in Appendix B stating that a 

banking entity may give some consideration of 

profitable hedging activities in determining 

compensation would provide inappropriate 

incentives. See id. 

1161See infra Part VI.C.3.; final rule Appendix A. 

1162See 12 U.S.C. 1851(d)(1)(C); proposed rule 

§ 75.5. 

1163See Ass’n. of Institutional Investors (Feb. 

2012); see also Barclays; ICI (Feb. 2012); Investure; 

MetLife; RBC; SIFMA et al. (Prop. Trading) (Feb. 

2012); SIFMA (Asset Mgmt.) (Feb. 2012); Morgan 

Stanley; Fixed Income Forum/Credit Roundtable; 

Fidelity; FTN. 

1164See Barclays. 

1165See 12 U.S.C. 1851(d)(1)(C) (stating that ‘‘riskmitigating hedging activities’’ are permitted under 

certain circumstances). 

and spreads factor.1155 One commenter 

appeared to support this proposed 

factor.1156 According to one commenter, 

this factor fails to recognize that market 

makers routinely pay a variety of fees in 

connection with their market makingrelated activity, including, for example, 

fees to access liquidity on another 

market to satisfy customer demand, 

transaction fees as a matter of course, 

and fees in connection with hedging 

transactions. This commenter also 

indicated that, because spreads in 

current, rapidly-moving markets are 

volatile, short-term measurements of 

profit compared to spread revenue is 

problematic, particularly for less liquid 

stocks.1157 Another commenter stated 

that this factor reflects a bias toward 

agency trading and principal market 

making in highly liquid, exchangetraded markets and does not reflect the 

nature of principal market making in 

most markets.1158 One commenter 

recommended that the rule require that 

a trader who pays a fee be prepared to 

document the chain of custody to show 

that the instrument is shortly re-sold to 

an interested customer.1159

Regarding the proposed compensation 

incentives factor, one commenter 

requested that the Agencies make clear 

that explanatory facts and 

circumstances cannot justify a trading 

unit providing compensation incentives 

that primarily reward proprietary risktaking to employees engaged in market 

making. In addition, the commenter 

recommended that the Agencies delete 

the word ‘‘primarily’’ from this 

factor.1160

c. Determination to Not Adopt Proposed 

Appendix B 

To improve clarity, the final rule 

establishes particular criteria for the 

exemption and does not incorporate the 

commentary in proposed Appendix B 

regarding the identification of permitted 

market making-related activities. This 

SUPPLEMENTARY INFORMATION provides 

guidance on the standards for 

compliance with the market-making 

exemption. 

9. Use of Quantitative Measurements 

Consistent with the FSOC study and 

the proposal, the Agencies continue to 

believe that quantitative measurements 

can be useful to banking entities and the 

Agencies to help assess the profile of a 

trading desk’s trading activity and to 

help identify trading activity that may 

warrant a more in-depth review.1161 The 

Agencies will not use quantitative 

measurements as a dispositive tool for 

differentiating between permitted 

market making-related activities and 

prohibited proprietary trading. Like the 

framework the Agencies have developed 

for the market-making exemption, the 

Agencies recognize that there may be 

differences in the quantitative 

measurements across markets and asset 

classes. 

4. Section 75.5: Permitted RiskMitigating Hedging Activities 

Section 75.5 of the proposed rule 

implemented section 13(d)(1)(C) of the 

BHC Act, which provides an exemption 

from the prohibition on proprietary 

trading for certain risk-mitigating 

hedging activities.1162 Section 

13(d)(1)(C) provides an exemption for 

risk-mitigating hedging activities in 

connection with and related to 

individual or aggregated positions, 

contracts, or other holdings of a banking 

entity that are designed to reduce the 

specific risks to the banking entity in 

connection with and related to such 

positions, contracts, or other holdings 

(the ‘‘hedging exemption’’). Section 75.5 

of the final rule implements the hedging 

exemption with a number of 

modifications from the proposed rule to 

respond to commenters’ concerns as 

described more fully below. 

a. Summary of Proposal’s Approach To 

Implementing the Hedging Exemption 

The proposed rule would have 

required seven criteria to be met in 

order for a banking entity’s activity to 

qualify for the hedging exemption. First, 

§§ 75.5(b)(1) and 75.5(b)(2)(i) of the 

proposed rule generally required that 

the banking entity establish an internal 

compliance program that is designed to 

ensure the banking entity’s compliance 

with the requirements of the hedging 

limitations, including reasonably 

designed written policies and 

procedures, internal controls, and 

independent testing, and that a 

transaction for which the banking entity 

is relying on the hedging exemption be 

made in accordance with the 

compliance program established under 

§ 75.5(b)(1). Next, § 75.5(b)(2)(ii) of the 

proposed rule required that the 

transaction hedge or otherwise mitigate 

one or more specific risks, including 

market risk, counterparty or other credit 

risk, currency or foreign exchange risk, 

interest rate risk, basis risk, or similar 

risks, arising in connection with and 

related to individual or aggregated 

positions, contracts, or other holdings of 

the banking entity. Moreover, 

§ 75.5(b)(2)(iii) of the proposed rule 

required that the transaction be 

reasonably correlated, based upon the 

facts and circumstances of the 

underlying and hedging positions and 

the risks and liquidity of those 

positions, to the risk or risks the 

transaction is intended to hedge or 

otherwise mitigate. Furthermore, 

§ 75.5(b)(2)(iv) of the proposed rule 

required that the hedging transaction 

not give rise, at the inception of the 

hedge, to significant exposures that are 

not themselves hedged in a 

contemporaneous transaction. Section 

75.5(b)(2)(v) of the proposed rule 

required that any hedge position 

established in reliance on the hedging 

exemption be subject to continuing 

review, monitoring and management. 

Finally, § 75.5(b)(2)(vi) of the proposed 

rule required that the compensation 

arrangements of persons performing the 

risk-mitigating hedging activities be 

designed not to reward proprietary risktaking. Additionally, § 75.5(c) of the 

proposed rule required the banking 

entity to document certain hedging 

transactions at the time the hedge is 

established. 

b. Manner of Evaluating Compliance 

With the Hedging Exemption 

A number of commenters expressed 

concern that the final rule required 

application of the hedging exemption on 

a trade-by-trade basis.1163 One 

commenter argued that the text of the 

proposed rule seemed to require a tradeby-trade analysis because each 

‘‘purchase or sale’’ or ‘‘hedge’’ was 

subject to the requirements.1164 The 

final rule modifies the proposal by 

generally replacing references to a 

‘‘purchase or sale’’ in the § 75.5(b) 

requirements with ‘‘risk-mitigating 

hedging activity.’’ The Agencies believe 

this approach is consistent with the 

statute, which refers to ‘‘risk-mitigating 

hedging activity.’’ 1165


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1166See 12 U.S.C. 1851(d)(1)(C). 

1167See Part VI.A.4.b., infra. 

1168See, e.g., AFR et al. (Feb. 2012); AFR (June 

2013); Better Markets (Feb. 2012); Sens. Merkley & 

Levin (Feb. 2012). 

1169See, e.g., Occupy. 

1170See, e.g., Australian Bankers’ Ass’n (Feb. 

2012); BoA; Barclays; Credit Suisse (Seidel); 

Goldman (Prop. Trading); HSBC; ICI (Feb. 2012); 

Japanese Bankers Ass’n.; JPMC; Morgan Stanley; 

Chamber (Feb. 2012); Wells Fargo (Prop. Trading); 

Rep. Bachus et al.; RBC; SIFMA et al. (Prop. 

Trading) (Feb. 2012); see also Stephen Roach. 

1171See Credit Suisse (Seidel); ICI (Feb. 2012); 

Wells Fargo (Prop. Trading); see also Banco de 

Me ́xico; SIFMA et al. (Prop. Trading) (Feb. 2012); 

Goldman (Prop. Trading); BoA. 

1172See MetLife; SIFMA et al. (Prop. Trading) 

(Feb. 2012); Morgan Stanley; Barclays; Goldman 

(Prop. Trading); BoA; ABA; HSBC; Fixed Income 

Forum/Credit Roundtable; ICI (Feb. 2012); ISDA 

(Feb. 2012). 

1173See Goldman (Prop. Trading); BoA. 

1174See Barclays; State Street (Feb. 2012); SIFMA 

et al. (Prop. Trading) (Feb. 2012); Japanese Bankers 

Ass’n.; Credit Suisse (Seidel); BoA; PNC et al.; ISDA 

(Feb. 2012). 

1175See SIFMA et al. (Prop. Trading) (Feb. 2012); 

JPMC; Goldman (Prop. Trading); BoA; Comm. on 

Capital Markets Regulation. Each of these types of 

activities is discussed further below. See infra Part 

VI.A.4.d.2. 

1176See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Credit Suisse (Seidel); Barclays; Goldman (Prop. 

Trading); BoA. 

1177See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Goldman (Prop. Trading); Credit Suisse (Seidel). 

1178See Barclays. 

1179See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Credit Suisse (Seidel). 

1180See SIFMA et al. (Prop. Trading) (Feb. 2012). 

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

specifically authorizes risk-mitigating 

hedging activities in connection with 

and related to ‘‘individual or aggregated 

positions, contracts or other 

holdings.’’ 1166 Thus, the statute does 

not require that exempt hedging be 

conducted on a trade-by-trade basis, and 

permits hedging of aggregated positions. 

The Agencies recognized this in the 

proposed rule, and the final rule 

continues to permit hedging activities in 

connection with and related to 

individual or aggregated positions. 

The statute also requires that, to be 

exempt under section 13(d)(1)(C), 

hedging activities be risk-mitigating. 

The final rule incorporates this statutory 

requirement. As explained in more 

detail below, the final rule requires that, 

in order to qualify for the exemption for 

risk-mitigating hedging activities: The 

banking entity implement, maintain, 

and enforce an internal compliance 

program, including policies and 

procedures that govern and control 

these hedging activities; the hedging 

activity be designed to reduce or 

otherwise significantly mitigate and 

demonstrably reduces or otherwise 

significantly mitigates specific, 

identifiable risks; the hedging activity 

not give rise to significant new risks that 

are left unhedged; the hedging activity 

be subject to continuing review, 

monitoring and management to address 

risk that might develop over time; and 

the compensation arrangements for 

persons performing risk-mitigating 

hedging activities be designed not to 

reward or incentivize prohibited 

proprietary trading. These requirements 

are designed to focus the exemption on 

hedging activities that are designed to 

reduce risk and that also demonstrably 

reduce risk, in accordance with the 

requirement under section 13(d)(1)(C) 

that hedging activities be risk-mitigating 

to be exempt. Additionally, the final 

rule imposes a documentation 

requirement on certain types of hedges. 

Consistent with the other exemptions 

from the ban on proprietary trading for 

market-making and underwriting, the 

Agencies intend to evaluate whether an 

activity complies with the hedging 

exemption under the final rule based on 

the totality of circumstances involving 

the products, techniques, and strategies 

used by a banking entity as part of its 

hedging activity.1167

c. Comments on the Proposed Rule and 

Approach To Implementing the Hedging 

Exemption 

Commenters expressed a variety of 

views on the proposal’s hedging 

exemption. A few commenters offered 

specific suggestions described more 

fully below regarding how, in their 

view, the hedging exemption should be 

strengthened to ensure proper oversight 

of hedging activities.1168 These 

commenters expressed concern that the 

proposal’s exemption was too broad and 

argued that all proprietary trading could 

be designated as a hedge under the 

proposal and thereby evade the 

prohibition of section 13.1169

By contrast, a number of other 

commenters argued that the proposal 

imposed burdensome requirements that 

were not required by statute, would 

limit the ability of banking entities to 

hedge in a prudent and cost-effective 

manner, and would reduce market 

liquidity.1170 These commenters argued 

that implementation of the requirements 

of the proposal would decrease safety 

and soundness of banking entities and 

the financial system by reducing costeffective risk management options. 

Some commenters emphasized that the 

ability of banking entities to hedge their 

positions and manage risks taken in 

connection with their permissible 

activities is a critical element of liquid 

and efficient markets, and that the 

cumulative impact of the proposal 

would inhibit this risk-mitigation by 

raising transaction costs and 

suppressing essential and beneficial 

hedging activities.1171

A number of commenters expressed 

concern that the proposal’s hedging 

exemption did not permit the full 

breadth of transactions in which 

banking entities engage to hedge or 

mitigate risks, such as portfolio 

hedging,1172 dynamic hedging,1173

anticipatory hedging,1174 or scenario 

hedging.1175 Some commenters stated 

that restrictions on a banking entity’s 

ability to hedge may have a chilling 

effect on its willingness to engage in 

other permitted activities, such as 

market making.1176 In addition, many of 

these commenters stated that, if a 

banking entity is limited in its ability to 

hedge its market-making inventory, it 

may be less willing or able to assume 

risk on behalf of customers or provide 

financial products to customers that are 

used for hedging purposes. As a result, 

according to these commenters, it will 

be more difficult for customers to hedge 

their risks and customers may be forced 

to retain risk.1177

Another commenter contended that 

the proposal represented an 

inappropriate ‘‘one-size-fits-all’’ 

approach to hedging that did not 

properly take into account the way 

banking entities and especially market 

intermediaries operate, particularly in 

less-liquid markets.1178 Two 

commenters requested that the Agencies 

clarify that a banking entity may use its 

discretion to choose any hedging 

strategy that meets the requirements of 

the proposed exemption and, in 

particular, that a banking entity is not 

obligated to choose the ‘‘best hedge’’ 

and may use the cheapest instrument 

available.1179 One commenter suggested 

uncertainty about the permissibility of a 

situation where gains on a hedge 

position exceed losses on the 

underlying position. The commenter 

suggested that uncertainty may lead 

banking entities to not use the most 

cost-effective hedge, which would make 

hedging less efficient and raise costs for 

banking entities and customers.1180

However, another commenter expressed 

concern about banking entities relying 

on the cheapest satisfactory hedge. The 

commenter explained that such hedges 

lead to more complicated risk profiles 

and require banking entities to engage in 

additional transactions to hedge the 


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1181See Occupy. 

1182See BoA; Barclays; CH/ABASA; Credit Suisse 

(Seidel); HSBC; ICI (Feb. 2012); ISDA (Apr. 2012); 

JPMC; Morgan Stanley; PNC; SIFMA et al. (Prop. 

Trading) (Feb. 2012); see also Stephen Roach. 

1183A detailed discussion of ALM activities is 

provided in Part VI.A.1.d.2 of this SUPPLEMENTARY

INFORMATION relating to the definition of trading 

account. As explained in that part, the final rule 

does not allow use of the hedging exemption for 

ALM activities that are outside of the hedging 

activities specifically permitted by the final rule. 

1184See BoA; JPMC; Morgan Stanley. 

1185See SIFMA et al. (Prop. Trading) (Feb. 2012); 

JPMC; PNC et al.; ICI. 

1186See Prof. Richardson; ABA (Keating). 

1187See Barclays; BoA; ISDA (Feb. 2012). 

1188See Johnson & Prof. Stiglitz. 

1189See HSBC. 

1190See final rule § 75.5. 

1191See SIFMA et al. (Prop. Trading) (Feb. 2012); 

JPMC; PNC et al.; ICI (Feb. 2012); BoA; Morgan 

Stanley. 

1192See BoA; Barclays; CH/ABASA; Credit Suisse 

(Seidel); HSBC; ICI (Feb. 2012); ISDA (Apr. 2012); 

JPMC; Morgan Stanley; PNC; SIFMA et al. (Prop. 

Trading) (Feb. 2012); see also Stephen Roach. 

1193Some commenters requested that the 

Agencies establish a safe harbor. See Prof. 

Richardson; ABA (Keating). One commenter 

requested that the Agencies adopt a bright-line test. 

See Johnson & Prof. Stiglitz. 

1194A few commenters requested that the 

Agencies establish a presumption of compliance. 

See Barclays; BoA; ISDA (Feb. 2012). 

1195One commenter suggested this principlesbased approach. See HSBC. 

1196Section 13(d)(1)(C) of the BHC Act permits 

‘‘risk-mitigating hedging activities in connection 

with and related to individual or aggregated 

positions, contracts, or other holdings of a banking 

entity that are designed to reduce the specific risks 

to the banking entity in connection with and related 

to such positions, contracts, or other holdings.’’ 12 

U.S.C. 1851(d)(1)(C). 

1197Some commenters were concerned that the 

proposed hedging exemption was too broad and 

that all proprietary trading could be designated as 

a hedge. See, e.g., Occupy. 

1198See, e.g., Australian Bankers Ass’n. (Feb. 

2012); BoA; Barclays; Credit Suisse (Seidel); 

Goldman (Prop. Trading); HSBC; Japanese Bankers 

Ass’n.; JPMC; Morgan Stanley; Chamber (Feb. 

2012); Wells Fargo (Prop. Trading); Rep. Bachus et 

al.; RBC; SIFMA et al. (Prop. Trading) (Feb. 2012). 

1199See supra Part VI.A.3.c.4. 

exposures resulting from the imperfect, 

cheapest hedge.1181

A few commenters suggested the 

hedging exemption be modified in favor 

of a simpler requirement that banking 

entities adopt risk limits and policies 

and procedures commensurate with 

qualitative guidance issued by the 

Agencies.1182 Many of these 

commenters also expressed concerns 

that the proposed rule’s hedging 

exemption would not allow so-called 

asset-liability management (‘‘ALM’’) 

activities.1183 Some commenters 

proposed that the risk-mitigating 

hedging exemption reference a set of 

relevant descriptive factors rather than 

specific prescriptive requirements.1184

Other alternative frameworks suggested 

by commenters include: (i) 

Reformulating the proposed 

requirements as supervisory 

guidance; 1185 (ii) establishing a safe 

harbor,1186 presumption of 

compliance,1187 or bright line test; 1188

or (iii) a principles-based approach that 

would require a banking entity to 

document its risk-mitigating hedging 

strategies for submission to its 

regulator.1189

d. Final Rule 

The final rule provides a multifaceted approach to implementing the 

hedging exemption that seeks to ensure 

that hedging activity is designed to be 

risk-reducing in nature and not 

designed to mask prohibited proprietary 

trading.1190 The final rule includes a 

number of modifications in response to 

comments. 

This multi-faceted approach is 

intended to permit hedging activities 

that are risk-mitigating and to limit 

potential abuse of the hedging 

exemption while not unduly 

constraining the important riskmanagement function that is served by 

a banking entity’s hedging activities. 

This approach is also intended to ensure 

that any banking entity relying on the 

hedging exemption has in place 

appropriate internal control processes to 

support its compliance with the terms of 

the exemption. While commenters 

proposed a number of alternative 

frameworks for the hedging exemption, 

the Agencies believe the final rule’s 

multi-faceted approach most effectively 

balances commenter concerns with 

statutory purpose. In response to 

commenter requests to reformulate the 

proposed rule as supervisory 

guidance,1191 including the suggestion 

that the Agencies simply require 

banking entities to adopt risk limits and 

policies and procedures commensurate 

with qualitative Agency guidance,1192

the Agencies believe that such an 

approach would provide less clarity 

than the adopted approach. Although a 

purely guidance-based approach could 

provide greater flexibility, it would also 

provide less specificity, which could 

make it difficult for banking entity 

personnel and the Agencies to 

determine whether an activity complies 

with the rule and could lead to an 

increased risk of evasion of the statutory 

requirements. Further, while a brightline or safe harbor approach to the 

hedging exemption would generally 

provide a high degree of certainty about 

whether an activity qualifies for the 

exemption, it would also provide less 

flexibility to recognize the differences in 

hedging activity across markets and 

asset classes.1193 In addition, the use of 

any bright-line approach would more 

likely be subject to gaming and 

avoidance as new products and types of 

trading activities are developed than 

other approaches to implementing the 

hedging exemption. Similarly, the 

Agencies decline to establish a 

presumption of compliance because, in 

light of the constant innovation of 

trading activities and the differences in 

hedging activity across markets and 

asset classes, establishing appropriate 

parameters for a presumption of 

compliance with the hedging exemption 

would potentially be less capable of 

recognizing these legitimate differences 

than our current approach.1194

Moreover, the Agencies decline to 

follow a principles-based approach 

requiring a banking entity to document 

its hedging strategies for submission to 

its regulator.1195 The Agencies believe 

that evaluating each banking entity’s 

trading activity based on an 

individualized set of documented 

hedging strategies could be 

unnecessarily burdensome and result in 

unintended competitive impacts since 

banking entities would not be subject to 

one uniform rule. The Agencies believe 

the multi-faceted approach adopted in 

the final rule establishes a consistent 

framework applicable to all banking 

entities that will reduce the potential for 

such adverse impacts. 

Further, the Agencies believe the 

scope of the final hedging exemption is 

appropriate because it permits riskmitigating hedging activities, as 

mandated by section 13 of the BHC 

Act,1196 while requiring a robust 

compliance program and other internal 

controls to help ensure that only 

genuine risk-mitigating hedges can be 

used in reliance on the exemption.1197

In response to concerns that the 

proposed hedging exemption would 

reduce legitimate hedging activity and 

thus impact market liquidity and the 

banking entity’s willingness to engage in 

permissible customer-related 

activity,1198 the Agencies note that the 

requirements of the final hedging 

exemption are designed to permit 

banking entities to properly mitigate 

specific risk exposures, consistent with 

the statute. In addition, hedging related 

to market-making activity conducted by 

a market-making desk is subject to the 

requirements of the market-making 

exemption, which are designed to 

permit banking entities to continue 

providing valuable intermediation and 

liquidity services, including related 

risk-management activity.1199 Thus, the 

final hedging exemption will not 

negatively impact the safety and 

soundness of banking entities or the 


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1200Some commenters believed that restrictions 

on hedging would have a chilling effect on banking 

entities’ willingness to engage in market making, 

and may result in customers experiencing difficulty 

in hedging their risks or force customers to retain 

risk. See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Credit Suisse (Seidel); Barclays; Goldman (Prop. 

Trading); BoA; IHS. 

1201These aspects of the compliance program 

requirement are described in further detail in Part 

VI.C. of this SUPPLEMENTARY INFORMATION. 

1202See SIFMA et al. (Prop. Trading) (Feb. 2012). 1203See BoA; Barclays; HSBC; JPMC; Morgan 

Stanley; see also Goldman (Prop. Trading); RBC; 

Barclays; ICI (Feb. 2012); ISDA (Apr. 2012); PNC; 

SIFMA et al. (Prop. Trading) (Feb. 2012). See the 

discussion of why the Agencies decline to take a 

presumption of compliance approach above. 

1204See Barclays. 

1205See ICBA; M&T Bank. 

1206See, e.g., Bank of Canada; Allen & Overy (on 

behalf of Canadian Banks). Additionally, foreign 

banking entities engaged in hedging activity may be 

able to rely on the exemption for trading activity 

conducted by foreign banking entities in lieu of the 

hedging exemption, provided they meet the 

requirements of the exemption for trading by 

foreign banking entities under § 75.6(e) of the final 

rule. See infra Part VI.A.8. 

1207See SIFMA et al. (Prop. Trading) (Feb. 2012); 

JPMC. 

1208See Sens. Merkley & Levin (Feb. 2012). 

1209See Better Markets (Feb. 2012). 

1210See Sens. Merkley & Levin (Feb. 2012); 

Occupy; Andrea Psoras. 

1211See final rule § 75.5(b)(1). The final rule 

retains the proposal’s requirement that the 

compliance program include, among other things, 

written hedging policies. 

1212See, e.g., BoA; ICI (Feb. 2012); ISDA (Feb. 

2012); JPMC; Morgan Stanley; PNC; SIFMA et al. 

(Prop. Trading) (Feb. 2012). 

1213See final rule § 75.20(a) (stating that ‘‘[t]he 

terms, scope and detail of [the] compliance program 

shall be appropriate for the types, size, scope and 

complexity of activities and business structure of 

the banking entity’’). The Agencies believe this 

helps address some commenters’ concern that the 

hedging exemption would be too limiting and 

burdensome for community and regional banks. See 

ICBA; M&T Bank. 

1214Many of these policies and procedures were 

contained as part of the proposed rule’s compliance 

program requirements under Appendix C. They 

have been moved, and in some cases modified, in 

order to more clearly demonstrate how they are 

incorporated into the requirements of the hedging 

exemption. 

1215See Better Markets (Feb. 2012). The final rule 

does not require affirmative certification of each 

hedge, as suggested by this commenter, because the 

Agencies believe it would unnecessarily slow 

legitimate transactions. The Agencies believe the 

final rule’s required management framework and 

escalation procedures achieve the same objective as 

the commenter’s suggested approach, while 

imposing fewer burdens on legitimate riskmitigating hedging activity. 

1216See final rule §§ 75.20(b), 75.5(b). This 

approach builds on the proposal’s requirement that 

senior management and intermediate managers be 

accountable for the effective implementation of the 

compliance program. 

financial system or have a chilling effect 

on a banking entity’s willingness to 

engage in other permitted activities, 

such as market making.1200

These limits and requirements are 

designed to prevent the type of activity 

conducted by banking entities in the 

past that involved taking large positions 

using novel strategies to attempt to 

profit from potential effects of general 

economic or market developments and 

thereby potentially offset the general 

effects of those events on the revenues 

or profits of the banking entity. The 

documentation requirements in the final 

rule support these limits by identifying 

activity that occurs in reliance on the 

risk-mitigating hedging exemption at an 

organizational level or desk that is not 

responsible for establishing the risk or 

positions being hedged. 

1. Compliance Program Requirement 

The first criterion of the proposed 

hedging exemption required a banking 

entity to establish an internal 

compliance program designed to ensure 

the banking entity’s compliance with 

the requirements of the hedging 

exemption and conduct its hedging 

activities in compliance with that 

program. While the compliance program 

under the proposal was expected to be 

appropriate for the size, scope, and 

complexity of each banking entity’s 

activities and structure, the proposal 

would have required each banking 

entity with significant trading activities 

to implement robust, detailed hedging 

policies and procedures and related 

internal controls and independent 

testing designed to prevent prohibited 

proprietary trading in the context of 

permitted hedging activity.1201 These 

enhanced programs for banking entities 

with large trading activity were 

expected to include written hedging 

policies at the trading unit level and 

clearly articulated trader mandates for 

each trader designed to ensure that 

hedging strategies mitigated risk and 

were not for the purpose of engaging in 

prohibited proprietary trading. 

Commenters, including industry 

groups, generally expressed support for 

requiring policies and procedures to 

monitor the safety and soundness, as 

well as appropriateness, of hedging 

activity.1202 Some of these commenters 

advocated that the final rule presume 

that a banking entity is in compliance 

with the hedging exemption if the 

banking entity’s hedging activity is done 

in accordance with the written policies 

and procedures required under its 

compliance program.1203 One 

commenter represented that the 

proposed compliance framework was 

burdensome and complex.1204

Other commenters expressed 

concerns that the hedging exemption 

would be too limiting and burdensome 

for community and regional banks.1205

Some commenters argued that foreign 

banking entities should not be subject to 

the requirements of the hedging 

exemption for transactions that do not 

introduce risk into the U.S. financial 

system.1206 Other commenters stated 

that coordinated hedging through and 

by affiliates should qualify as permitted 

risk-mitigating hedging activity.1207

Some commenters urged the Agencies 

to adopt detailed limitations on hedging 

activities. For example, one commenter 

urged that all hedging trades be labeled 

as such at the inception of the trade and 

detailed information regarding the 

trader, manager, and supervisor 

authorizing the trade be kept and 

reviewed.1208 Another commenter 

suggested that the hedging exemption 

contain a requirement that the banking 

entity employee who approves a hedge 

affirmatively certify that the hedge 

conforms to the requirements of the rule 

and has not been put in place for the 

direct or indirect purpose or effect of 

generating speculative profits.1209 A few 

commenters requested limitations on 

instruments that can be used for 

hedging purposes.1210

The final rule retains the proposal’s 

requirement that a banking entity 

establish an internal compliance 

program that is designed to ensure the 

banking entity limits its hedging 

activities to hedging that is riskmitigating.1211 The final rule largely 

retains the proposal’s approach to the 

compliance program requirement, 

except to the extent that, as requested by 

some commenters,1212 the final rule 

modifies the proposal to provide 

additional detail regarding the elements 

that must be included in a compliance 

program. Similar to the proposal, the 

final rule contemplates that the scope 

and detail of a compliance program will 

reflect the size, activities, and 

complexity of banking entities in order 

to ensure that banking entities engaged 

in more active trading have enhanced 

compliance programs without imposing 

undue burden on smaller organizations 

and entities that engage in little or no 

trading activity.1213 The final rule also 

requires, like the proposal, that the 

banking entity implement, maintain, 

and enforce the program.1214

In response to commenter concerns 

about ensuring the appropriate level of 

senior management involvement in 

establishing these policies,1215 the final 

rule requires that the written policies 

and procedures be developed and 

implemented by a banking entity at the 

appropriate level of organization and 

expressly address the banking entity’s 

requirements for escalation procedures, 

supervision, and governance related to 

hedging activities.1216


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1217This approach is generally consistent with 

some commenters’ suggested approach of limiting 

the instruments that can be used for hedging 

purposes; although the final rules provide banking 

entities with discretion to determine the types of 

positions, contracts, or other holdings that will 

mitigate specific risks of individual or aggregated 

holdings and thus may be used for risk-mitigating 

hedging activity. See Sens. Merkley & Levin (Feb. 

2012); Occupy; Andrea Psoras. In response to one 

commenter’s request that the final rule require all 

hedges to be labeled at inception and certain 

detailed information be documented for each hedge, 

the Agencies note that the final rules continue to 

require detailed documentation for hedging activity 

that presents a heightened risk of evasion. See Sens. 

Merkley & Levin (Feb. 2012); final rule § 75.5(c); 

infra Part VI.A.4.d.4. The Agencies believe a 

documentation requirement targeted at these 

scenarios balances the need to prevent evasion of 

the general prohibition on proprietary trading with 

the concern that documentation requirements can 

slow or impede legitimate risk-mitigating activity in 

the normal course. 

1218See final rule § 75.5(b)(1)(i). Some 

commenters expressed support for the use of risk 

limits in determining whether trading activity 

qualifies for the hedging exemption. See, e.g., 

Barclays; Credit Suisse (Seidel); ICI (Feb. 2012); 

Morgan Stanley. 

1219See final rule § 75.5(b)(1)(ii). 

1220See final rule § 75.5(b)(1)(iii). The final rule’s 

requirement to demonstrably reduce or otherwise 

significantly mitigate is discussed in greater detail 

below. 

1221The proposal also contained a continuing 

review, monitoring, and management requirement. 

See proposed rule § 75.5(b)(2)(v). The final rule 

modifies the proposed requirement, however, by 

removing the ‘‘reasonable correlation’’ requirement 

and instead requiring that the hedge demonstrably 

reduce or otherwise significantly mitigate specific 

identifiable risks. Correlation analysis is, however, 

a necessary component of the analysis element in 

the compliance program requirement of the hedging 

exemption in the final rule. See final rule § 75.5(b). 

This change is discussed below. 

1222See Barclays. 

1223See infra Part VI.C.1. Some commenters 

expressed concern that the compliance program 

requirement would place undue burden on regional 

or community banks. See ICBA; M&T Bank. 

1224See SIFMA et al. (Prop. Trading) (Feb. 2012); 

JPMC. 

Like the proposal, the final rule 

specifies that a banking entity’s 

compliance regime must include 

reasonably designed written policies 

and procedures regarding the positions, 

techniques and strategies that may be 

used for hedging, including 

documentation indicating what 

positions, contracts or other holdings a 

trading desk may use in its riskmitigating hedging activities.1217 The 

focus on policies and procedures 

governing risk identification and 

mitigation, analysis and testing of 

position limits and hedging strategies, 

and internal controls and ongoing 

monitoring is expected to limit use of 

the hedging exception to risk-mitigating 

hedging. The final rule adds to the 

proposed compliance program approach 

by requiring that the banking entity’s 

written policies and procedures include 

position and aging limits with respect to 

such positions, contracts, or other 

holdings.1218 The final rule, similar to 

the proposed rule, also requires that the 

compliance program contain internal 

controls and ongoing monitoring, 

management, and authorization 

procedures, including relevant 

escalation procedures.1219 Further, the 

final rule retains the proposed 

requirement that the compliance 

program provide for the conduct of 

analysis and independent testing 

designed to ensure that the positions, 

techniques, and strategies that may be 

used for hedging may reasonably be 

expected to demonstrably reduce or 

otherwise significantly mitigate the 

specific, identifiable risks being 

hedged.1220

The final rule also adds that 

correlation analysis be undertaken as 

part of the analysis of the hedging 

positions, techniques, and strategies that 

may be used. This provision effectively 

changes the requirement in the 

proposed rule that the hedge must 

maintain correlation into a requirement 

that correlation be analyzed as part of 

the compliance program before a 

hedging activity is undertaken. This 

provision incorporates the concept in 

the proposed rule that a hedge should 

be correlated (negatively, when sign is 

considered) to the risk being hedged. 

However, the Agencies recognize that 

some effective hedging activities, such 

as deep out-of-the-money puts and calls, 

may not be exhibit a strong linear 

correlation to the risks being hedged 

and also that correlation over a period 

of time between two financial positions 

does not necessarily mean one position 

will in fact reduce or mitigate a risk of 

the other. Rather, the Agencies expect 

the banking entity to undertake a 

correlation analysis that will, in many 

but not all instances, provide a strong 

indication of whether a potential 

hedging position, strategy, or technique 

will or will not demonstrably reduce the 

risk it is designed to reduce. It is 

important to recognize that the rule does 

not require the banking entity to prove 

correlation mathematically or by other 

specific methods. Rather, the nature and 

extent of the correlation analysis 

undertaken would be dependent on the 

facts and circumstances of the hedge 

and the underlying risks targeted. If 

correlation cannot be demonstrated, 

then the Agencies would expect that 

such analysis would explain why not 

and also how the proposed hedging 

position, technique, or strategy is 

designed to reduce or significantly 

mitigate risk and how that reduction or 

mitigation can be demonstrated without 

correlation. 

Moreover, the final rule requires 

hedging activity conducted in reliance 

on the hedging exemption be subject to 

continuing review, monitoring, and 

management that is consistent with the 

banking entity’s written hedging 

policies and procedures and is designed 

to reduce or otherwise significantly 

mitigate, and demonstrably reduces or 

otherwise significantly mitigates, the 

specific, identifiable risks that develop 

over time from hedging activity and 

underlying positions.1221 This ongoing 

review should consider market 

developments, changes in positions or 

the configuration of aggregated 

positions, changes in counterparty risk, 

and other facts and circumstances 

related to the risks associated with the 

underlying and hedging positions, 

contracts, or other holdings. 

The Agencies believe that requiring 

banking entities to develop and follow 

detailed compliance policies and 

procedures related to risk-mitigating 

hedging activity will help both banking 

entities and examiners understand the 

risks to which banking entities are 

exposed and how these risks are 

managed in a safe and sound manner. 

With this increased understanding, 

banking entities and examiners will be 

better able to evaluate whether banking 

entities are engaged in legitimate, riskreducing hedging activity, rather than 

impermissible proprietary trading. 

While the Agencies recognize there are 

certain costs associated with this 

compliance program requirement,1222

we believe this provision is necessary to 

ensure compliance with the statute and 

the final rule. As discussed in Part 

VI.C.1., the Agencies have modified the 

proposed compliance program structure 

to reduce burdens on small banking 

entities.1223

The Agencies note that hedging may 

occur across affiliates under the hedging 

exemption.1224 To ensure that hedging 

across trading desks or hedging done at 

a level of the organization outside of the 

trading desk does not result in 

prohibited proprietary trading, the final 

rule imposes enhanced documentation 

requirements on these activities, which 

are discussed more fully below. The 

Agencies also note that nothing in the 

final rule limits or restricts the ability of 

the appropriate supervisory agency of a 

banking entity to place limits on 

interaffiliate hedging in a manner 

consistent with their safety and 

soundness authority to the extent the 


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5904 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

1225 In addition, section 608 of the Dodd-Frank 

Act added credit exposure arising from securities 

borrowing and lending or a derivative transaction 

with an affiliate to the list of covered transactions 

subject to the restrictions of section 23A of the FR 

Act, in each case to the extent that such transaction 

causes a bank to have credit exposure to the 

affiliate. See 12 U.S.C. 371c(b)(7) and (8). As a 

consequence, interaffiliate hedging activity within a 

banking entity may be subject to limitation or 

restriction under section 23A of the FR Act. 

1226See 17 CFR 50.52. 

1227See proposed rule § 75.5(b)(2)(ii); see also 

Joint Proposal, 76 FR at 68875. 

1228See AFR (June 2013); Sens. Merkley & Levin 

(Feb. 2012); Public Citizen; Johnson & Prof. Stiglitz. 

1229See Sens. Merkley & Levin (Feb. 2012). 

1230See Public Citizen; see also Occupy. 

1231See Occupy. 

1232See, e.g., Japanese Bankers Ass’n. 

1233See Barclays. 

1234See ABA (Keating); Wells Fargo (Prop. 

Trading). Although certain accounting standards, 

such as FASB ASC Topic 815 hedge accounting 

standards, address circumstances in which a 

transaction may be considered a hedge of another 

transaction, the final rule does not refer to or 

expressly rely on these accounting standards 

because such standards: (i) are designed for 

financial statement purposes, not to identify 

proprietary trading; and (ii) change often and are 

likely to change in the future without consideration 

of the potential impact on section 13 of the BHC 

Act. 

1235See JPMC. 

1236 12 U.S.C. 1851(d)(1)(C). 

1237Some commenters expressed support for the 

requirement that a banking entity tie a hedge to a 

specific risk. See AFR (June 2012); Sens. Merkley 

& Levin (Feb. 2012); Public Citizen; Johnson & Prof. 

Stiglitz. 

1238See final rule § 75.5(b)(2)(ii). 

1239See final rule § 75.5(b)(1)(iii). 

1240Some commenters represented that the 

proposed list of risks eligible to be hedged could 

justify transactions that should be considered 

proprietary trading. See Public Citizen; Occupy. 

One commenter was concerned about the proposed 

inclusion of ‘‘basis risk’’ in this list. See Occupy. 

As noted in the proposal, the Agencies believe the 

inclusion of a list of eligible risks, including basis 

risk, helps implement the essential element of the 

statutory hedging exemption—i.e., that the 

transaction is risk-reducing in connection with a 

specific risk. See Joint Proposal, 76 FR at 68875. See 

also 12 U.S.C. 1851(d)(1)(C). Further, the Agencies 

believe the other requirements of the final hedging 

exemption, including requirements regarding 

internal controls and a compliance program, help 

to ensure that only legitimate hedging activity 

qualifies for the exemption. 

1241See, e.g., Occupy. 

agency has such authority.1225

Additionally, nothing in the final rule 

limits or modifies the applicability of 

CFTC regulations with respect to the 

clearing of interaffiliate swaps.1226

2. Hedging of Specific Risks and 

Demonstrable Reduction of Risk 

Section 75.5(b)(2)(ii) of the proposed 

rule required that a qualifying 

transaction hedge or otherwise mitigate 

one or more specific risks, including 

market risk, counterparty or other credit 

risk, currency or foreign exchange risk, 

interest rate risk, basis risk, or similar 

risks, arising in connection with and 

related to individual or aggregated 

positions, contracts, or other holdings of 

a banking entity.1227 This criterion 

implemented the essential element of 

the hedging exemption that the 

transaction be risk-mitigating. 

Some commenters expressed support 

for this provision, particularly the 

requirement that a banking entity be 

able to tie a hedge to a specific risk.1228

One of these commenters stated that a 

demonstrated reduction in risk should 

be a key indicator of whether a hedge 

is in fact permitted.1229 However, some 

commenters argued that the list of risks 

eligible to be hedged under the 

proposed rule, which included risks 

arising from aggregated positions, could 

justify transactions that should be 

viewed as prohibited proprietary 

trading.1230 Another commenter 

contended that the term ‘‘basis risk’’ 

was undefined and could heighten the 

potential that this exemption would be 

used to evade the prohibition on 

proprietary trading.1231

Other commenters argued that 

requiring a banking entity to specify the 

particular risk being hedged discourages 

effective hedging and increases the risk 

at banking entities. These commenters 

contended that hedging activities must 

address constantly changing positions 

and market conditions.1232 Another 

commenter argued that this requirement 

could render a banking entity’s hedges 

impermissible if those hedges do not 

succeed in fully hedging or mitigating 

an identified risk as determined by a 

post hoc analysis and could prevent 

banking entities from entering into 

hedging transactions in anticipation of 

risks that the banking entity expects will 

arise (or increase).1233 Certain 

commenters requested that the hedging 

exemption provide a safe harbor for 

positions that satisfy FASB ASC Topic 

815 (formerly FAS 133) hedging 

accounting standards, which provides 

that an entity recognize derivative 

instruments, including certain 

derivative instruments embedded in 

other contracts, as assets or liabilities in 

the statement of financial position and 

measure them at fair value.1234 Another 

commenter suggested that scenario 

hedges could be identifiable and subject 

to review by the Agencies using VaR, 

Stress VaR, and VaR Exceedance, as 

well as revenue metrics.1235

The Agencies have considered these 

comments carefully in light of the 

statute. Section 13(d)(1)(C) of the BHC 

Act provides an exemption from the 

prohibition on proprietary trading only 

for hedging activity that is ‘‘designed to 

reduce the specific risks to the banking 

entity in connection with and related 

to’’ individual or aggregated positions, 

contracts, or other holdings of the 

banking entity.1236 Thus, while the 

statute permits hedging of individual or 

aggregated positions (as discussed more 

fully below), the statute requires that, to 

be exempt from the prohibition on 

proprietary trading, hedging 

transactions be designed to reduce 

specific risks.1237 Moreover, it requires 

that these specific risks be in connection 

with or related to the individual or 

aggregated positions, contracts, or other 

holdings of the banking entity. 

The final rule implements these 

requirements. To ensure that exempt 

hedging activities are designed to 

reduce specific risks, the final rule 

requires that the hedging activity at 

inception of the hedging activity, 

including, without limitation, any 

adjustments to the hedging activity, be 

designed to reduce or otherwise 

significantly mitigate and demonstrably 

reduces or otherwise significantly 

mitigates one or more specific, 

identifiable risks, including market risk, 

counterparty or other credit risk, 

currency or foreign exchange risk, 

interest rate risk, commodity price risk, 

basis risk, or similar risks, arising in 

connection with and related to 

identified individual or aggregated 

positions, contracts, or other holdings of 

the banking entity, based upon the facts 

and circumstances of the individual or 

aggregated underlying and hedging 

positions, contracts, or other holdings of 

the banking entity and the risks and 

liquidity thereof.1238 Hedging activities 

and limits should be based on analysis 

conducted by the banking entity of the 

appropriateness of hedging instruments, 

strategies, techniques, and limits. As 

discussed above, this analysis must 

include analysis of correlation between 

the hedge and the specific identifiable 

risk or risks that the hedge is designed 

to reduce or significantly mitigate.1239

This language retains the focus of the 

statute and the proposed rule on 

reducing or mitigating specific and 

identified risks.1240 As discussed more 

fully above, banking entities are 

required to describe in their compliance 

policies and procedures the types of 

strategies, techniques, and positions that 

may be used for hedging. 

The final rule does not prescribe the 

hedging strategy that a banking entity 

must employ. While one commenter 

urged that the final rule require each 

banking entity to adopt the ‘‘best hedge’’ 

for every transaction,1241 the Agencies 

believe that the complexity of positions, 

market conditions at the time of a 

transaction, availability of hedging 


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1242A banking entity must satisfy the enhanced 

documentation requirements of § 75.5(c) if it 

engages in hedging activity utilizing positions, 

contracts, or holdings that were not identified in its 

written policies and procedures. 

1243See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Barclays; ICI (Feb. 2012); Morgan Stanley. 

1244See Barclays. 

1245Final rule § 75.5(b)(2)(iv)(B). The Agencies 

believe this provision addresses some commenters’ 

concern that the ongoing review, monitoring, and 

management requirement would limit hedging of 

aggregated positions, and that such ongoing review 

of individual hedge transactions with a variety of 

underlying risks would be impossible. See SIFMA 

(Prop. Trading) (Feb. 2012); Barclays; ICI (Feb. 

2012); Morgan Stanley. 

1246See ABA (Keating); BoA; Barclays; Credit 

Suisse (Seidel); Goldman (Prop. Trading); SIFMA et 

al. (Prop. Trading) (Feb. 2012); see also AFR et al. 

(Feb. 2012). 

1247See Credit Suisse (Seidel); Goldman (Prop. 

Trading); SIFMA et al. (Prop. Trading) (Feb. 2012). 

1248See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Barclays. 

1249See SIFMA et al. (Prop. Trading) (Feb. 2012). 

1250See BoA. 

1251See Sens. Merkley & Levin (Feb. 2012); Public 

Citizen; AFR (Nov. 2012). 

1252See Better Markets (Feb. 2012); AFR et al. 

(Feb. 2012). 

1253See FSOC study (stating that ‘‘[p]rudent risk 

management is at the core of both institutionspecific safety and soundness, as well as 

macroprudential and financial stability’’). 

1254See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012). 

1255Some commenters stated that it is not always 

possible to hedge a new risk exposure arising from 

a hedge in a cost-effective manner, and requiring 

contemporaneous hedges would raise transaction 

costs and the potential for hedges to become 

uneconomical. See SIFMA et al. (Prop. Trading) 

(Feb. 2012); Barclays. As noted in the proposal, the 

Agencies believe that requiring a contemporaneous 

hedge of any significant new risk that arises at the 

inception of a hedge is appropriate because a 

transaction that creates significant new risk 

exposure that is not itself hedged at the same time 

would appear to be indicative of prohibited 

proprietary trading. See Joint Proposal, 76 FR at 

68876. Thus, the Agencies believe this requirement 

is necessary to prevent evasion of the general 

prohibition on proprietary trading. In response to 

Continued 

transactions, costs of hedging, and other 

circumstances at the time of the 

transaction make a requirement that a 

banking entity always adopt the ‘‘best 

hedge’’ impractical, unworkable, and 

subjective. 

Nonetheless, the statute requires that, 

to be exempt under section 13(d)(1)(C), 

hedging activity must be risk-mitigating. 

To ensure that only risk-mitigating 

hedging is permitted under this 

exemption, the final rule requires that in 

its written policies and procedures the 

banking entity identify the instruments 

and positions that may be used in 

hedging, the techniques and strategies 

the banking entity deems appropriate 

for its hedging activities, as well as 

position limits and aging limits on 

hedging positions. These written 

policies and procedures also must 

specify the escalation and approval 

procedures that apply if a trader seeks 

to conduct hedging activities beyond the 

limits, position types, strategies, or 

techniques authorized for the trader’s 

activities.1242

As noted above, commenters were 

concerned that risks associated with 

permitted activities and holdings 

change over time, making a 

determination regarding the 

effectiveness of hedging activities in 

reducing risk dependent on the time 

when risk is measured. To address this, 

the final rule requires that the exempt 

hedging activity be designed to reduce 

or otherwise significantly mitigate, and 

demonstrably reduces or otherwise 

significantly mitigates, risk at the 

inception of the hedge. As explained 

more fully below, because risks and the 

effectiveness of a hedging strategy may 

change over time, the final rule also 

requires the banking entity to 

implement a program to review, 

monitor, and manage its hedging 

activity over the period of time the 

hedging activity occurs in a manner 

designed to reduce or significantly 

mitigate and demonstrably reduce or 

otherwise significantly mitigate new or 

changing risks that may develop over 

time from both the banking entity’s 

hedging activities and the underlying 

positions. Many commenters expressed 

concern that the proposed ongoing 

review, monitoring, and management 

requirement would limit a banking 

entity’s ability to engage in aggregated 

position hedging.1243 One commenter 

stated that because aggregated position 

hedging may result in modification of 

hedging exposures across a variety of 

underlying risks, even as the overall risk 

profile of a banking entity is reduced, it 

would become impossible to 

subsequently review, monitor, and 

manage individual hedging transactions 

for compliance.1244 The Agencies note 

that the final rule, like the statute, 

requires that the hedging activity relate 

to individual or aggregated positions, 

contracts or other holdings being 

hedged, and accordingly, the review, 

monitoring and management 

requirement would not limit the extent 

of permitted hedging provided for in 

section 13(d)(1)(C) as implied by some 

commenters. Further, the final rule 

recognizes that the determination of 

whether hedging activity demonstrably 

reduces or otherwise significantly 

mitigates risks that may develop over 

time should be ‘‘based upon the facts 

and circumstances of the underlying 

and hedging positions, contracts and 

other holdings of the banking entity and 

the risks and liquidity thereof.’’ 1245

A number of other commenters 

argued that a legitimate risk-reducing 

hedge may introduce new risks at 

inception.1246 A few commenters 

contended that a requirement that no 

new risks be associated with a hedge 

would be inconsistent with prudent risk 

management and greatly reduce the 

ability of banking entities to reduce 

overall risk through hedging.1247 A few 

commenters stated that the proposed 

requirement does not recognize that it is 

not always possible to hedge a new risk 

exposure arising from a hedge in a costeffective manner.1248 With respect to the 

timing of the initial hedge and any 

additional transactions necessary to 

reduce significant exposures arising 

from it, one of these commenters 

represented that requiring 

contemporaneous hedges is 

impracticable, would raise transaction 

costs, and would make hedging 

uneconomic.1249 Another commenter 

stated that this requirement could have 

a chilling effect on risk managers’ 

willingness to engage in otherwise 

permitted hedging activity.1250

Other commenters stated that a 

position that does not fully offset the 

risk of an underlying position is not in 

fact a hedge.1251 These commenters 

believed that the introduction of new 

risks at inception of a transaction 

indicated that the transaction was 

impermissible proprietary trading and 

not a hedge.1252

The Agencies recognize that prudent 

risk-reducing hedging activities by 

banking entities are important to the 

efficiency of the financial system.1253

The Agencies further recognize that 

hedges are generally imperfect; 

consequently, hedging activities can 

introduce new and sometimes 

significant risks, such as credit risk, 

basis risk, or new market risk, especially 

when hedging illiquid positions.1254

However, the Agencies also recognize 

that hedging activities present an 

opportunity to engage in impermissible 

proprietary trading designed to profit 

from exposure to these types of risks. 

To address these competing concerns, 

the final rule substantially retains the 

proposed requirement that, at the 

inception of the hedging activity, the 

risk-reducing hedging activity does not 

give rise to significant new or additional 

risk that is not itself contemporaneously 

hedged. This approach is designed to 

allow banking entities to continue to 

engage in prudent risk-mitigating 

activities while ensuring that the 

hedging exemption is not used to engage 

in prohibited proprietary trading by 

taking on prohibited short-term 

exposures under the guise of 

hedging.1255 As noted in the proposal, 


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commenters’ concerns about transaction costs and 

uneconomical hedging, the Agencies note that this 

provision only requires additional hedging of 

‘‘significant’’ new or additional risk and does not 

apply to any risk exposure arising from a hedge. 

1256See Joint Proposal, 76 FR at 68876. 

1257See final rule § 75.5(b)(2)(ii). 

1258See SIFMA (Prop. Trading) (Feb. 2012); 

Credit Suisse (Seidel); Barclays; Goldman (Prop. 

Trading); BoA. 

1259See Occupy. 

1260See Barclays. 

1261 12 U.S.C. 1851(d)(1)(C). 

1262See Joint Proposal, 76 FR at 68875. 

1263See, e.g., Australian Bankers’ Ass’n. (Feb. 

2012); BoA; Barclays; Credit Suisse (Seidel); 

Goldman (Prop. Trading); HSBC; ICI (Feb. 2012); 

Japanese Bankers Ass’n.; JPMC; Morgan Stanley; 

Wells Fargo (Prop. Trading); Rep. Bachus et al.; 

RBC; SIFMA (Prop. Trading) (Feb. 2012). 

1264See, e.g. ABA (Keating); Ass’n. of 

Institutional Investors (Sept. 2012); BoA; see also 

Barclays (expressing concern that the proposed rule 

could result in regulatory review of individual 

hedging trades for compliance on a post hoc basis); 

HSBC; ISDA (Apr. 2012); ICI (Feb. 2012); PNC; 

MetLife; RBC; SIFMA (Prop. Trading) (Feb. 2012). 

1265See, e.g., AFR et al. (Feb. 2012); Sens. 

Merkley & Levin (Feb. 2012); Occupy; Public 

Citizen; Johnson & Prof. Stiglitz. 

1266See Sens. Merkley & Levin (Feb. 2012) 

(commenting that the use of the term ‘‘aggregate’’ 

positions was intended to note that firms do not 

have to hedge on a trade-by-trade basis but could 

not hedge on a portfolio basis); Johnson & Prof. 

Stiglitz. 

1267See AFR et al. (Feb. 2012) (citing 156 Cong. 

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

Sen. Merkley)). 

1268See, e.g., Occupy; Public Citizen. 

1269See Public Citizen; Occupy; AFR et al. (Feb. 

2012). 1270See AFR et al. (Feb. 2012) (citing 156 Cong. 

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

Sen. Merkley)). 1271See MetLife; SIFMA et al. (Prop. Trading) 

(Feb. 2012); Morgan Stanley; Barclays; Goldman 

(Prop. Trading); BoA; ABA (Keating); HSBC; Fixed 

Income Forum/Credit Roundtable; ICI (Feb. 2012); 

ISDA (Feb. 2012). 1272The Agencies believe certain limits suggested 

by commenters, such as the formation of central 

however, the Agencies recognize that 

exposure to new risks may result from 

legitimate hedging transactions; 1256 this 

provision only prohibits the 

introduction of additional significant 

exposures through the hedging 

transaction unless those additional 

exposures are contemporaneously 

hedged. 

As noted above, the final rule 

recognizes that whether hedging activity 

will demonstrably reduce risk must be 

based upon the facts and circumstances 

of the individual or aggregated 

underlying and hedging positions, 

contracts, or other holdings of the 

banking entity and the risks and 

liquidity thereof.1257 The Agencies 

believe this approach balances 

commenters’ request that the Agencies 

clarify that a banking entity may use its 

discretion to choose any hedging 

strategy that meets the requirements of 

the proposed exemption 1258 with 

concerns that allowing banking entities 

to rely on the cheapest satisfactory 

hedge will lead to additional hedging 

transactions.1259 The Agencies expect 

that hedging strategies and techniques, 

as well as assessments of risk, will vary 

across positions, markets, activities and 

banking entities, and that a ‘‘one-sizefits-all’’ approach would not 

accommodate all types of appropriate 

hedging activity.1260

By its terms, section 13(d)(1)(C) of the 

BHC Act permits a banking entity to 

engage in risk-mitigating hedging 

activity ‘‘in connection with and 

related to individual or aggregated 

positions . . . .’’ 1261 The preamble to 

the proposed rule made clear that, 

consistent with the statutory reference 

to mitigating risks of individual or 

aggregated positions, this criterion 

permits hedging of risks associated with 

aggregated positions.1262 This approach 

is consistent with prudent riskmanagement and safe and sound 

banking practice.1263

The proposed rule explained that, to 

be exempt under this provision, hedging 

activities must reduce risk with respect 

to ‘‘positions, contracts, or other 

holdings of the banking entity.’’ The 

proposal also required that a banking 

entity relying on the exemption be 

prepared to identify the specific 

position or risks associated with 

aggregated positions being hedged and 

demonstrate that the hedging 

transaction was risk-reducing in the 

aggregate, as measured by appropriate 

risk management tools. 

Some commenters were of the view 

that the hedging exemption applied to 

aggregated positions or portfolio 

hedging and was consistent with 

prudent risk-management practices. 

These commenters argued that 

permitting a banking entity to hedge 

aggregate positions and risks arising 

from a portfolio of assets would be more 

efficient from both a procedural and 

business standpoint.1264

By contrast, other commenters argued 

that portfolio-based hedging could be 

used to mask prohibited proprietary 

trading.1265 One commenter contended 

that the statute provides no basis for 

portfolio hedging, and another 

commenter similarly suggested that 

portfolio hedging should be 

prohibited.1266 Another commenter 

suggested adopting limits that would 

prevent the use of the hedging 

exemption to conduct proprietary 

activity at one desk as a theoretical 

‘‘hedge for proprietary trading at 

another desk.’’ 1267 Among the limits 

suggested by these commenters were a 

requirement that a banking entity have 

a well-defined compliance program, the 

formation of central ‘‘risk management’’ 

groups to perform and monitor hedges 

of aggregated positions, and a 

requirement that the banking entity 

demonstrate the capacity to measure 

aggregate risk across the institution with 

precision using proven models.1268 A 

few commenters suggested that the 

presence of portfolio hedging should be 

viewed as an indicator of imperfections 

in hedging at the desk level and be a flag 

used by examiners to identify and 

review the integrity of specific 

hedges.1269

The final rule, like the proposed rule, 

implements the statutory language 

providing for risk-mitigating hedging 

activities related to individual or 

aggregated positions. For example, 

activity permitted under the hedging 

exemption would include the hedging 

of one or more specific risks arising 

from identified positions, contracts, or 

other holdings, such as the hedging of 

the aggregate risk of identified positions 

of one or more trading desks. Further, 

the final rule requires that these hedging 

activities be risk-reducing with respect 

to the identified positions, contracts, or 

other holdings being hedged and that 

the risk reduction be demonstrable. 

Specifically, the final rule requires, 

among other things: That the banking 

entity has a robust compliance program 

reasonably designed to ensure 

compliance with the exemption; that 

each hedge is subject to continuing 

review, monitoring and management 

designed to demonstrably reduce or 

otherwise significantly mitigate the 

specific, identifiable risks that develop 

over time related to the hedging activity 

and the underlying positions, contracts, 

or other holdings of the banking entity; 

and that the banking entity meet a 

documentation requirement for hedges 

not established by the trading desk 

responsible for the underlying position 

or for hedges effected through a 

financial instrument, technique or 

strategy that is not specifically 

identified in the trading desk’s written 

policies and procedures. The Agencies 

believe this approach addresses 

concerns that a banking entity could use 

the hedging exemption to conduct 

proprietary activity at one desk as a 

theoretical hedge for proprietary trading 

at another desk in a manner consistent 

with the statute.1270 Further, the 

Agencies believe the adopted exemption 

allows banking entities to engage in 

hedging of aggregated positions 1271

while helping to ensure that such 

hedging activities are truly riskmitigating.1272


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‘‘risk management’’ groups to monitor hedges of 

aggregated positions, are unnecessary given the 

aforementioned limits in the final rule. See Occupy; 

Public Citizen. 

1273See 12 U.S.C. 1851(d)(1)(C). 

1274The Agencies believe that it would be 

inconsistent with Congressional intent to permit 

some or all of these activities under the hedging 

exemption, regardless of whether certain metrics 

could be useful for monitoring such activity. See 

JPMC. 

1275See proposed rule § 75.5(b)(2)(ii) (requiring 

that the hedging transaction ‘‘hedges or otherwise 

mitigates one or more specific risks . . . arising in 

connection with and related to individual or 

aggregated positions, contracts, or other holdings of 

[the] banking entity’’). The proposal noted that this 

requirement would include, for example, dynamic 

hedging. See Joint Proposal, 76 FR at 68875. 

1276The proposal noted that this corresponding 

modification to the hedge should also be reasonably 

correlated to the material changes in risk that are 

intended to be hedged or otherwise mitigated, as 

required by § 75.5(b)(2)(iii) of the proposed rule. 

1277See AFR et al. (Feb. 2012); Public Citizen; see 

also Better Markets (Feb. 2012), Sens. Merkley & 

Levin (Feb. 2012). 

1278See Japanese Bankers Ass’n. 

1279See, e.g., BoA; Barclays; ISDA (Apr. 2012); 

PNC; PNC et al.; SIFMA et al. (Prop. Trading) (Feb. 

2012). 

1280See, e.g., Occupy; Public Citizen; AFR et. al. 

(Feb. 2012); AFR (June 2013); Better Markets (Feb. 

2012); Sens. Merkley & Levin (Feb. 2012). 

1281See BoA; Barclays; Comm. on Capital Markets 

Regulation; Credit Suisse (Seidel); FTN; Goldman 

(Prop. Trading); ICI (Feb. 2012); Japanese Bankers 

Ass’n.; JPMC; Morgan Stanley; SIFMA et al. (Prop. 

Trading) (Feb. 2012); STANY; see also Chamber 

(Feb. 2012). 

1282See Japanese Bankers Ass’n.; Goldman (Prop. 

Trading); BoA. 

1283See BoA; SIFMA (Asset Mgmt.) (Feb. 2012). 

As discussed above, market-maker hedging at the 

trading desk level is no longer subject to the 

hedging exemption and is instead subject to the 

requirements of the market-making exemption, 

which is designed to permit banking entities to 

continue providing legitimate market-making 

services, including managing the risk of marketmaking activity. See also supra Part VI.A.3.c.4. of 

this SUPPLEMENTARY INFORMATION. 

1284See Barclays; Goldman (Prop. Trading); 

Chamber (Feb. 2012); SIFMA et al. (Prop. Trading) 

(Feb. 2012); see also FTN; BoA. 

As noted above, several commenters 

questioned whether the hedging 

exemption should apply to ‘‘portfolio’’ 

hedging and whether portfolio hedging 

may create the potential for abuse of the 

hedging exemption. The term ‘‘portfolio 

hedging’’ is not used in the statute. The 

language of section 13(d)(1)(C) of the 

BHC Act permits a banking entity to 

engage in risk-mitigating hedging 

activity ‘‘in connection with and 

related to individual or aggregated 

positions . . . .’’ 1273 After consideration 

of the comments regarding portfolio 

hedging, and in light of the statutory 

language, the Agencies are of the view 

that the statutory language is clear on its 

face that a banking entity may engage in 

risk-mitigating hedging in connection 

with aggregated positions of the banking 

entity. The permitted hedging activity, 

when involving more than one position, 

contract, or other holding, must be in 

connection with or related to aggregated 

positions of the banking entity. 

Moreover, hedging of aggregated 

positions under this exemption must be 

related to identifiable risks related to 

specific positions, contracts, or other 

holdings of the banking entity. Hedging 

activity must mitigate one or more 

specific risks arising from an identified 

position or aggregation of positions. The 

risks in this context are not intended to 

be more generalized risks that a trading 

desk or combination of desks, or the 

banking entity as a whole, believe exists 

based on non-position-specific 

modeling or other considerations. For 

example, the hedging activity cannot be 

designed to: Reduce risks associated 

with the banking entity’s assets and/or 

liabilities generally, general market 

movements or broad economic 

conditions; profit in the case of a 

general economic downturn; 

counterbalance revenue declines 

generally; or otherwise arbitrage market 

imbalances unrelated to the risks 

resulting from the positions lawfully 

held by the banking entity.1274 Rather, 

the hedging exemption permits the 

banking entity to engage in trading 

activity designed to reduce or otherwise 

mitigate specific identifiable risks 

related to identified individual or 

aggregated positions that the banking 

entity is otherwise lawfully permitted to 

have. 

When undertaking a hedge to mitigate 

the risk of an aggregation of positions, 

the banking entity must be able to 

specifically identify the risk factors 

arising from this set of positions. In 

identifying the aggregate set of positions 

that is being hedged for purposes of 

§ 75.5(b)(2)(ii) and, where applicable, 

§ 75.5(c)(2)(i), the banking entity needs 

to identify the positions being hedged 

with sufficient specificity so that at any 

point in time, the specific financial 

instrument positions or components of 

financial instrument positions held by 

the banking entity that comprise the set 

of positions being hedged can be clearly 

identified. 

The proposal would have permitted a 

series of hedging transactions designed 

to rebalance hedging position(s) based 

on changes resulting from permissible 

activities or from a change in the price 

or other characteristic of the individual 

or aggregated positions, contracts, or 

other holdings being hedged.1275 The 

Agencies recognized that, in such 

dynamic hedging, material changes in 

risk may require a corresponding 

modification to the banking entity’s 

current hedge positions.1276

Some commenters questioned the 

risk-mitigating nature of a hedge if, at 

inception, that hedge contained 

component risks that must be 

dynamically managed throughout the 

life of the hedge. These commenters 

stated that hedges that do not 

continuously match the risk of 

underlying positions are not in fact riskmitigating hedges in the first place.1277

On the other hand, other commenters 

argued that banking entities must be 

permitted to engage in dynamic hedging 

activity, such as in response to market 

conditions which are unforeseeable or 

out of the control of the banking 

entity,1278 and expressed concern that 

the limitations of the proposed rule, 

especially the requirement that hedging 

transactions ‘‘maintain a reasonable 

level of correlation,’’ might impede truly 

risk-reducing hedging activity.1279

A number of commenters asserted 

that there could be confusion over the 

meaning of ‘‘reasonable correlation,’’ 

which was used in the proposal as part 

of explaining what type of activity 

would qualify for the hedging 

exemption. Some commenters urged 

requiring that there be a ‘‘high’’ or 

‘‘strong’’ correlation between the hedge 

and the risk of the underlying asset.1280

Other commenters indicated that 

uncertainty about the meaning of 

reasonable correlation could limit valid 

risk-mitigating hedging activities 

because the level of correlation between 

a hedge and the risk of the position or 

aggregated positions being hedged 

changes over time as a result of changes 

in market factors and conditions.1281

Some commenters represented that the 

proposed provision would cause certain 

administrative burdens 1282 or may 

result in a reduction in market-making 

activities in certain asset classes.1283 A 

few commenters expressed concern that 

the reasonable correlation requirement 

could render a banking entity’s hedges 

impermissible if they do not succeed in 

being reasonably correlated to the 

relevant risk or risks based on an afterthe-fact analysis that incorporates 

market developments that could not 

have been foreseen at the time the hedge 

was placed. These commenters tended 

to favor a different approach or a type 

of safe harbor based on an initial 

determination of correlation.1284 Some 

commenters argued the focus of the 

hedging exemption should be on risk 

reduction and not on reasonable 


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1285See, e.g., FTN; Goldman (Prop. Trading); 

ISDA (Apr. 2012); see also Sens. Merkley & Levin 

(Feb. 2012); Occupy. 

1286See Goldman (Prop. Trading). Consistent 

with the FSOC study and the proposal, the 

Agencies continue to believe that quantitative 

measurements can be useful to banking entities and 

the Agencies to help assess the profile of a trading 

desk’s trading activity and to help identify trading 

activity that may warrant a more in-depth review. 

See infra Part VI.C.3.; final rule Appendix A. The 

Agencies do not intend to use quantitative 

measurements as a dispositive tool for 

differentiating between permitted hedging activities 

and prohibited proprietary trading. 

1287Some commenters stated that the hedging 

exemption should focus on risk reduction, not 

reasonable correlation. See, e.g., FTN; Goldman 

(Prop. Trading); ISDA (Apr. 2012); Sens. Merkley & 

Levin (Feb. 2012); Occupy. One of these 

commenters noted that demonstrated risk reduction 

should be a key requirement. See Sens. Merkley & 

Levin (Feb. 2012). 

1288See FTN; Goldman (Prop. Trading); ISDA 

(Apr. 2012); see also Sens. Merkley & Levin (Feb. 

2012); Occupy. 

1289See final rule § 75.5(b)(1)(iii). 

1290Some commenters expressed concern that the 

proposed ‘‘reasonable correlation’’ requirement 

might impede truly risk-reducing activity. See, e.g., 

BoA; Barclays; Comm. on Capital Markets 

Regulation; Credit Suisse (Seidel); FTN; Goldman 

(Prop. Trading); ICI (Feb. 2012); ISDA (Apr. 2012); 

Japanese Bankers Ass’n.; JPMC; Morgan Stanley; 

PNC; PNC et al.; SIFMA et al. (Prop. Trading) (Feb. 

2012); STANY. Some of these commenters stated 

that the proposed requirement would cause 

administrative burdens. See Japanese Bankers 

Ass’n.; Goldman (Prop. Trading); BoA. 

1291See Barclays; Goldman (Prop. Trading); 

Chamber (Feb. 2012); SIFMA et al. (Prop. Trading) 

(Feb. 2012; see also FTN. 

1292By contrast, the proposed requirement did 

not specify that the hedging activity reduce risk ‘‘at 

the inception of the hedge.’’ See proposed rule 

§ 75.5(b)(2)(ii). 

1293Some commenters noted that hedging 

activities must address constantly changing 

positions and market conditions and expressed 

concern about requiring a banking entity to identify 

the particular risk being hedged. See Japanese 

Bankers Ass’n.; Barclays. 

1294A few commenters expressed concern that 

the proposed ‘‘reasonable correlation’’ requirement 

would render hedges impermissible if not 

reasonably correlated to the relevant risk(s) based 

on a post hoc analysis. See, e.g., Barclays; Goldman 

(Prop. Trading); Chamber (Feb. 2012); SIFMA et al. 

(Prop. Trading) (Feb. 2012). 

1295Some commenters questioned the riskmitigating nature of a hedge if, at inception, it 

contained risks that must be dynamically managed 

throughout the life of the hedge. See, e.g., AFR et 

al. (Feb. 2012); Public Citizen. 

correlation.1285 One commenter 

suggested that risk management metrics 

such as VaR and risk factor sensitivities 

could be the focus for permitted hedging 

instead of requirements like reasonable 

correlation under the proposal.1286

In consideration of commenter 

concerns about the proposed reasonable 

correlation requirement, the final rule 

modifies the proposal in the following 

key respects. First, the final rule 

modifies the requirement of ‘‘reasonable 

correlation’’ by providing that the hedge 

demonstrably reduce or otherwise 

significantly mitigate specific 

identifiable risks.1287 This change is 

designed to reinforce that hedging 

activity should be demonstrably risk 

reducing or mitigating rather than 

simply correlated to risk. This change 

acknowledges that hedges need not 

simply be correlated to underlying 

positions, and that hedging activities 

should be consciously designed to 

reduce or mitigate identifiable risks, not 

simply the result of pairing correlated 

positions, as some commenters 

suggested.1288 As discussed above, the 

Agencies do, however, recognize that 

correlation is often a critical element of 

demonstrating that a hedging activity 

reduces the risks it is designed to 

address. Accordingly, the final rule 

requires that banking entities conduct 

correlation analysis as part of the 

required compliance program in order 

to utilize the hedging exemption.1289

The Agencies believe this change better 

allows consideration of the facts and 

circumstances of the particular hedging 

activity as part of the correlation 

analysis and therefore addresses 

commenters’ concerns that the proposed 

reasonable correlation requirement 

could cause administrative burdens, 

impede legitimate hedging activity,1290

and require an after-the-fact 

analysis.1291

Second, the final rule provides that 

the determination of whether an activity 

or strategy is risk-reducing or mitigating 

must, in the first instance, be made at 

the inception of the hedging activity. A 

trade that is not risk-reducing at its 

inception is not viewed as a hedge for 

purposes of the exemption in § 75.5.1292

Third, the final rule requires that the 

banking entity conduct analysis and 

independent testing designed to ensure 

that the positions, techniques, and 

strategies used for hedging are 

reasonably designed to reduce or 

otherwise mitigate the risk being 

hedged. As noted above, such analysis 

and testing must include correlation 

analysis. Evidence of negative 

correlation may be a strong indicator 

that a given hedging position or strategy 

is risk-reducing. Moreover, positive 

correlation, in some instances, may be 

an indicator that a hedging position or 

strategy is not designed to be riskmitigating. The type of analysis and 

factors considered in the analysis 

should take account of the facts and 

circumstances, including type of 

position being hedged, market 

conditions, depth and liquidity of the 

market for the underlying and hedging 

position, and type of risk being hedged. 

The Agencies recognize that markets 

and risks are dynamic and that the risks 

from a permissible position or 

aggregated positions may change over 

time, new risks may emerge in the 

positions underlying the hedge and in 

the hedging position, new risks may 

emerge from the hedging strategy over 

time, and hedges may become less 

effective over time in addressing the 

related risk.1293 The final rule, like the 

proposal, continues to allow dynamic 

hedging. Additionally, the final rule 

requires the banking entity to engage in 

ongoing review, monitoring, and 

management of its positions and related 

hedging activity to reduce or otherwise 

significantly mitigate the risks that 

develop over time. This ongoing 

hedging activity must be designed to 

reduce or otherwise significantly 

mitigate, and must demonstrably reduce 

or otherwise significantly mitigate, the 

material changes in risk that develop 

over time from the positions, contracts, 

or other holdings intended to be hedged 

or otherwise mitigated in the same way, 

as required for the initial hedging 

activity. Moreover, the banking entity is 

required under the final rule to support 

its decisions regarding appropriate 

hedging positions, strategies and 

techniques for its ongoing hedging 

activity in the same manner as for its 

initial hedging activities. In this 

manner, the final rule permits a banking 

entity to engage in effective 

management of its risks throughout 

changing market conditions 1294 while 

also seeking to prohibit the banking 

entity from taking large proprietary 

positions through action or inaction 

related to an otherwise permissible 

hedge.1295

As explained above, the final rule 

requires a banking entity relying on the 

hedging exemption to be able to 

demonstrate that the banking entity is 

exposed to the specific risks being 

hedged at the inception of the hedge 

and any adjustments thereto. However, 

in the proposal, the Agencies requested 

comment on whether the hedging 

exemption should be available in 

certain cases where hedging activity 

begins before the banking entity 

becomes exposed to the underlying risk. 

The Agencies proposed that the hedging 

exemption would be available in certain 

cases where the hedge is established 

‘‘slightly’’ before the banking entity 

becomes exposed to the underlying risk 

if such anticipatory hedging activity: (i) 

Was consistent with appropriate risk 

management practices; (ii) otherwise 

met the terms of the hedging exemption; 

and (iii) did not involve the potential for 

speculative profit. For example, a 

banking entity that was contractually 

obligated or otherwise highly likely to 


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1296See Joint Proposal, 76 FR at 68875. 1297See, e.g., Barclays; SIFMA et al. (Prop. 

Trading); Japanese Bankers Ass’n.; Credit Suisse 

(Seidel); BoA; PNC et al.; ISDA (Feb. 2012). 1298See BoA; Credit Suisse (Seidel); ISDA (Feb. 

2012); JPMC; Morgan Stanley; PNC et al.; SIFMA et 

al. (Prop. Trading) (Feb. 2012). 

1299See Credit Suisse (Seidel); BoA. 1300See PNC et al. 1301See SIFMA et al. (Prop. Trading) (Feb. 2012); 

JPMC; Goldman (Prop. Trading); BoA; Comm. on 

Capital Market Regulation. As discussed above, 

hedging activity relying on this exemption cannot 

be designed to: Reduce risks associated with the 

banking entity’s assets and/or liabilities generally, 

general market movements or broad economic 

conditions; profit in the case of a general economic 

downturn; counterbalance revenue declines 

generally; or otherwise arbitrage market imbalances 

unrelated to the risks resulting from the positions 

lawfully held by the banking entity. 

1302See ABA (Keating); CH/ABASA; see also 

Credit Suisse (Seidel); PNC; PNC et al.; SIFMA et 

al. (Prop. Trading) (Feb. 2012). One commenter 

argued that anticipatory hedging should not be 

permitted because it represents illegal front 

running. See Occupy. The Agencies note that not 

all anticipatory hedging would constitute illegal 

front running. Any activity that is illegal under 

another provision of law, such as front running 

under section 10(b) of the Exchange Act, remains 

illegal; and section 13 of the BHC Act and any 

implementing rules thereunder do not represent a 

grant of authority to engage in any such activity. 

See 15 U.S.C. 78j. 

1303As discussed above, the final hedging 

exemption replaces the ‘‘reasonable correlation’’ 

concept with the requirement that hedging activity 

‘‘demonstrably reduce or otherwise significantly 

mitigate’’ specific, identifiable risks. 1304See AFR et al. (Feb. 2012); see also Part 

VI.C.3.d., infra. 

1305This requirement modifies proposed rule 

§ 75.5(b)(2)(ii) and (iii). As discussed above, the 

addition of ‘‘demonstrably reduces or significantly 

mitigates’’ language replaces the proposed 

‘‘reasonable correlation’’ requirement. 

1306The proposed rule contained a similar 

provision, except that the proposed provision also 

required that the continuing review maintain a 

reasonable level of correlation between the hedge 

transaction and the risk being hedged. See proposed 

rule § 75.5(b)(2)(v). As discussed above, the 

proposed ‘‘reasonable correlation’’ requirement was 

removed from that provision and instead a 

requirement has been added to the compliance 

program provision that correlation analysis be 

undertaken when analyzing hedging positions, 

techniques, and strategies before they are 

implemented. 

1307See AFR et al. (Feb. 2012). 

1308See proposed rule § 75.5(b)(2)(vi). 

become exposed to a particular risk 

could engage in hedging that risk in 

advance of actual exposure.1296

A number of commenters argued that 

anticipatory hedging is a necessary and 

prudent activity and that the final rule 

should permit anticipatory hedging 

more broadly than did the proposed 

rule.1297 In particular, commenters were 

concerned that permitting hedging 

activity only if it occurs ‘‘slightly’’ 

before a risk is taken could limit 

hedging activities that are crucial to risk 

management.1298 Commenters 

expressed concern that the proposed 

approach would, among other things, 

make it difficult for banking entities to 

accommodate customer requests for 

transactions with specific price or size 

executions 1299 and limit dynamic 

hedging activities that are important to 

sound risk management.1300 In addition, 

a number of commenters requested that 

the rule permit banking entities to 

engage in scenario hedging, a form of 

anticipatory hedging that addresses 

potential exposures to ‘‘tail risks.’’ 1301

Some commenters expressed concern 

about the proposed criterion that the 

hedging activity not involve the 

potential for speculative profit.1302

These commenters argued that the 

proper focus of the hedging exemption 

should be on the purpose of the 

transaction, and whether the hedge is 

correlated to the underlying risks being 

hedged (in other words, whether the 

hedge is effective in mitigating risk).1303

By contrast, another commenter urged 

the Agencies to adopt a specific metric 

to track realized profits on hedging 

activities as an indicator of prohibited 

arbitrage trading.1304

Like the proposal, the final rule does 

not prohibit anticipatory hedging. 

However, in response to commenter 

concerns that the proposal would limit 

a banking entity’s ability to respond to 

customer requests and engage in 

prudent risk management, the final rule 

does not retain the proposed 

requirement discussed above that an 

anticipatory hedge be established 

‘‘slightly’’ before the banking entity 

becomes exposed to the underlying risk 

and meet certain conditions. To address 

commenter concerns with the statutory 

mandate, several parts of the final rule 

are designed to ensure that all hedging 

activities, including anticipatory 

hedging activities, are designed to be 

risk reducing and not impermissible 

proprietary trading activities. For 

example, the final rule retains the 

proposed requirement that a banking 

entity have reasonably designed policies 

and procedures indicating the positions, 

techniques and strategies that each 

trading desk may use for hedging. These 

policies and procedures should 

specifically address when anticipatory 

hedging is appropriate and what 

policies and procedures apply to 

anticipatory hedging. 

The final rule also requires that a 

banking entity relying on the hedging 

exemption be able to demonstrate that 

the hedging activity is designed to 

reduce or significantly mitigate, and 

does demonstrably reduce or otherwise 

significantly mitigate, specific, 

identifiable risks in connection with 

individual or aggregated positions of the 

banking entity.1305 Importantly, to use 

the hedging exemption, the final rule 

requires that the banking entity subject 

its hedging activity to continuing 

review, monitoring, and management 

that is designed to reduce or 

significantly mitigate specific, 

identifiable risks, and that demonstrably 

reduces or otherwise significantly 

mitigates identifiable risks, in 

connection with individual or 

aggregated positions of the banking 

entity.1306 The final rule also requires 

ongoing recalibration of the hedging 

activity by the banking entity to ensure 

that the hedging activity satisfies the 

requirements set out in § 75.5(b)(2) and 

is not prohibited proprietary trading. If 

an anticipated risk does not materialize 

within a limited time period 

contemplated when the hedge is entered 

into, under these provisions, the 

banking entity would be required to 

extinguish the anticipatory hedge or 

otherwise demonstrably reduce the risk 

associated with that position as soon as 

reasonably practicable after it is 

determined that the anticipated risk will 

not materialize. This requirement 

focuses on the purpose of the hedge as 

a trade designed to reduce anticipated 

risk and not for other purposes. The 

Agencies will (and expect that banking 

entities also will) monitor the activities 

of banking entities to identify prohibited 

trading activity that is disguised as 

anticipatory hedging. 

As noted above, one commenter 

suggested the Agencies adopt a metric to 

monitor the profitability of a banking 

entity’s hedging activity.1307 We are not 

adopting such a metric because we do 

not believe it would be useful to 

monitor the profit and loss associated 

with hedging activity in isolation 

without considering the profit and loss 

associated with the individual or 

aggregated positions being hedged. For 

example, the commenter’s suggested 

metric would not appear to provide 

information about whether the gains 

arising from hedging positions offset or 

mitigate losses from individual or 

aggregated positions being hedged. 

3. Compensation 

The proposed rule required that the 

compensation arrangements of persons 

performing risk-mitigating hedging 

activities be designed not to reward 

proprietary risk-taking.1308 In the 

proposal, the Agencies stated that 

hedging activities for which a banking 

entity has established a compensation 

incentive structure that rewards 

speculation in, and appreciation of, the 

market value of a covered financial 

position, rather than success in reducing 


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1309See Joint Proposal, 76 FR at 68868. 

1310See, e.g., AFR et al. (Feb. 2012); Sens. 

Merkley & Levin (Feb. 2012); Public Citizen. 

1311See AFR et al. (Feb. 2012); AFR (June 2013). 

1312See Morgan Stanley. 

1313One commenter stated that the compensation 

requirement should restrict only compensation 

arrangements that incentivize employees to engage 

in prohibited proprietary risk-taking, rather than 

apply to hedging activities. See Morgan Stanley. 

1314Thus, the Agencies agree with one 

commenter who stated that compensation for 

hedging should not be based purely on profits 

derived from hedging. However, the final rule does 

not require compensation vesting, as suggested by 

this commenter, because the Agencies believe the 

final hedging exemption includes sufficient 

requirements to ensure that only risk-mitigating 

hedging is permitted under the exemption without 

a compensation vesting provision. See AFR et al. 

(Feb. 2012); AFR (June 2013). 

1315See 12 U.S.C. 5641. 

1316For example, as explained under the 

proposal, a hedge would be established at a 

different level of organization of the banking entity 

if multiple market-making desks were exposed to 

similar risks and, to hedge such risks, a hedge was 

established at the direction of a supervisor or risk 

manager responsible for more than one desk rather 

than at each of the market-making desks that 

established the initial positions, contracts, or other 

holdings. See Joint Proposal, 76 FR at 68876 n.161. 

1317See AFR (June 2013); Occupy. 

1318See Occupy. 

1319See Sens. Merkley & Levin (Feb. 2012); 

Occupy; AFR (June 2013). 

1320See SIFMA et al. (Prop. Trading) (Feb. 2012); 

JPMC; Barclays; see also Japanese Bankers Ass’n. 

1321See JPMC; SIFMA et al. (Prop. Trading) (Feb. 

2012). 

1322See JPMC; Barclays. 

1323See Barclays; JPMC; SIFMA et al. (Prop. 

Trading) (Feb. 2012); see also Japanese Bankers 

Ass’n. 

1324See JPMC. 

risk, are inconsistent with permitted 

risk-mitigating hedging activities.1309

Commenters generally supported this 

requirement and indicated that its 

inclusion was very important and 

valuable.1310 Some commenters argued 

that the final rule should limit 

compensation based on profits derived 

from hedging transactions, even if those 

hedging transactions were in fact riskmitigating hedges, and urged that 

employees be compensated instead 

based on success in risk mitigation at 

the end of the life of the hedge.1311 In 

contrast, other commenters argued that 

the compensation requirement should 

restrict only compensation 

arrangements that incentivize 

employees to engage in prohibited 

proprietary risk-taking.1312

After considering comments received 

on the compensation requirements of 

the proposed hedging exemption, the 

final rule substantially retains the 

proposed requirement that the 

compensation arrangements of persons 

performing risk-mitigating hedging 

activities be designed not to reward 

prohibited proprietary trading. The final 

rule is also modified to make clear that 

rewarding or incentivizing profit 

making from prohibited proprietary 

trading is not permitted.1313

The Agencies recognize that 

compensation, especially incentive 

compensation, may be both an 

important motivator for employees as 

well as a useful indicator of the type of 

activity that an employee or trading 

desk is engaged in. For instance, an 

incentive compensation plan that 

rewards an employee engaged in 

activities under the hedging exemption 

based primarily on whether that 

employee’s positions appreciate in 

value instead of whether such positions 

reduce or mitigate risk would appear to 

be designed to reward prohibited 

proprietary trading rather than riskreducing hedging activities.1314

Similarly, a compensation arrangement 

that is designed to incentivize an 

employee to exceed the potential losses 

associated with the risks of the 

underlying position rather than reduce 

risks of underlying positions would 

appear to reward prohibited proprietary 

trading rather than risk-mitigating 

hedging activities. The banking entity 

should review its compensation 

arrangements in light of the guidance 

and rules imposed by the appropriate 

Federal supervisor for the entity 

regarding compensation.1315

4. Documentation Requirement 

Section 75.5(c) of the proposed rule 

would have imposed a documentation 

requirement on certain types of hedging 

transactions. Specifically, for any 

transaction that a banking entity 

conducts in reliance on the hedging 

exemption that involved a hedge 

established at a level of organization 

different than the level of organization 

establishing or responsible for the 

positions, contracts, or other holdings 

the risks of which the hedging 

transaction is designed to reduce, the 

banking entity was required, at a 

minimum, to document: The riskmitigating purpose of the transaction; 

the risks of the individual or aggregated 

positions, contracts, or other holdings of 

a banking entity that the transaction is 

designed to reduce; and the level of 

organization that is establishing the 

hedge.1316 Such documentation was 

required to be established at the time 

the hedging transaction is effected. The 

Agencies expressed concern in the 

proposal that hedging transactions 

established at a different level of 

organization than the positions being 

hedged may present or reflect 

heightened potential for prohibited 

proprietary trading, either at the trading 

desk level or at the level instituting the 

hedging transaction. In other words, the 

further removed hedging activities are 

from the specific positions, contracts, or 

other holdings the banking entity 

intends to hedge, the greater the danger 

that such activity is not limited to 

hedging specific risks of individual or 

aggregated positions, contracts, or other 

holdings of the banking entity, as 

required by the rule. 

Some commenters argued that the 

final rule should require comprehensive 

documentation for all activity 

conducted pursuant to the hedging 

exemption, regardless of where it occurs 

in an organization.1317 One of these 

commenters stated that such 

documentation can be easily and 

quickly produced by traders and noted 

that traders already record execution 

details of every trade.1318 Several 

commenters argued that the rule should 

impose a requirement that banks label 

all hedges at their inception and provide 

information regarding the specific risk 

being offset, the expected duration of 

the hedge, how it will be monitored, 

how it will be wound down, and the 

names of the trader, manager, and 

supervisor approving the hedge.1319

Some commenters requested that the 

documentation requirement be applied 

at a higher level of organization,1320 and 

some commenters noted that policies 

and procedures alone would be 

sufficient to address hedging activity, 

wherever conducted within the 

organization.1321 Two commenters 

indicated that making the 

documentation requirement narrower is 

necessary to avoid impacts or delays in 

daily trading operations that could lead 

to a banking entity being exposed to 

greater risks.1322 A number of 

commenters stated that any enhanced 

documentation requirement would be 

burdensome and costly, and would 

impede rapid and effective risk 

mitigation, whether done at a trading 

desk or elsewhere in the banking 

entity.1323

At least one commenter also argued 

that a banking entity should be 

permitted to consolidate some or all of 

its hedging activity into a trading desk 

that is not responsible for the 

underlying positions without triggering 

a requirement that all hedges 

undertaken by a trading desk be 

documented solely because the hedges 

are not undertaken by the trading desk 

that originated the underlying 

position.1324

The final rule substantially retains the 

proposed requirement for enhanced 

documentation for hedging activity 


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1325One commenter suggested that the rule 

require documentation when a banking entity needs 

to engage in new types of hedging transactions that 

are not covered by its hedging policies, although 

this commenter’s suggested approach would only 

apply when a hedge is conducted two levels above 

the level at which the risk arose. See SIFMA et al. 

(Prop. Trading) (Feb. 2012). The Agencies agree that 

documentation is needed when a trading desk is 

acting outside of its hedging policies and 

procedures. However, the final rule does not limit 

this documentation requirement to circumstances 

when the hedge is conducted two organizational 

levels above the trading desk. Such an approach 

would be less effective than the adopted approach 

at addressing evasion concerns. 

1326See final rule § 75.5(c)(3). 

1327See proposed rule § 75.6. 

1328See 12 U.S.C. 1851(d)(1)(A), (C), (F), and (H). 

1329 12 U.S.C. 1851(d)(1)(A). 

1330The Agencies proposed that United States 

‘‘agencies’’ for this purpose would include those 

agencies described in section 201.108(b) of the 

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

Agencies also noted that the terms of the exemption 

would encompass the purchase or sale of 

enumerated government obligations on a forward 

basis (e.g., in a to-be-announced market). In 

addition, this would include pass-through or 

participation certificates that are issued and 

guaranteed by a government-sponsored entity (e.g., 

the Federal National Mortgage Association and the 

Federal Home Loan Mortgage Corporation) in 

connection with its securitization activities. 

1331See Joint Proposal, 76 FR at 68878. 

1332See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); Sens. Merkley & Levin (Feb. 2012). 

1333See BoA; CalPERS; Credit Suisse (Seidel); 

CME Group; Fixed Income Forum/Credit 

Roundtable; FIA; JPMC; Morgan Stanley; PNC; 

SIFMA et al. (Prop. Trading) (Feb. 2012); Wells 

Fargo (Prop. Trading). 

conducted under the hedging exemption 

if the hedging is not conducted by the 

specific trading desk establishing or 

responsible for the underlying positions, 

contracts, or other holdings, the risks of 

which the hedging activity is designed 

to reduce. The final rule clarifies that a 

banking entity must prepare enhanced 

documentation if a trading desk 

establishes a hedging position and is not 

the trading desk that established the 

underlying positions, contracts, or other 

holdings. The final rule also requires 

enhanced documentation for hedges 

established to hedge aggregated 

positions across two or more desks. This 

change in the final rule clarifies that the 

level of the organization at which the 

trading desk exists is important for 

determining whether the trading desk 

established or is responsible for the 

underlying positions, contracts, or other 

holdings. The final rule recognizes that 

a trading desk may be responsible for 

hedging aggregated positions of that 

desk and other desks, business units, or 

affiliates. In that case, the trading desk 

putting on the hedge is at least one step 

removed from some of the positions 

being hedged. Accordingly, the final 

rule provides that the documentation 

requirements in § 75.5 apply if a trading 

desk is hedging aggregated positions 

that include positions from more than 

one trading desk. 

The final rule adds to the proposal by 

requiring enhanced documentation for 

hedges established by the specific 

trading desk establishing or directly 

responsible for the underlying positions, 

contracts, or other holdings, the risks of 

which the purchases or sales are 

designed to reduce, if the hedge is 

effected through a financial instrument, 

technique, or strategy that is not 

specifically identified in the trading 

desk’s written policies and procedures 

as a product, instrument, exposure, 

technique, or strategy that the trading 

desk may use for hedging.1325 The 

Agencies note that this documentation 

requirement does not apply to hedging 

activity conducted by a trading desk in 

connection with the market makingrelated activities of that desk or by a 

trading desk that conducts hedging 

activities related to the other 

permissible trading activities of that 

desk so long as the hedging activity is 

conducted in accordance with the 

compliance program for that trading 

desk. 

The Agencies continue to believe that, 

for the reasons stated in the proposal, it 

is appropriate to retain documentation 

of hedging transactions conducted by 

those other than the traders responsible 

for the underlying position in order to 

permit evaluation of the activity. In 

order to reduce the burden of the 

documentation requirement while still 

giving effect to the rule’s purpose, the 

final rule requires limited 

documentation for hedging activity that 

is subject to a documentation 

requirement, consisting of: (1) The 

specific, identifiable risk(s) of the 

identified positions, contracts, or other 

holdings that the purchase or sale is 

designed to reduce; (2) the specific riskmitigating strategy that the purchase or 

sale is designed to fulfill; and (3) the 

trading desk or other business unit that 

is establishing and responsible for the 

hedge transaction. As in the proposal, 

this documentation must be established 

contemporaneously with the hedging 

transaction. Documentation would be 

contemporaneous if it is completed 

reasonably promptly after a trade is 

executed. The banking entity is required 

to retain records for no less than 5 years 

(or such longer period as may be 

required under other law) in a form that 

allows the banking entity to promptly 

produce such records to the Agency on 

request.1326 While the Agencies 

recognize this documentation 

requirement may result in certain costs, 

the Agencies believe this requirement is 

necessary to prevent evasion of the 

statute and final rule. 

5. Section 75.6(a)–(b): Permitted Trading 

in Certain Government and Municipal 

Obligations 

Section 75.6 of the proposed rule 

permitted a banking entity to engage in 

trading activities that were authorized 

by section 13(d)(1) of the BHC Act,1327

including trading in certain government 

obligations, trading on behalf of 

customers, trading by insurance 

companies, and trading outside of the 

United States by certain foreign banking 

entities.1328 Section 75.6 of the final 

rule generally incorporates these same 

statutory exemptions. However, the 

final rule has been modified in some 

ways in response to comments received 

on the proposal. 

a. Permitted Trading in U.S. 

Government Obligations 

Section 13(d)(1)(A) permits trading in 

various U.S. government, U.S. agency 

and municipal securities.1329 Section 

75.6(a) of the proposed rule, which 

implemented section 13(d)(1)(A) of the 

BHC Act, permitted the purchase or sale 

of a financial instrument that is an 

obligation of the United States or any 

agency thereof or an obligation, 

participation, or other instrument of or 

issued by the Government National 

Mortgage Association, the Federal 

National Mortgage Association, the 

Federal Home Loan Mortgage 

Corporation, a Federal Home Loan 

Bank, the Federal Agricultural Mortgage 

Corporation or a Farm Credit System 

institution chartered under and subject 

to the provisions of the Farm Credit Act 

of 1971 (12 U.S.C. 2001 et seq.).1330 The 

proposal did not contain an exemption 

for trading in derivatives referencing 

exempt U.S. government and agency 

securities, but requested comment on 

whether the final rule should contain an 

exemption for proprietary trading in 

options or other derivatives referencing 

an exempt government obligation.1331

Commenters were generally 

supportive of the manner in which the 

proposal implemented the exemption 

for permitted trading in U.S. 

government and U.S. agency 

obligations.1332 Many commenters 

argued that the exemption for 

permissible proprietary trading in 

government obligations should be 

expanded, however, to include trading 

in derivatives on government 

obligations.1333 These commenters 

asserted that failure to provide an 

exemption would adversely impact 

liquidity in the underlying government 

obligations themselves and increase 


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1334See BoA; FIA; HSBC; JPMC; Morgan Stanley; 

Wells Fargo (Prop. Trading). 

1335See Barclays; Credit Suisse (Seidel); Fixed 

Income Forum/Credit Roundtable; FIA. 

1336See Barclays; CME Group; Fixed Income 

Forum/Credit Roundtable; see also UBS. 

1337See CME Group; see also Morgan Stanley; 

PNC; SIFMA et al. (Prop. Trading) (Feb. 2012); 

Wells Fargo (Prop. Trading). 

1338See Barclays; CME Group; JPMC. 

1339See Occupy; Alfred Brock. 1340See supra note 1335. 1341See infra Part VI.A.3.c.2.c.i. 

borrowing costs to governments.1334

Several commenters asserted that U.S. 

government and agency obligations and 

derivatives on those instruments are 

substitutes and pose the same 

investment risks and opportunities.1335

According to some commenters, the 

significant connections between these 

markets and the interchangeable nature 

of these instruments significantly 

contribute to price discovery, in 

particular, in the cash market for U.S. 

Treasury obligations.1336 Commenters 

also argued that trading in Treasury 

futures and options improves liquidity 

in Treasury securities markets by 

providing an outlet to relieve any 

supply and demand imbalances in spot 

obligations. Many commenters argued 

that the authority to engage in trading in 

derivatives on U.S. government, agency, 

and municipal obligations is inherent in 

the statutory exceptions granted by 

section 13(d)(1)(A) to trade in the 

underlying obligation.1337 To the extent 

there is any doubt about the scope of 

those exemptions, commenters urged 

the Agencies to use the exemptive 

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

necessary to permit proprietary trading 

in derivatives on government 

obligations.1338 Two commenters 

opposed providing an exemption for 

proprietary trading in derivatives on 

exempt government obligations.1339

The final rule has not been modified 

to permit a banking entity to engage in 

proprietary trading of derivatives on 

U.S. government and agency 

obligations. 

The Agencies note that the cash 

market for exempt government 

obligations is already one of the most 

liquid markets in the world, and the 

final rule will permit banking entities to 

participate fully in these cash markets. 

In addition, the final rule permits 

banking entities to make a market in 

U.S. government securities and in 

derivatives on those securities. 

Moreover, the final rule allows banking 

entities to continue to use U.S. 

government obligations and derivatives 

on those obligations in risk-mitigating 

hedging activities permitted by the rule. 

Further, proprietary trading in 

derivatives on such obligations will 

continue by entities other than banking 

entities. 

Proprietary trading of derivatives on 

U.S. government obligations is not 

necessary to promote and protect the 

safety and soundness of a banking entity 

or the financial stability of the United 

States. Commenters offered no 

compelling reasons why derivatives on 

exempt government obligations pose 

little or no risk to the financial system 

as compared to derivatives on other 

financial products for which proprietary 

trading is generally prohibited and did 

not indicate how proprietary trading in 

derivatives of U.S. government and 

agency obligations by banking entities 

would promote the safety and 

soundness of those entities or the 

financial stability of the United States. 

For these reasons, the Agencies have not 

determined to provide an exemption for 

proprietary trading in derivatives on 

exempt government obligations. 

The Agencies believe banking entities 

will continue to provide significant 

support and liquidity to the U.S. 

government and agency security 

markets through permitted trading in 

the cash exempt government obligations 

markets, making markets in government 

obligation derivatives and through 

derivatives trading for hedging 

purposes. The final rule adopts the same 

approach as the proposed rule for the 

exemption for permitted trading in U.S. 

government and U.S. agency 

obligations. In response to commenters, 

the Agencies are clarifying how banking 

entities would be permitted to use 

Treasury derivatives on Treasury 

securities when relying on the 

exemptions for market-making related 

activities and risk-mitigating hedging 

activities. The Agencies agree with 

commenters that some Treasury 

derivatives are close economic 

substitutes for Treasury securities and 

provide many of the same economic 

exposures.1340 The Agencies also 

understand that the markets for 

Treasury securities and Treasury futures 

are fully integrated, and that trading in 

these derivative instruments is essential 

to ensuring the continued smooth 

functioning of market-making related 

activities in Treasury securities. 

Treasury derivatives are frequently used 

by market makers to hedge their marketmaking related positions across many 

different types of fixed-income 

securities. Under the final rule, market 

makers will generally be able to 

continue their practice of using 

Treasury futures to hedge their activities 

as block positioners off exchanges. 

Additionally, when engaging in 

permitted market-making related or riskmitigating hedging activities in 

accordance with the requirements in 

§§ 75.4(b) or 75.(5), the final rule 

permits banking entities to acquire a 

short or long position in Treasury 

futures through manual trading or 

automated processes. For example, a 

banking entity would be permitted to 

use Treasury futures to hedge the 

duration risk (i.e., the measure of a 

bond’s price sensitivity to interest rates 

movements) associated with the banking 

entity’s market-making in Treasury 

securities or other fixed-income 

products, provided that the banking 

entity complies with the market-making 

requirements in § 75.4(b). In their 

market making, banking entities also 

frequently trade Treasury futures (and 

acquire a corresponding long or short 

position) in reasonable anticipation of 

the near-term demands of their clients, 

customers, and counterparties. For 

example, banking entities may acquire a 

long or short position in Treasury 

futures to hedge anticipated market risk 

when they reasonably expect clients, 

customers, or counterparties will seek to 

establish long or short positions in onor off-the-run Treasury securities. 

Similarly, banking entities could 

acquire a long or short position in the 

‘‘Treasury basis’’ to hedge the 

anticipated basis risk associated with 

making markets for clients, customers, 

or counterparties that are reasonably 

expected to engage in basis trading of 

the price spread between Treasury 

futures and Treasury securities. A 

banking entity can also use Treasury 

futures (or other derivatives on exempt 

government obligations) to hedge other 

risks such as the aggregated interest rate 

risk for specifically identified loans as 

well as other financial instruments such 

as asset-backed securities, corporate 

bonds, and interest rate swaps. 

Therefore, depending on the relevant 

facts and circumstances, banking 

entities would be permitted to acquire a 

very large long or short position in 

Treasury derivatives provided that they 

comply with the requirements in 

§§ 75.4(b) or 75.(5). The Agencies also 

understand that banking entities that 

have been designated as ‘‘primary 

dealers’’ by the Federal Reserve Bank of 

New York are required to underwrite 

issuances of Treasury securities. This 

necessitates the banking entities to 

frequently establish very large short 

positions in Treasury futures to order to 

hedge the duration risk associated with 

potentially owning a large volume of 

Treasury securities. As described 

below,1341 the Agencies note that, with 


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1342See supra note 910 (explaining the functions 

of primary dealers). 

1343See supra Part VI.A.3.c.2.b.ix. (discussing 

commenters’ concerns regarding primary dealer 

activity, as well as one commenter’s request for 

such an interpretation). 

1344See final rule § 75.6(a)(4). 

1345See Joint Proposal, 76 FR at 68878. 

1346See, e.g., Allen & Overy (Gov’t Obligations); 

Allen & Overy (Canadian Banks); BoA; Australian 

Bankers Ass’n. (Feb. 2012); AFMA; Banco de 

Me ́xico; Bank of Canada; Ass’n of German Banks; 

BAROC; Barclays; BEC (citing the National Institute 

of Banking and Finance); British Bankers’ Ass’n.; 

BaFin/Deutsche Bundesbank; Chamber (Feb. 2012); 

Mexican Banking Comm’n.; French Treasury et al.; 

EFAMA; ECOFIN; EBF; French Banking Fed’n.; 

FSA (Apr. 2012); FIA; Goldman (Prop. Trading); 

HSBC; Hong Kong Inv. Funds Association; IIB/EBF; 

ICFR; ICSA; IRSG; Japanese Bankers Ass’n.; Ass’n. 

of Banks in Malaysia; OSFI; British Columbia; 

Que ́bec; Sumitomo Trust; TMA Hong Kong; UBS; 

Union Asset. 

1347See, e.g., Allen & Overy (Gov’t Obligations); 

Bank of Canada; British Columbia; Ontario; IIAC; 

Quebec; IRSG; IIB/EBF; Mitsubishi; Gov’t of Japan/ 

Bank of Japan; Australian Bankers Ass’n (Feb. 

2012); AFMA; Banco de Me ́xico; Ass’n. of German 

Banks; ALFI; Embassy of Switzerland. 

1348See Ass’n. of German Banks; Goldman (Prop. 

Trading); IIB/EBF; ICFR; FIA; Mitsubishi; 

Sumitomo Trust; Allen & Overy (Gov’t Obligations). 

1349See Allen & Overy (Gov’t. Obligations); Banco 

de Me ́xico; Barclays; BaFIN/Deutsche Bundesbank; 

EFAMA; Union Asset; TMA Hong Kong; ICI (Feb. 

2012) (arguing that such an exemption would be 

consistent with Congressional intent to limit the 

extra-territorial application of U.S. law). 

1350See Banco de Me ́xico; Barclays; BoA; Gov’t of 

Japan/Bank of Japan; IIAC; OSFI. 

1351See, e.g., Allen & Overy (Gov’t. Obligations); 

AFMA; Banco de Me ́xico; Ass’n. of German Banks; 

Barclays; Mexican Banking Comm’n.; EFAMA; EBF; 

French Banking Fed’n.; Goldman (Prop. Trading); 

HSBC; IIB/EBF; HSBC; ICSA; T. Rowe Price; UBS; 

Union Asset; IRSG; EBF; Mitsubishi (citing Japanese 

Bankers Ass’n. and IIB); Wells Fargo (Prop. 

Trading); ICI Global. 

1352See Allen & Overy (Gov’t. Obligations) 

(contending that ‘‘even if not primary dealers, 

banking entities or their branches or agencies acting 

in certain foreign jurisdictions, such as Singapore 

and India, are still required to hold or transact in 

local sovereign debt under local law’’); BoA; 

Barclays; Citigroup; SIFMA et al. (Prop. Trading) 

(Feb. 2012). 

1353See Allen & Overy (Gov’t. Obligations); 

Australian Bankers Ass’n. (Feb. 2012); BoA; Banco 

de Me ́xico; Barclays; Citigroup; Goldman (Prop. 

Trading); IIB/EBF; see also JPMC (suggesting that, 

at a minimum, the Agencies should make clear that 

all of a firm’s activities that are necessary or 

reasonably incidental to its acting as a primary 

dealer in a foreign government’s debt securities are 

protected by the market-making-related permitted 

activity); SIFMA et al. (Prop. Trading) (Feb. 2012). 

As discussed in Parts VI.A.2.c.2.c. and 

VI.A.2.c.2.b.ix of this SUPPLEMENTARY INFORMATION, 

the Agencies believe primary dealing activities 

would generally qualify under the scope of the 

market-making or underwriting exemption. 

respect to a banking entity that acts as 

a primary dealer for Treasury securities, 

the U.S. government will be considered 

a client, customer, or counterparty of 

the banking entity for purposes of the 

market-making exemption.1342 We 

believe this interpretation appropriately 

captures the unique relationship 

between a primary dealer and the 

government. Moreover, this 

interpretation clarifies that a banking 

entity may rely on the market-making 

exemption for its activities as primary 

dealer to the extent those activities are 

outside the scope of the underwriting 

exemption.1343

The final rule also includes an 

exemption for obligations of or 

guaranteed by the United States or an 

agency of the United States. An 

obligation guaranteed by the U.S. or an 

agency of the U.S. is, in effect, an 

obligation of the U.S. or that agency. 

The final rule also includes an 

exemption for an obligation of the FDIC, 

or any entity formed by or on behalf of 

the FDIC for the purpose of facilitating 

the disposal of assets acquired or held 

by the FDIC in its corporate capacity or 

as conservator or receiver under the 

Federal Deposit Insurance Act (‘‘FDI 

Act’’) or Title II of the Dodd-Frank 

Act.1344 These FDIC receivership and 

conservatorship operations are 

authorized under the FDI Act and Title 

II of the Dodd-Frank Act and are 

designed to lower the FDIC’s resolution 

costs. The Agencies believe that an 

exemption for these types of obligations 

would promote and protect the safety 

and soundness of banking entities and 

the financial stability of the United 

States because they facilitate the FDIC’s 

ability to conduct receivership and 

conservatorship operations in an orderly 

manner, thereby limiting risks to the 

financial system generally that might 

otherwise occur if the FDIC was 

restricted in its ability to conduct these 

operations. 

b. Permitted Trading in Foreign 

Government Obligations 

The proposed rule did not contain an 

exemption for trading in obligations of 

foreign sovereign entities. As part of the 

proposal, however, the Agencies 

specifically requested comment on 

whether proprietary trading in the 

obligations of foreign governments 

would promote and protect the safety 

and soundness of banking entities and 

the financial stability of the United 

States under section 13(d)(1)(J) of the 

BHC Act.1345

The treatment of proprietary trading 

in foreign sovereign obligations 

prompted a significant number of 

comments. Many commenters, 

including foreign governments, foreign 

and domestic banking entities, and 

various trade groups, argued that the 

final rule should permit trading in 

foreign sovereign debt, including 

obligations issued by political 

subdivisions of foreign governments.1346

Representatives from foreign 

governments such as Canada, Germany, 

Luxembourg, Japan, Australia, and 

Mexico specifically requested an 

exemption for trading in obligations of 

their governments and argued that an 

exemption was necessary and 

appropriate to maintain and promote 

financial stability in their markets.1347

Some commenters also requested an 

exemption for trading in obligations of 

multinational central banks, such as 

Eurobonds issued or guaranteed by the 

European Central Bank.1348

Many commenters argued that the 

same rationale for the statutory 

exemption for proprietary trading in 

U.S. government obligations supported 

exempting proprietary trading in foreign 

sovereign debt and related 

obligations.1349 Commenters contended 

that lack of an express exemption for 

trading in foreign sovereign obligations 

could critically impact the functioning 

of money market operations of foreign 

central banks and limit the ability of 

foreign sovereign governments to 

conduct monetary policy or finance 

their operations.1350 These commenters 

also contended that an exemption for 

proprietary trading in foreign sovereign 

debt would promote and protect the 

safety and soundness and the financial 

stability of the United States by 

avoiding the possible negative effects of 

a contraction of government bond 

market liquidity.1351

Commenters also contended that in 

some foreign markets, local regulations 

or market practice require U.S. banking 

entities operating in those jurisdictions 

to hold, trade or support government 

issuance of local sovereign securities. 

They also indicated that these 

instruments are traded in the United 

States or on U.S. markets.1352 In 

addition, a number of commenters 

contended that U.S. and foreign banking 

entities often perform functions for 

foreign governments similar to those 

provided in the United States by U.S. 

primary dealers and alleged that 

restricting these trading activities would 

have a significant negative impact on 

the ability of foreign governments to 

implement their monetary policy and on 

liquidity for such securities in many 

foreign markets.1353 A few commenters 

further argued that banking entities use 

foreign sovereign debt, particularly debt 

of their home country and of the 

country in which they are operating, to 

manage their risk by posting sovereign 

securities as collateral in foreign 

jurisdictions, to manage international 

rate and foreign exchange risk 

(particularly in local operations), and 

for liquidity and asset-liability 

management purposes in different 


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1354See Citigroup; SIFMA et al. (Prop. Trading) 

(Feb. 2012). 

1355See Allen & Overy (Gov’t. Obligations); BoA. 

1356See Barclays; IIAC; UBS; Ass’n. of Banks in 

Malaysia; IIB/EBF. 

1357See Comm. on Capital Markets Regulation. 

1358See Allen & Overy (Gov’t. Obligations); Banco 

de Me ́xico; IIB/EBF; Ass’n. of Banks in Malaysia. 

1359See Sumitomo Trust; SIFMA et al. (Prop. 

Trading) (Feb. 2012); Allen & Overy (Govt. 

Obligations); BoA; ICI Global; RBC; ICFR; ICI (Feb. 

2012); Bank of Canada; Cadwalader (on behalf of 

Singapore Banks); Ass’n. of Banks in Malaysia; 

Cadwalader (on behalf of Thai Banks); Chamber 

(Feb. 2012); BAROC. See also IIB/EBF. 

1360See Sens. Merkley & Levin (Feb. 2012). 

1361See Cadwalader (on behalf of Thai Banks); 

IIB/EBF; Ass’n. of Banks in Malaysia; UBS; see also 

BAROC. 

1362See BoA; Cadwalader (on behalf of Singapore 

Banks); IIB/EBF; Norinchukin; OSFI; Cadwalader 

(on behalf of Thai Banks); Ass’n. of Banks in 

Malaysia; UBS; see also BAROC; ICFR; Japanese 

Bankers Ass’n.; JPMC; Que ́bec. 

1363See, e.g., Allen & Overy (Gov’t Obligations). 

1364See Allen & Overy (Gov’t. Obligations); 

HSBC. 

1365See Better Markets (Feb. 2012); Occupy; Prof. 

Johnson; Sens. Merkley & Levin (Feb. 2012). 

1366See Prof. Johnson; Better Markets (Feb. 2012). 

1367See Better Markets (Feb. 2012); see also Prof. 

Johnson. 

1368See final rule § 75.6(e). 

1369See Joint Proposal, 76 FR at 68862. 

1370See final rule § 75.3(d)(3). 

countries.1354 Similarly, commenters 

expressed concern that the lack of an 

exemption for trading in foreign 

government obligations could adversely 

interact with other banking regulations, 

such as liquidity requirements under 

the Basel III capital rules that encourage 

financial institutions to hold large 

concentrations of sovereign bonds to 

match foreign currency denominated 

obligations.1355 Commenters also 

expressed particular concern that the 

limitations and obligations of section 13 

of the BHC Act would likely be 

problematic and unduly burdensome if 

banking entities were able to trade in 

foreign sovereign obligations only under 

the market making or other proposed 

exemptions from the proprietary trading 

prohibition.1356 One commenter 

expressed the view that lack of an 

exemption for proprietary trading in 

foreign government obligations together 

with the proposed exemption for trading 

that occurs solely outside the U.S. may 

cause foreign banks to close their U.S. 

branches to avoid being subject to 

section 13 of the BHC Act and any final 

rule thereunder.1357

According to some commenters, 

providing an exemption only for 

proprietary trading in U.S. government 

obligations, without a similar exemption 

for foreign government obligations, 

would be discriminatory and 

inconsistent with longstanding 

principles of national treatment and 

with U.S. treaty obligations, such as 

obligations under the World Trade 

Organization framework or bilateral 

trade agreements.1358 In addition, 

several commenters argued that not 

exempting proprietary trading of foreign 

sovereign debt may encourage foreign 

regulators to enact similar regulations to 

the detriment of U.S. financial 

institutions operating abroad.1359

However, another commenter disagreed 

that the failure to exempt trading in 

foreign government obligations would 

violate trade agreements or that the 

proposal discriminated in any way 

against foreign banking entities’ ability 

to compete with U.S. banking entities in 

the U.S.1360

Based on these concerns, some 

commenters suggested that the Agencies 

exempt proprietary trading by foreign 

banking entities in obligations of their 

home or host country.1361 Other 

commenters suggested allowing trading 

in foreign government obligations that 

meet some condition on quality (e.g., 

OECD-member country obligations, 

government bonds eligible as collateral 

for Federal Reserve advances, sovereign 

bonds issued by G–20 countries, or 

other highly liquid or rated 

instruments).1362 One commenter 

indicated that in their view, provided 

appropriate risk-management 

procedures are followed, investing in 

non-U.S. government securities is as 

low risk as investing in U.S. government 

securities despite current price volatility 

in certain types of sovereign debt.1363

Some commenters also suggested the 

final rule give deference to home 

country regulation and permit foreign 

banking entities to engage in proprietary 

trading in any government obligation to 

the extent that such trading is permitted 

by the entity’s primary regulator.1364

By contrast, other commenters argued 

that proprietary trading in foreign 

sovereign obligations represents a risky 

activity and that there is no effective 

way to draw the line between safe and 

unsafe foreign debt.1365 Two of these 

commenters pointed to several publicly 

reported instances where proprietary 

trading in foreign sovereign obligations 

resulted in significant losses to certain 

firms. These commenters argued that 

restricting proprietary trading in foreign 

sovereign debt would not cause reduced 

liquidity in government bond markets 

since banking entities would still be 

permitted to make a market in and 

underwrite foreign government 

obligations.1366 A few commenters 

suggested that, if the final rule 

exempted proprietary trading in foreign 

sovereign debt, foreign governments 

should commit to pay for any damage to 

the U.S. financial system related to 

proprietary trading in their obligations 

pursuant to such exemption.1367

The Agencies carefully considered all 

the comments related to proprietary 

trading in foreign sovereign debt in light 

of the language, purpose and standards 

for exempting activity contained in 

section 13 of the BHC Act. Under 

section 13(d)(1)(J), the Agencies may 

grant an exemption from the 

prohibitions of the section for any 

activity that the Agencies determine 

would promote and protect the safety 

and soundness of the banking entity and 

the financial stability of the United 

States. 

The Agencies note as an initial matter 

that section 13 permits banking 

entities—both inside the United States 

and outside the United States—to make 

markets in and to underwrite all types 

of securities, including all types of 

foreign sovereign debt. The final rule 

implements the statutory market-making 

and underwriting exemptions, and thus, 

the key role of banking entities in 

facilitating trading and liquidity in 

foreign government debt through 

market-making and underwriting is 

maintained. This includes underwriting 

and marketmaking as a primary dealer 

in foreign sovereign obligations. 

Banking entities may also hold foreign 

sovereign debt in their long-term 

investment book. In addition, the final 

rule does not prevent foreign banking 

entities from engaging in proprietary 

trading outside of the United States in 

any type of sovereign debt.1368

Moreover, the Agencies continue to 

believe that positions, including 

positions in foreign government 

obligations, acquired or taken for the 

bona fide purpose of liquidity 

management and in accordance with a 

documented liquidity management plan 

that is consistent with the relevant 

Agency’s supervisory requirements, 

guidance and expectations regarding 

liquidity management are not covered 

by the prohibitions in section 13.1369

The final rule continues to incorporate 

this view.1370

The issue raised by commenters, 

therefore, is the extent to which 

proprietary trading in foreign sovereign 

obligations by U.S. banking entities 

anywhere in the world and by foreign 

banking entities in the United States is 

consistent with promoting and 

protecting the safety and soundness of 

the banking entity and the financial 

stability of the United States. Taking 


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1371See final rule § 75.6(b). Some commenters 

requested an exemption for trading in obligations of 

multinational central banks. See Ass’n. of German 

Banks; Goldman (Prop. Trading); IIB/EBF; ICFR; 

FIA; Mitsubishi; Sumitomo Trust; Allen & Overy 

(Gov’t. Obligations). In the case of a foreign banking 

entity that is owned or controlled by a second 

foreign banking entity domiciled in a country other 

than the home country of the first foreign banking 

entity, the final rule would permit the eligible U.S. 

operations of the first foreign banking entity to 

engage in proprietary trading only in the sovereign 

debt of the first foreign banking entity’s home 

country, and would permit the U.S. operations of 

the second foreign banking entity to engage in 

proprietary trading only in the sovereign debt of the 

home country of the second foreign banking entity. 

As noted earlier, other provisions of the final rule 

make clear that the rule does not restrict the 

proprietary trading outside of the United States of 

either foreign banking organization in debt of any 

foreign sovereign. 

1372See Part VI.A.5.c., infra. Many commenters 

requested an exemption for trading in foreign 

sovereign debt, including obligations issued by 

political subdivisions of foreign governments. See, 

e.g., Allen & Overy (Gov’t. Obligations); BoA; 

Australian Bankers Ass’n. (Feb. 2012); Banco de 

Me ́xico; Bank of Canada; Ass’n. of German Banks; 

BAROC; Barclays. 

1373As part of this exemption, for example, the 

U.S. operations of a European bank would be able 

to trade in obligations issued by the European 

Central Bank. Many commenters represented that 

the same rationale for exempting trading in U.S. 

government obligations supports exempting trading 

in foreign sovereign debt. See, e.g., Allen & Overy 

(Gov’t. Obligations); Banco de Me ́xico; Barclays; 

EFAMA; ICI (Feb. 2012). 

1374The Agencies believe this approach 

appropriately balances commenter concerns that 

proprietary trading in foreign sovereign obligations 

represents a risky activity and the interest in 

preserving the ability of U.S. operations of foreign 

banking entities to continue to support the smooth 

functioning of markets in foreign sovereign 

obligations in the same manner as U.S. banking 

entities are permitted to support the smooth 

functioning of markets in U.S. government and 

agency obligations. See Better Markets (Feb. 2012); 

Occupy; Prof. Johnson; Sens. Merkley & Levin (Feb. 

2012). 

1375See final rule § 75.6(c). Many commenters 

requested an exemption for trading in foreign 

sovereign debt, and some commenters suggested 

exempting proprietary trading by foreign banking 

entities in obligations of their home country. See, 

e.g., Allen & Overy (Gov’t. Obligations); BoA; FSA 

(Apr. 2012); Cadwalader (on behalf of Thai Banks); 

IIB/EBF; Ass’n. of Banks in Malaysia; UBS. 

1376Commenters argued that in some foreign 

markets, U.S. banks operating in those jurisdictions 

are required by local regulation or market practice 

to trade in local sovereign securities. See, e.g., Allen 

& Overy (Gov’t. Obligations); AFMA; Ass’n. of 

German Banks; Barclays; EBF; Goldman (Prop. 

Trading); UBS. 

1377Some commenters represented that the 

limitations and obligations of section 13 would be 

problematic and unduly burdensome on banking 

entities because they would only be able to trade 

in foreign sovereign obligations under existing 

exemptions, such as the market-making exemption. 

See Barclays; IIAC; UBS; Ass’n. of Banks in 

Malaysia; IIB/EBF. 

1378See, e.g., BoA; Citigroup; Goldman (Prop. 

Trading); IIB/EBF; Allen & Overy (Gov’t. 

Obligations); Australian Bankers Ass’n. (Feb. 2012).; 

Banco de Me ́xico; Barclays. The Agencies recognize 

some commenters’ representation that restricting 

trading in foreign sovereign debt would not 

necessarily cause reduced liquidity in government 

bond markets because banking entities would still 

be able to make a market in and underwrite foreign 

government obligations. See Prof. Johnson; Better 

Markets (Feb. 2012). 

into account the information provided 

by commenters, the Agencies’ 

understanding of market operations, and 

the purpose and language of section 13, 

the Agencies have determined to grant 

a limited exemption to the prohibition 

on proprietary trading for trading in 

foreign sovereign obligations under 

certain circumstances. 

This exemption, which is contained 

in § 75.6(b) of the final rule, permits the 

U.S. operations of foreign banking 

entities to engage in proprietary trading 

in the United States in the foreign 

sovereign debt of the foreign sovereign 

under whose laws the banking entity— 

or the banking entity that controls it— 

is organized (hereinafter, the ‘‘home 

country’’), and any multinational central 

bank of which the foreign sovereign is 

a member so long as the purchase or 

sale as principal is not made by an 

insured depository institution.1371

Similar to the exemption for proprietary 

trading in U.S. government obligations, 

the permitted trading activity in the U.S. 

by the eligible U.S. operations of a 

foreign banking entity would extend to 

obligations of political subdivisions of 

the foreign banking entity’s home 

country.1372

Permitting the eligible U.S. operations 

of a foreign banking entity to engage in 

proprietary trading in the United States 

in the foreign sovereign obligations of 

the foreign entity’s home country allows 

these U.S. operations of foreign banking 

entities to continue to support the 

smooth functioning of markets in 

foreign sovereign obligations in the 

same manner as U.S. banking entities 

are permitted to support the smooth 

functioning of markets in U.S. 

government and agency obligations.1373

At the same time, the risk of these 

trading activities is largely determined 

by the foreign sovereign that charters 

the foreign bank. By not permitting 

proprietary trading in foreign sovereign 

debt in insured depository institutions 

(other than in accordance with the 

limitations in other exemptions), the 

exemption limits the direct risks of 

these activities to insured depository 

institutions in keeping with the 

statute.1374 Thus, the Agencies have 

determined that this limited exemption 

for proprietary trading in foreign 

sovereign obligations promotes and 

protects the safety and soundness of 

banking entities and also promotes and 

protects the financial stability of the 

United States. 

The Agencies have also determined to 

permit a foreign bank or foreign brokerdealer regulated as a securities dealer 

and controlled by a U.S. banking entity 

to engage in proprietary trading in the 

obligations of the foreign sovereign 

under whose laws the foreign entity is 

organized (hereinafter, the ‘‘home 

country’’), including obligations of an 

agency or political subdivision of that 

foreign sovereign.1375 This limited 

exemption is necessary to allow U.S. 

banking organizations to continue to 

own and acquire foreign banking 

organizations and broker-dealers 

without requiring those foreign banking 

organizations and broker-dealers to 

discontinue proprietary trading in the 

sovereign debt of the foreign banking 

entity’s home country.1376 The Agencies 

have determined that this limited 

exemption will promote the safety and 

soundness of banking entities and the 

financial stability of the United States 

by allowing U.S. banking entities to 

continue to be affiliated with and 

operate foreign banking entities and 

benefit from international 

diversification and participation in 

global financial markets.1377 However, 

the Agencies intend to monitor activity 

of banking entities under this exemption 

to ensure that U.S. banking entities are 

not seeking to evade the restrictions of 

section 13 by using an affiliated foreign 

bank or broker-dealer to engage in 

proprietary trading in foreign sovereign 

debt on behalf of or for the benefit of 

other parts of the U.S. banking entity. 

Apart from this limited exemption, 

the Agencies have not extended this 

exemption to proprietary trading in 

foreign sovereign debt by U.S. banking 

entities for several reasons. First, section 

13 was primarily concerned with the 

risks posed to the U.S. financial system 

by proprietary trading activities. This 

risk is most directly transmitted by U.S. 

banking entities, and while commenters 

alleged that prohibiting U.S. banking 

entities from engaging in proprietary 

trading in debt of foreign sovereigns 

would harm liquidity in those markets, 

the evidence provided by commenters 

did not sufficiently indicate that 

permitting U.S. banking entities to 

engage in proprietary trading (as 

opposed to market-making or 

underwriting) in debt of foreign 

sovereigns contributed in any 

significant degree to the liquidity of 

markets in foreign sovereign 

instruments.1378 Thus, expanding the 

exemption to permit U.S. banking 

entities to engage in proprietary trading 

in debt of foreign sovereigns would 

likely increase the risks to these entities 

and the U.S. financial system without a 

significant concomitant and offsetting 

benefit. As explained above, these U.S. 


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1379Representatives from foreign governments 

stated that an exemption allowing trading in 

obligations of their governments is necessary to 

maintain financial stability in their markets. See, 

e.g., Allen & Overy (Gov’t. Obligations); Bank of 

Canada; IRSG; IIB/EBF; Gov’t of Japan/Bank of 

Japan; Australian Bankers Ass’n. (Feb. 2012); Banco 

de Me ́xico; Ass’n. of German Banks; ALFI. 

Commenters argued that exempting trading in 

foreign sovereign debt would avoid the possible 

negative impacts of a contraction of government 

bond market liquidity. See, e.g., BoA; Citigroup; 

Goldman (Feb. 2012); IIB/EBF. Additionally, 

commenters suggested that failing to provide an 

exemption for this activity would impact money 

market operations of foreign central banks and limit 

the ability of foreign sovereign governments to 

conduct monetary policy or finance their 

operations. See, e.g., Barclays; BoA; Gov’t of Japan/ 

Bank of Japan; OSFI. A number of commenters also 

argued that, since U.S. and foreign banking entities 

often perform functions for foreign governments 

similar to those provided in the U.S. by U.S. 

primary dealers, the lack of an exemption would 

have a significant, negative impact on the ability of 

foreign governments to implement monetary policy 

and on liquidity in many foreign markets. See, e.g., 

Allen & Overy (Gov’t. Obligations); Australian 

Bankers Ass’n. (Feb. 2012); BoA; Banco de Me ́xico; 

Barclays; Citigroup (Feb. 2012); Goldman (Prop. 

Trading); IIB/EBF. Some commenters argued that 

banking entities and their customers use foreign 

sovereign debt to manage their risk by posting 

collateral in foreign jurisdictions and to manage 

international rate and foreign exchange risk. See 

Citigroup (Feb. 2012); SIFMA et al. (Prop. Trading) 

(Feb. 2012). 

1380The Agencies generally concur with 

commenters’ concerns that because the lack of an 

exemption could result in negative consequences— 

such as harming liquidity in foreign sovereign debt 

markets, making it more difficult and more costly 

for foreign governments to fund themselves, or 

subjecting banking entities to increased 

concentration risk—systemic risk could increase or 

there could be spillover effects that would harm 

global markets, including U.S. markets. See IIF; 

EBF; ICI Global; HSBC; Barclays; ICI (Feb. 2012); 

IIB/EBF; Union Asset. Additionally, in 

consideration of one commenter’s statements, the 

Agencies believe that failing to provide this 

exemption may cause foreign banks to close their 

U.S. branches, which could harm U.S. markets. See 

Comm. on Capital Markets Regulation. 

1381See, e.g., BoA; Cadwalader (on behalf of 

Singapore Banks); IIB/EBF; OSFI; UBS; BAROC; 

Japanese Bankers Ass’n.; JPMC. 

1382Some commenters suggested permitting nonU.S. banking entities to trade in any government 

obligation to the extent that such trading is 

permitted by the entity’s primary regulator. See 

Allen & Overy (Gov’t. Obligations); HSBC. 

1383See Better Markets (Feb. 2012); see also Prof. 

Johnson. 

1384See Barclays; Credit Suisse (Seidel); IIB/EBF; 

Japanese Bankers Ass’n.; Norinchukin; RBC; 

Sumitomo Trust; UBS. 1385See Barclays; FIA. 1386See Barclays. 1387See Joint Proposal, 76 FR at 68878 n.165. 

entities are permitted by the final rule 

to continue to engage fully in marketmaking in and underwriting of debt of 

foreign sovereigns anywhere in the 

world. The only restriction placed on 

these entities is on the otherwise 

impermissible proprietary trading in 

these instruments for the purpose of 

selling in the near term or otherwise 

with the intent to resell in order to 

profit from short-term price movements. 

The Agencies recognize that, 

depending on the extent to which 

banking entities subject to the rule have 

contributed to the liquidity of trading 

markets for foreign sovereign debt, the 

lack of an exemption for proprietary 

trading in foreign sovereign debt could 

result in certain negative impacts on the 

markets for such debt. In general, the 

Agencies believe these concerns should 

be mitigated somewhat by the refined 

exemptions for market making, 

underwriting and permitted trading 

activity of foreign banking entities; 

however, those exemptions do not 

address certain of the collateral, capital, 

and other operational issues identified 

by commenters.1379 Foreign sovereign 

debt of home and host countries 

generally serves these purposes. Due to 

the relationships among global financial 

markets, permitting trading that 

supports these essential functions 

promotes the financial stability and the 

safety and soundness of banking 

entities.1380 In contrast, a broad 

exemption for proprietary trading in all 

foreign sovereign debt without the 

limitations contained in the 

underwriting, market making and 

hedging exemptions could lead to more 

complicated risk profiles and significant 

unhedged risk exposures that section 13 

of the BHC Act is designed to address. 

Thus, the Agencies believe use of 

section 13(d)(1)(J) exemptive authority 

to permit proprietary trading in foreign 

government obligations in certain 

limited circumstances is appropriate. 

The Agencies decline to follow 

commenters’ suggested alternative of 

allowing trading in foreign government 

obligations if the obligations meet a 

particular condition on quality, such as 

obligations of OECD member 

countries.1381 The Agencies do not 

believe such an approach responds to 

the statutory purpose of limiting risks 

posed to the U.S. financial system by 

proprietary trading activities as directly 

as our current approach, which is 

structured to limit the exposure of 

banking entities, including insured 

depository institutions, to the risks of 

foreign sovereign debt. Additionally, the 

Agencies decline to permit proprietary 

trading in any obligation permitted 

under the laws of the foreign banking 

entity’s home country,1382 because such 

an approach could result in unintended 

competitive impacts since banking 

entities would not be subject to one 

uniform standard inside the United 

States. Further, unlike some 

commenters, the Agencies do not 

believe it is appropriate to require 

foreign governments to commit to 

paying for any damage to the U.S. 

financial system resulting from the 

foreign sovereign debt exemption.1383

The proposal also did not contain an 

exemption for trading in derivatives on 

foreign government obligations. Many 

commenters who recommended 

providing an exemption for proprietary 

trading in foreign government 

obligations also requested that the 

exemption be extended to derivatives on 

foreign government obligations.1384 Two 

of these commenters urged that trading 

in derivatives on foreign sovereign 

obligations should be exempt for the 

same reason that trading in derivatives 

on U.S. government obligations is 

exempt because such trading supports 

liquidity and price stability in the 

market for the underlying government 

obligations.1385 One commenter 

recommended that the Agencies use the 

authority in section 13(d)(1)(J) to grant 

an exemption for proprietary trading in 

derivatives on foreign government 

obligations.1386

The final rule has not been modified 

in § 75.6(b) to permit a banking entity to 

engage in proprietary trading in 

derivatives on foreign government 

obligations. As noted above, the 

Agencies have determined not to permit 

proprietary trading in derivatives on 

U.S. exempt government obligations 

under section 13(d) and, for the same 

reasons, have determined not to extend 

the permitted activities to include 

proprietary trading in derivatives on 

foreign government obligations. 

c. Permitted Trading in Municipal 

Securities 

Section 75.6(a) of the proposed rule 

implemented an exemption to the 

prohibition against proprietary trading 

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

Act, which permits trading in certain 

governmental obligations. This 

exemption permits the purchase or sale 

of obligations issued by any State or any 

political subdivision thereof (the 

‘‘municipal securities trading 

exemption’’). The proposed rule 

included both general obligation bonds 

and limited obligation bonds, such as 

revenue bonds, within the scope of this 

municipal securities trading exemption. 

The proposed rule, however, did not 

extend to obligations of ‘‘agencies’’ of 

States or political subdivisions 

thereof.1387

Many commenters, including industry 

participants, trade groups, and Federal 

and state governmental representatives, 

argued that the municipal securities 

trading exemption should be interpreted 

to permit banking entities to engage in 

proprietary trading in a broader range of 

municipal securities, including the 


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1388See, e.g., ABA (Keating); Ashurst; Ass’n. of 

Institutional Investors (Feb. 2012); BoA; BDA (Feb. 

2012); Capital Group; Chamber (Feb. 2012); 

Citigroup (Jan. 2012); CHFA; Eaton Vance; Fidelity; 

Fixed Income Forum/Credit Roundtable; HSBC; 

MEFA; Nuveen Asset Mgmt.; Sens. Merkley & Levin 

(Feb. 2012); Am. Pub. Power et al.; MSRB; Fidelity; 

State of New York; STANY; SIFMA (Municipal 

Securities) (Feb. 2012); State Street (Feb. 2012); 

North Carolina; T. Rowe Price; Sumitomo Trust; 

UBS; Washington State Treasurer; Wells Fargo 

(Prop. Trading). 

1389See, e.g., CHFA; Sens. Merkley & Levin (Feb. 

2012); Am. Pub. Power et al.; North Carolina; 

Washington State Treasurer; see also NABL; 

Ashurst; BDA (Feb. 2012); Chamber (Feb. 2012); 

Eaton Vance; Fidelity; MEFA; MSRB; Am. Pub. 

Power et al.; Nuveen Asset Mgmt.; PNC; SIFMA 

(Municipal Securities) (Feb. 2012); UBS. 

1390See Ashurst; Citigroup (Jan. 2012); Eaton 

Vance; Am. Pub. Power et al.; SIFMA (Municipal 

Securities) (Feb. 2012); North Carolina; T. Rowe 

Price; Wells Fargo (Prop. Trading); see also Capital 

Group (arguing that municipal securities are not 

generally used as a profit making strategy and thus, 

including all municipal securities in the exemption 

by itself should not adversely affect the safety and 

soundness of banking entities); PNC (arguing that 

the safe and sound nature of trading in State and 

municipal agency obligations was ‘‘a fact 

recognized by Congress in 1999 when it authorized 

well capitalized national banks to underwrite and 

deal in, without limit, general obligation, limited 

obligation and revenue bonds issued by or on behalf 

of any State, or any public agency or authority of 

any State or political subdivision of a State’’); Sens. 

Merkley & Levin (Feb. 2012). 

1391See, e.g., MSRB; City of New York; Am. Pub. 

Power et al.; Wells Fargo; State of New York; 

Washington State Treasurer; ABA (Keating); Capital 

Group; North Carolina; Eaton Vance; Port 

Authority; Connecticut; Citigroup (Jan. 2012); 

Ashurst; Nuveen Asset Mgmt.; SIFMA (Municipal 

Securities) (Feb. 2012). 

1392See, e.g., MSRB (stating that, based on data 

from Thomson Reuters, 41.4 percent of the 

municipal securities issued in FY 2011 were issued 

by agencies and authorities). 

1393See 15 U.S.C. 78c(a)(29). 

1394See ABA (Keating); Ashurst; BoA; Capital 

Group; Chamber (Feb. 2012); Comm. on Capital 

Markets Regulation; Citigroup (Jan. 2012); Eaton 

Vance; Fidelity; MEFA; MTA–NY; MSRB; Am. Pub. 

Power et al.; NABL; NCSL; State of New York; 

Nuveen Asset Mgmt.; Port Authority; PNC; SIFMA 

(Municipal Securities) (Feb. 2012); North Carolina; 

T. Rowe Price; UBS; Washington State Treasurer; 

Wells Fargo (Prop. Trading). 

1395See Ashurst; Citigroup (Jan. 2012) (noting 

that the National Bank Act explicitly lists State 

agencies and authorities as examples of political 

subdivisions); MSRB. 

1396See, e.g., Citigroup (Jan. 2012). 

1397See, e.g., MSRB; Citigroup (Jan. 2012). In 

addition to the Federal securities laws, the National 

Bank Act explicitly includes agencies and 

authorities as examples of political subdivisions. 

See 12 U.S.C. 24(seventh) (permitting investments 

in securities ‘‘issued by or on behalf of any State 

or political subdivision of a State, including any 

municipal corporate instrumentality of 1 or more 

States, or any public agency or authority of any 

State or political subdivision of a State . . . .’’). In 

addition, a number of banking regulations also 

include agencies as examples of political 

subdivisions or define political subdivision to 

include municipal agencies, authorities, districts, 

municipal corporations and similar entities. See, 

e.g., 12 CFR 1.2; 12 CFR 160.30; 12 CFR 161.38; 12 

CFR 330.15. Further, for purposes of the tax-exempt 

bond provisions in the Internal Revenue Code, 

Treasury regulations treat obligations issued by or 

‘‘on behalf of’’ States or political subdivisions by 

‘‘constituted authorities’’ as obligations of such 

States or political subdivisions, and the Treasury 

regulations define the term ‘‘political subdivision’’ 

to mean ‘‘any division of any State or local 

governmental unit which is a municipal 

corporation or which has been delegated the right 

to exercise part of the sovereign power of the 

unit. . . .’’ See 26 CFR 1.103–1(b). 

1398See ABA (Keating); Ashurst; Ass’n. of 

Institutional Investors (Feb. 2012); Citigroup (Jan. 

2012); Comm. on Capital Markets Regulation; Sens. 

Merkley & Levin (Feb. 2012); MSRB; Wells Fargo 

(Prop. Trading); SIFMA et al. (Prop. Trading) (Feb. 

2012). 

1399See Occupy. 

1400See AFR et al. (Feb. 2012); Occupy. 

1401See 26 U.S.C. 141. In general, the rules 

applicable to the issuance of tax-exempt private 

activity bonds under the Internal Revenue Code of 

1986, as amended (the ‘‘Code’’) are more restrictive 

than those applicable to traditional governmental 

bonds issued by States or political subdivisions 

thereof. Section 146 of the Code imposes an annual 

State bond volume cap on most tax-exempt private 

activity bonds that is tied to measures of State 

populations. Sections 141–150 of the Code impose 

other additional restrictions on tax-exempt private 

activity bonds, including, among others, eligible 

project and use restrictions, bond maturity 

restrictions, land and existing property financing 

restrictions, an advance refunding prohibition, and 

a public approval requirement. 

following: Obligations issued directly by 

States and political subdivisions 

thereof; obligations issued by agencies, 

constituted authorities, and similar 

governmental entities acting as 

instrumentalities on behalf of States and 

political subdivisions thereof; and 

obligations issued by such governmental 

entities that are treated as political 

subdivisions under various more 

expansive definitions of political 

subdivisions under Federal and state 

laws.1388 These commenters argued that 

States and municipalities often issue 

obligations through agencies and 

instrumentalities and that these 

obligations generally have the same 

level of risk as direct obligations of 

States and political subdivisions.1389

Commenters asserted that permitting 

trading in a broader group of municipal 

securities would be consistent with the 

terms and purposes of section 13 and 

would not adversely affect the safety 

and soundness of banking entities 

involved in these transactions or create 

additional risk to the financial stability 

of the United States.1390

Commenters expressed concerns that 

the proposed rule would result in a 

bifurcation of the municipal securities 

market that would achieve no 

meaningful benefits to the safety and 

soundness of banking entities, create 

administrative burdens for determining 

whether or not a municipal security 

qualifies for the exemption, result in 

inconsistent applications across 

different States, increase costs, and 

decrease liquidity in the diverse 

municipal securities market.1391

Commenters also argued that the market 

for securities issued by agencies and 

instrumentalities of States and political 

subdivisions thereof would be 

especially disrupted, and would affect 

about 40 percent of the municipal 

securities market.1392

Commenters recommended that the 

final rule provide a broad exemption to 

the prohibition on proprietary trading 

for municipal securities, based on the 

definition of ‘‘municipal securities’’ 

used in section 3(a)(29) of the Exchange 

Act,1393 which is understood by market 

participants and by Congress, and has a 

well-settled meaning and an established 

body of law. 1394 Other commenters 

contended that adopting the same 

definition of municipal securities as 

used in the Federal securities laws 

would reduce regulatory burden, 

remove uncertainty, and lead to 

consistent treatment of these securities 

under the banking and securities 

laws.1395 According to some 

commenters, the terms ‘‘agency’’ and 

‘‘political subdivision’’ are used 

differently under some State laws, and 

some State laws identify certain 

agencies as political subdivisions or 

define political subdivision to include 

agencies.1396 Commenters also noted 

that a number of Federal statutes and 

regulations define the term ‘‘political 

subdivision’’ to include municipal 

agencies and instrumentalities.1397

Commenters suggested that the 

Agencies interpret the term ‘‘political 

subdivision’’ in section 13 more broadly 

than in the proposal to include a wider 

range of State and municipal 

governmental obligations issued by 

agencies and instrumentalities or, 

alternatively, that the Agencies use the 

exemptive authority in section 

13(d)(1)(J) if necessary to permit 

proprietary trading of a broader array of 

State and municipal obligations.1398

On the other hand, one commenter 

contended that bonds issued by 

agencies and instrumentalities of States 

or municipalities pose risks to the 

banking system because the commenter 

believed the market for these bonds has 

not been properly regulated or 

controlled.1399 A few commenters also 

recommended tightening the proposed 

municipal securities trading exemption 

to exclude conduit obligations that 

benefit private businesses and private 

organizations.1400 One commenter 

suggested that the proposed municipal 

securities trading exemption should not 

apply to tax-exempt municipal bonds 

that benefit private businesses (referred 

to as ‘‘private activity bonds’’ in the 

Internal Revenue Code 1401) and that 

allow private businesses to finance 

private projects at lower interest rates as 


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5918 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

1402See AFR et al. (Feb. 2012). 

1403See final rule § 75.6(a)(3). 

1404Many commenters requested that the final 

rule use the definition of ‘‘municipal securities’’ 

used in the Federal securities laws because, among 

other reasons, the industry is familiar with that 

definition and such an approach would promote 

consistent treatment of these securities under 

banking and securities laws. See, e.g., ABA 

(Keating); Ashurst; BoA; Comm. on Capital Markets 

Regulation; Citigroup (Jan. 2012); NCSL; Port 

Authority; SIFMA (Municipal Securities) (Feb. 

2012); MSRB. Section 3(a)(29) of the Exchange Act 

defines the term ‘‘municipal securities’’ to mean 

‘‘securities which are direct obligations of, or 

obligations guaranteed as to principal or interest by, 

a State or any political subdivision thereof, or any 

agency or instrumentality of a State or any political 

subdivision thereof, or any municipal corporate 

instrumentality of one or more States, or any 

security which is an industrial development bond 

(as defined in section 103(c)(2) of Title 26) the 

interest on which is excludable from gross income 

under section 103(a)(1) of Title 26 if, by reason of 

the application of paragraph (4) or (6) of section 

103(c) of Title 26 (determined as if paragraphs 

(4)(A), (5), and (7) were not included in such 

section 103(c)), paragraph (1) of such section 103(c) 

does not apply to such security.’’ See 15 U.S.C. 

78c(a)(29). 

1405The definition of municipal securities in 

section 3(a)(29) of the Exchange Act has outdated 

tax references to the prior law under the former 

Internal Revenue Code of 1954, including 

particularly references to certain provisions 

involving the concept of ‘‘industrial development 

bonds.’’ The successor current Internal Revenue 

Code of 1986, as amended, replaces the prior 

definition of ‘‘industrial development bonds’’ with 

a revised, more restrictive successor definition of 

‘‘private activity bonds’’ and related definitions of 

‘‘exempt facility bonds’’ and ‘‘small issue bonds.’’ 

In recognition of the numerous tax law changes 

since the last statutory revision of section 3(a)(29) 

of the Exchange Act in 1970 and the potential 

attendant confusion, the Agencies determined to 

use a simpler, streamlined, independent definition 

of municipal securities for purposes of the 

municipal securities trading exception. This revised 

definition is intended to encompass, among others, 

any securities that are covered by the definition of 

the term ‘‘municipal securities’’ under section 

3(a)(29) of the Exchange Act. 

1406Many commenters requested that the 

municipal securities trading exemption be 

interpreted to include a broader range of State and 

municipal obligations issued by agencies and 

instrumentalities. See, e.g., ABA (Keating); Ashurst; 

BoA; BDA (Feb. 2012); Fixed Income Forum/Credit 

Roundtable; Sens. Merkley & Levin (Feb. 2012); 

SIFMA (Municipal Securities) (Feb. 2012); 

Citigroup (Jan. 2012); Comm. on Capital Markets 

Regulation. 

1407See, e.g., Citigroup (Jan. 2012); Ashurst; 

SIFMA et al. (Prop. Trading) (Feb. 2012); SIFMA 

(Municipal Securities) (Feb. 2012); Chamber (Dec. 

2011); BlackRock; Fixed Income Forum/Credit 

Roundtable. 

1408Commenters represented that the proposed 

rule would result in inconsistent applications of the 

exemption across States and political subdivisions. 

The Agencies also recognize, as noted by 

commenters, that the proposed rule would likely 

have resulted in a bifurcation of the municipal 

securities market and associated administrative 

burdens and disruptions. See, e.g., MSRB; Am. Pub. 

Power et al.; Port Authority; Citigroup (Jan. 2012); 

SIFMA et al. (Prop. Trading) (Feb. 2012); SIFMA 

(Municipal Securities) (Feb. 2012). 

1409Commenters asserted that permitting trading 

in a broader group of municipal securities would 

be consistent with the terms and purposes of 

section 13. See, e.g., Ashurst; Citigroup (Jan. 2012); 

Eaton Vance; Am. Pub. Power et al.; SIFMA 

(Municipal Securities) (Feb. 2012). 

1410Commenters argued that obligations issued 

by agencies and instrumentalities generally have 

the same level of risk as direct obligations of States 

and political subdivisions. See, e.g., CHFA; Sens. 

Merkley & Levin (Feb. 2012); Am. Pub. Power et al.; 

North Carolina. In response to one commenter’s 

concern that the markets for bonds issued by 

agencies and instrumentalities are not properly 

regulated, the Agencies note that all types of 

municipal securities, as defined under the 

securities laws to include, among others, State 

direct obligation bonds and agency or 

instrumentality bonds, are generally subject to the 

same regulations under the securities laws. Thus, 

the Agencies do not believe that obligations of 

agencies and instrumentalities are subject to less 

effective regulation than obligations of States and 

political subdivisions. See Occupy. 

1411Commenters noted that a number of Federal 

statutes and regulations define ‘‘political 

subdivision’’ to include municipal agencies and 

instrumentalities. See, e.g., MSRB; Citigroup (Jan. 

2012). 

1412See AFR et al. (Feb. 2012); Occupy. The 

Agencies do not believe it is appropriate to exclude 

conduit obligations, which are tax-exempt 

municipal bonds, from this exemption because such 

obligations are used to finance important projects 

related to, for example, multi-family housing, 

healthcare (hospitals and nursing homes), colleges 

and universities, power and energy companies and 

resource recovery facilities. See U.S. Securities & 

Exchange Comm’n., Report on the Municipal 

Securities Market 7 (2012), available at http://

www.sec.gov/news/studies/2012/

munireport073112.pdf. 

1413See Joint Proposal, 76 FR at 68878. 

a result of the exemption from Federal 

income taxation for the interest received 

by investors.1402

The final rule includes the statutory 

exemption for proprietary trading of 

obligations of any State or political 

subdivision thereof.1403 In response to 

the public comments and for the reasons 

discussed below, this exemption uses 

the definition of the term ‘‘municipal 

security’’ modeled after the definition of 

‘‘municipal securities’’ under section 

3(a)(29) of the Exchange Act,1404 but 

with simplifications.1405 The final rule 

defines the term ‘‘municipal security’’ to 

mean ‘‘a security which is a direct 

obligation of or issued by, or an 

obligation guaranteed as to principal or 

interest by, a State or any political 

subdivision thereof, or any agency or 

instrumentality of a State or any 

political subdivision thereof, or any 

municipal corporate instrumentality of 

one or more States or political 

subdivisions thereof.’’ 

The final rule modifies the proposal 

to permit proprietary trading in 

obligations issued by agencies and 

instrumentalities acting on behalf of 

States and municipalities (e.g., port 

authority bonds and bonds issued by 

municipal agencies or corporations).1406

As noted by commenters, many States 

and municipalities rely on securities 

issued by agencies and instrumentalities 

to fund essential activities, including 

utility systems, infrastructure projects, 

affordable housing, hospitals, 

universities, and other nonprofit 

institutions.1407 Both obligations issued 

directly by States and political 

subdivisions thereof and obligations 

issued by an agency or instrumentality 

of such a State or local governmental 

entity are ultimately obligations of the 

State or local governmental entity on 

whose behalf they act. Moreover, 

exempting obligations issued by State 

and municipal agencies and 

instrumentalities in the same manner as 

the direct obligations of States and 

municipalities lessens potential 

inconsistent treatment of government 

obligations across States and 

municipalities that use different funding 

methods for government projects.1408

The Agencies believe that interpreting 

the language of section 13(d)(1)(A) of 

the BHC Act to provide an exemption to 

the prohibition on proprietary trading 

for obligations issued by States and 

municipal agencies and 

instrumentalities as described above is 

consistent with the terms and purposes 

of section 13 of the BHC Act.1409 The 

Agencies recognize that state and 

political subdivision agency obligations 

generally present the same level of risk 

as direct obligations of States and 

political subdivisions.1410 Moreover, the 

Agencies recognize that other Federal 

laws and regulations define the term 

‘‘political subdivision’’ to include 

municipal agencies and 

instrumentalities.1411 The Agencies 

decline to exclude from this exemption 

conduit obligations that benefit private 

entities, as suggested by some 

commenters.1412

The proposal did not exempt 

proprietary trading of derivatives on 

obligations of States and political 

subdivisions. The proposal solicited 

comment on whether exempting 

proprietary trading in options or other 

derivatives referencing an obligation of 

a State or political subdivision thereof 

was consistent with the terms and 

purpose of the statute.1413 The Agencies 

did not receive persuasive information 

on this topic and, for the same reasons 

discussed above related to derivatives 

on U.S. government securities, the 

Agencies have determined not to 

provide an exemption for proprietary 

trading in municipal securities, beyond 

the underwriting, market-making, 

hedging and other exemptions provided 

generally in the rule. The Agencies note 

that banking entities may trade 

derivatives on municipal securities 

under any other available exemption to 

the prohibition on proprietary trading, 


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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 5919 

1414See id. 

1415Commenters argued that including 

obligations of multilateral developments banks in a 

foreign sovereign debt exemption is necessary to 

avoid endangering international cooperation in 

financial regulation and potential retaliatory 

prohibitions against U.S. government obligations. 

See Ass’n. of German Banks; Sumitomo; SIFMA et 

al. (Prop. Trading) (Feb. 2012). Additionally, some 

commenters represented that an exemption for 

obligations of international and multilateral 

development banks is appropriate for many of the 

same reasons provided for exempting U.S. 

government obligations and foreign sovereign debt 

generally. See Ass’n. of German Banks; Barclays; 

Goldman (Prop. Trading); IIB/EBF; ICFR; ICI Global; 

FIA; Sumitomo Trust; Allen & Overy (Gov’t. 

Obligations); SIFMA et al. (Prop. Trading) (Feb. 

2012). 

1416 12 U.S.C. 1851(d)(1)(D). 

1417See Joint Proposal, 76 FR at 68879. 1418This language generally mirrors that used in 

the Board’s Regulation Y, OCC interpretive letters, 

and the SEC’s Rule 3a5–1 under the Exchange Act. 

See 12 CFR 225.28(b)(7)(ii); 17 CFR 240.3a5–1(b); 

OCC Interpretive Letter 626 (July 7, 1993). 

1419See, e.g., Am. Express; BoA; ISDA (Apr. 

2012); RBC; SIMFA et al. (Prop. Trading) (Feb. 

2012); Wells Fargo (Prop. Trading). 

1420See, e.g., Am. Express; SIMFA et al. (Prop. 

Trading) (Feb. 2012). 

1421See Am. Express. 

1422See RBC. The Agencies note that acting as a 

block positioner is expressly contemplated and 

included as part of the exemption for market 

making-related activities under the final rule. 

1423See BoA; SIMFA et al. (Prop. Trading) (Feb. 

2012). 

1424See SIMFA et al. (Prop. Trading) (Feb. 2012). 

1425See SIMFA et al. (Prop. Trading) (Feb. 2012). 

providing the requirements of the 

relevant exemption are met. 

d. Determination to Not Exempt 

Proprietary Trading in Multilateral 

Development Bank Obligations 

The proposal did not exempt 

proprietary trading in obligations of 

multilateral banks or derivatives on 

multilateral development bank 

obligations but requested comment on 

this issue.1414 A number of commenters 

argued that the final rule should include 

an exemption for obligations of 

multilateral development banks.1415

The Agencies have not included an 

exemption to permit banking entities to 

engage in proprietary trading in 

obligations of multilateral development 

banks at this time. The Agencies do not 

believe that providing an exemption for 

trading obligations of multilateral 

development banks will help enhance 

the markets for these obligations and 

therefore promote and protect the safety 

and soundness of banking entities and 

U.S. financial stability. 

6. Section 75.6(c): Permitted Trading on 

Behalf of Customers 

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

provides an exemption from the 

prohibition on proprietary trading for 

the purchase, sale, acquisition, or 

disposition of financial instruments on 

behalf of customers.1416 The statute 

does not define when a transaction or 

activity is conducted ‘‘on behalf of 

customers.’’ 

a. Proposed Exemption for Trading on 

Behalf of Customers 

Section 75.6(b) of the proposed rule 

implemented the exemption for trading 

on behalf of customers by exempting 

three types of trading activity. Section 

75.6(b)(i) of the proposed rule provided 

that a purchase or sale of a financial 

instrument occurred on behalf of 

customers if the transaction (i) was 

conducted by a banking entity acting as 

investment adviser, commodity trading 

advisor, trustee, or in a similar fiduciary 

capacity for the account of that 

customer, and (ii) involved solely 

financial instruments for which the 

banking entity’s customer, and not the 

banking entity or any affiliate of the 

banking entity, was the beneficial 

owner. This exemption was intended to 

permit trading activity that a banking 

entity conducts in the context of 

providing investment advisory, trust, or 

fiduciary services to customers provided 

that the banking entity structures the 

activity so that the customer, and not 

the banking entity, benefits from any 

gains and suffers any losses on the 

traded positions. 

Section 75.6(b)(ii) of the proposed 

rule exempted the purchase or sale of a 

covered financial position if the banking 

entity was acting as riskless 

principal.1417 Under the proposed rule, 

a banking entity qualified as a riskless 

principal if the banking entity, after 

having received an order to purchase or 

sell a covered financial position from a 

customer, purchased or sold the covered 

financial position for its own account to 

offset a contemporaneous sale to or 

purchase from the customer.1418

Section 75.6(b)(iii) of the proposed 

rule permitted trading by a banking 

entity that was an insurance company 

for the separate account of insurance 

policyholders. Under the proposed rule, 

only a banking entity that is an 

insurance company directly engaged in 

the business of insurance and subject to 

regulation by a State insurance regulator 

or foreign insurance regulator was 

eligible for this prong of the exemption 

for trading on behalf of customers. 

Additionally, the purchase or sale of the 

covered financial position was exempt 

only if it was solely for a separate 

account established by the insurance 

company in connection with one or 

more insurance policies issued by that 

insurance company under which all 

profits and losses arising from the 

purchase or sale of the financial 

instrument were allocated to the 

separate account and inured to the 

benefit or detriment of the owners of the 

insurance policies supported by the 

separate account, and not the banking 

entity. These types of transactions are 

customer-driven and do not expose the 

banking entity to gains or losses on the 

value of separate account assets even 

though the banking entity is treated as 

the owner of those assets for certain 

purposes. 

b. Comments on the Proposed Rule 

Several commenters contended that 

the Agencies construed the statutory 

exemption too narrowly by limiting 

permissible proprietary trading on 

behalf of customers to only three 

categories of transactions.1419 Some of 

these commenters argued the exemption 

in the proposal was not consistent with 

the statutory language or Congressional 

intent to permit all transactions that are 

‘‘on behalf of customers.’’ 1420 One of 

these commenters expressed concern 

that the proposed exemption for trading 

on behalf of customers may be 

construed to permit only customerdriven transactions involving securities 

and not other financial instruments 

such as foreign exchange forwards and 

other derivatives.1421

Several commenters urged the 

Agencies to expand the exemption for 

trading on behalf of customers to permit 

other categories of customer-driven 

transactions in which the banking entity 

may be acting as principal but that serve 

legitimate customer needs including 

capital formation. For example, one 

commenter urged the Agencies to 

permit customer-driven transactions in 

which the banking entity has no ready 

counterparty but that are undertaken at 

the instruction or request of a customer 

or client or in anticipation of such an 

instruction or request, such as 

facilitating customer liquidity needs or 

block positioning transactions.1422

Other commenters urged the Agencies 

to exempt transactions where the 

banking entity acts as principal to 

accommodate a customer and 

substantially and promptly hedges the 

risks of the transaction.1423 Commenters 

argued that these kinds of transactions 

are similar in purpose and level of risk 

to riskless principal transactions.1424

Commenters also argued that these 

transactions could be viewed as marketmaking related activities, but indicated 

that the potential uncertainty and costs 

of making that determination would 

discourage banking entities from taking 

principal risks to accommodate 

customer needs.1425 Commenters also 

requested that the Agencies expressly 


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1426See SIMFA et al. (Prop. Trading) (Feb. 2012). 

1427See, e.g., Alfred Brock; ICBA; Occupy. 

1428See ICBA. 

1429See Occupy. 

1430See Public Citizen. 

1431See Occupy; Alfred Brock. 

1432See Occupy; Public Citizen. Conversely, other 

commenters supported the approach taken in the 

proposed rule without requesting such a definition. 

See Alfred Brock. 

1433See, e.g., Am. Express; SIMFA et al. (Prop. 

Trading) (Feb. 2012). 

1434See Am. Express. 

1435See ACLI; Chris Barnard; NAMIC; Fin. 

Services Roundtable (Feb. 3, 2012). 1436See Chris Barnard. 

1437See ACLI; Sutherland (on behalf of Comm. of 

Annuity Insurers); Fin. Services Roundtable (Feb. 3, 

2012); NAMIC. 

1438See ACLI; Sutherland (on behalf of Comm. of 

Annuity Insurers); Fin. Services Roundtable (Feb. 3, 

2012); NAMIC. 

1439See ACLI; Sutherland (on behalf of Comm. of 

Annuity Insurers); Fin. Services Roundtable (Feb. 3, 

2012); NAMIC. 

1440See ACLI; Sutherland (on behalf of Comm. of 

Annuity Insurers); Fin. Services Roundtable (Feb. 3, 

2012); NAMIC. 

1441See ACLI; Sutherland (on behalf of Comm. of 

Annuity Insurers); Fin. Services Roundtable (Feb. 3, 

2012); NAMIC. 

1442See 156 Cong. Rec. S5896 (daily ed. July 15, 

2010) (statement of Sen. Merkley) (arguing that 

‘‘this permitted activity is intended to allow 

financial firms to use firm funds to purchase assets 

on behalf of their clients, rather than on behalf of 

themselves.’’). 

1443Some commenters urged narrowing the 

exemption. See, e.g., Alfred Brock; ICBA; Occupy. 

The Agencies believe the final rule is appropriately 

narrow to limit potential abuse. 

1444See final rule § 75.6(c)(1)(ii)–(iii). See also 

proposed rule § 75.6(b)(2)(i)(B)–(C). 

permit transactions on behalf of 

customers to create structured products, 

as well as for client funding needs, 

customer clearing, and prime brokerage, 

if these transactions are included within 

the trading account.1426

In contrast, some commenters 

supported the proposed approach for 

implementing the exemption for trading 

on behalf of customers or urged 

narrowing the exemption.1427 One 

commenter expressed general support 

for the requirement that all profits (or 

losses) from the transaction flow to the 

customer and not the banking entity 

providing the service for a transaction to 

be exempt.1428 One commenter 

contended that the statute did not 

permit transactions on behalf of 

customers to be performed by an 

investment adviser.1429 Another 

commenter argued that the final rule 

should permit a banking entity to 

engage in a riskless principal 

transaction only where the banking 

entity has already arranged for another 

customer to be on the other side of the 

transaction.1430 Other commenters 

urged the Agencies to ensure that both 

parties to the transaction agree 

beforehand to the time and price of any 

relevant trade to ensure that the banking 

entity solely stands in the middle of the 

transaction and in fact passes on all 

gains (or losses) from the transaction to 

the customers.1431 Commenters also 

urged the Agencies to define other key 

terms used in the exemption. For 

instance, some commenters requested 

that the final rule define which entities 

may qualify as a ‘‘customer’’ for 

purposes of the exemption.1432

Some commenters urged the Agencies 

to provide uniform guidance on how the 

Agencies will interpret the riskless 

principal exemption.1433 One 

commenter urged the Agencies to clarify 

how the riskless principal exemption 

would be implemented with respect to 

transactions in derivatives, including a 

hedged derivative transaction executed 

at the request of a customer.1434

Several commenters generally 

expressed support for the exemption for 

trading for the separate account of 

insurance policyholders under the 

proposed rule.1435 One commenter 

requested that the final rule more 

clearly articulate who may qualify as a 

permissible owner of an insurance 

policy to whom the profits and losses 

arising from the purchase or sale of a 

financial instrument allocated to the 

separate account may inure.1436

Several commenters argued that 

certain types of separate account 

activities, including the allocation of 

seed money by an insurance company to 

a separate account or the offering of 

certain non-variable separate account 

contracts by the insurance company, 

would not appear to be permitted under 

the proposal.1437 Commenters also 

expressed concern that these separate 

account activities might not satisfy the 

proposed requirement that all profits 

and losses arising from the purchase or 

sale of the financial position inure to the 

benefit or detriment of the owners of the 

insurance policies supported by the 

separate account, and not the insurance 

company.1438 In addition, commenters 

argued that under the proposed rule, 

these activities would appear to fall 

outside of the exemption for activities in 

the general account of an insurance 

company because the proposed rule 

defined a general account as excluding 

a separate account.1439 Commenters 

urged the Agencies to more closely align 

the exemptions for trading by an 

insurance company for the general 

account and separate account.1440

According to these commenters, this 

change would permit insurance 

companies to continue to engage in the 

business of insurance by offering the 

full suite of insurance products to their 

customers.1441

c. Final Exemption for Trading on 

Behalf of Customers 

The Agencies have carefully 

considered the comments and are 

adopting the exemption for trading on 

behalf of customers with several 

modifications. The Agencies believe 

that the final rule implements the 

exemption in section 13(d)(1)(D) in a 

manner consistent with the legislative 

intent to allow banking entities to use 

their own funds to purchase or sell 

financial instruments when acting on 

behalf of their customers.1442 At the 

same time, the limited activities 

permitted under the final rule limit the 

potential for abuse.1443

The final rule slightly modifies the 

proposed rule by providing that a 

banking entity is not prohibited from 

trading on behalf of customers when 

that activity is conducted by the 

banking entity as trustee or in a similar 

fiduciary capacity for a customer and so 

long as the transaction is conducted for 

the account of, or on behalf of the 

customer and the banking entity does 

not have or retain a beneficial 

ownership of the financial instruments. 

The final rule removes the proposal’s 

express exemption for investment 

advisers. After further consideration, the 

Agencies do not believe an express 

reference to investment advisers is 

necessary because investment advisers 

generally act in a fiduciary capacity on 

behalf of clients in a manner that is 

separately covered by other exclusions 

and exemptions in the final rule. 

Additionally, the final rule deletes the 

proposal’s express exemption for 

commodity trading advisors because the 

legal relationship between a commodity 

trading advisor and its client depends 

on the facts and circumstances of each 

relationship. Therefore, the Agencies 

determined that it was appropriate to 

limit the discussion to fiduciary 

obligations generally and to omit any 

specific discussion of commodity 

trading advisors. In order to ensure that 

a banking entity utilizes this exemption 

to engage only in transactions for 

customers and not to conduct its own 

trading activity, the final rule 

(consistent with the proposed rule) 

requires that the purchase or sale of 

financial instruments be conducted for 

the account of the customer and that it 

involve solely financial instruments of 

which the customer, and not the 

banking entity, is beneficial owner.1444

The final rule, like the proposed rule, 

permits transactions in any financial 

instrument, including derivatives such 

as foreign exchange forwards, so long as 


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1445Some commenters expressed concern that the 

proposed exemption for trading on behalf of 

customers may be construed to not permit 

transactions in foreign exchange forwards and other 

derivatives. See Am. Express; SIFMA et al. (Prop. 

Trading) (Feb. 2012). 

1446See Occupy; Public Citizen. 

1447See final rule § 75.6(c)(2). 

1448Some commenters urged the Agencies to 

ensure that the banking entity passes on all gains 

(or losses) from the transaction to the customers. 

See Occupy; Public Citizen. 

1449See RBC; SIFMA et al. (Prop. Trading) (Feb. 

2012). 

1450See, e.g., Am. Express; SIFMA et al. (Prop. 

Trading) (Feb. 2012). 

1451See, e.g., 12 CFR 225.28(b)(7)(ii); 17 CFR 

240.3a5–1(b); OCC Interpretive Letter 626 (July 7, 

1993). One commenter stated that a banking entity 

should only be allowed to engage in a riskless 

principal transaction where the banking entity has 

already arranged for another customer to be on the 

other side of the transaction. See Public Citizen. 

The Agencies believe that the contemporaneous 

requirement in the final rule addresses this 

comment. 

1452One commenter requested an exemption for 

transactions at the instruction or request of a 

customer or client or in anticipation of such an 

instruction or request, such as facilitating customer 

liquidity needs or block positioning transactions. 

See RBC. 

1453Some commenters requested an exemption 

for these types of transactions. See BoA; SIFMA et 

al. (Prop. Trading) (Feb. 2012). 

1454Some commenters stated that the potential 

uncertainty and costs of determining whether an 

activity qualifies for the market-making exemption 

would discourage banking entities from taking 

principal risks to accommodate customer needs. 

See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012). 

The Agencies believe that adjustments made to the 

market-making exemption in the final rule help 

address this concern. Specifically, the final marketmaking exemption better accounts for the varying 

characteristics of market-making across markets and 

assets classes. 

1455See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012). 

1456See final rule § 75.3(d)(4)–(6). See also infra 

Part VI.A.1.d.3–4. 

1457Some commenters requested that the 

Agencies more closely align the exemptions for 

trading by an insurance company for the general 

account and separate account. See ACLI; 

Sutherland (on behalf of Comm. of Annuity 

Insurers); Fin. Services Roundtable (Feb. 3, 2012); 

NAMIC. 

1458See 12 U.S.C. 1851(d)(1)(F). 

1459One commenter requested clarification on 

who may qualify as a permissible owner of an 

insurance policy to whom the profits and losses 

arising from the purchase or sale of a financial 

instrument allocated to the separate account may 

inure. See Chris Barnard. The Agencies note that 

the proposed requirement that all profits and losses 

arising from the purchase or sale of a financial 

instrument inure to the benefit or detriment of the 

‘‘owners of the insurance policies supported by the 

separate account’’ has been removed. See proposed 

rule § 75.6(b)(2)(iii)(C). Instead, the final rule 

requires that the income, gains, and losses from 

assets allocated to a separate account be credited to 

Continued 

those transactions are on behalf of 

customers.1445

While some commenters requested 

that the final rule define ‘‘customer’’ for 

purposes of this exemption,1446 the 

Agencies believe the requirements of 

this exemption address commenters’ 

underlying concerns about what 

constitutes a ‘‘customer.’’ Specifically, 

the Agencies believe that requiring a 

transaction relying on this exemption to 

be conducted in a fiduciary capacity for 

a customer, to be conducted for the 

account of the customer, and to involve 

solely financial instruments of which 

the customer is beneficial owner 

address the underlying concerns that a 

transaction could qualify for this 

exemption if done on behalf of an 

indirect customer or on behalf of a 

customer not served by the banking 

entity. 

The final rule also provides that a 

banking entity may act as riskless 

principal in a transaction in which the 

banking entity, after receiving an order 

to purchase (or sell) a financial 

instrument from a customer, purchases 

(or sells) the financial instrument for its 

own account to offset the 

contemporaneous sale of the financial 

instrument to (purchase from) the 

customer.1447 Any transaction 

conducted pursuant to the exemption 

for riskless principal activity must be 

customer-driven and may not expose 

the banking entity to gains (or losses) on 

the value of the traded instruments as 

principal.1448 Importantly, the final rule 

does not permit a banking entity to 

purchase (or sell) a financial instrument 

without first having a customer order to 

buy (sell) the instrument. While some 

commenters requested that the Agencies 

modify the final rule to permit activity 

without a customer order,1449 the 

Agencies are concerned that broadening 

the exemption in this manner would 

enable banking entities to evade the 

requirements of section 13 and engage 

in prohibited proprietary trading under 

the guise of trading on behalf of 

customers. 

Several commenters requested that 

the final rule explain how a banking 

entity may determine when it is acting 

as riskless principal.1450 The Agencies 

note that riskless principal transactions 

typically are undertaken as an 

alternative method of executing orders 

by customers to buy or sell financial 

instruments on an agency basis. Acting 

as riskless principal does not include 

acting as underwriter or market maker 

in the particular financial instrument 

and is generally understood to be 

equivalent to agency or brokerage 

transactions in which all of the risks 

associated with ownership of financial 

instruments are borne by customers. 

The Agencies have generally equivalent 

standards for determining when a 

banking entity acts as riskless principal 

and require that the banking entity, after 

receiving an order to buy (or sell) a 

financial instrument from a customer, 

buys (or sells) the instrument for its own 

account to offset a contemporaneous 

sale to (or purchase from) the 

customer.1451 The Agencies intend to 

determine whether a banking entity acts 

as riskless principal in accordance with 

and subject to the requirements of these 

standards. 

Some commenters requested that the 

final rule permit a greater variety of 

transactions to be conducted on behalf 

of customers. Many of these 

transactions, such as transactions that 

facilitate customer liquidity needs or 

block positioning transactions 1452 or 

transactions in which the banking entity 

acts as principal to accommodate a 

customer and substantially and 

promptly hedges the risks of the 

transaction,1453 may be permissible 

under the market-making exemption. To 

the extent these transactions are 

conducted by a market maker, the 

Agencies believe that the restrictions 

and limits required in connection with 

market making-related activities are 

important for limiting the risks to the 

banking entity from these 

transactions.1454 While some 

commenters requested that clearing and 

settlement activities and prime 

brokerage activities be viewed as 

permitted proprietary trading on behalf 

of customers,1455 these transactions are 

not considered proprietary trading as an 

initial matter under the final rule.1456

Finally, the Agencies have decided to 

move the exemption for trading activity 

conducted by an insurance company for 

a separate account into the provision 

exempting trading activity in an 

insurance company’s general account in 

order to better align the two 

exemptions.1457 As discussed below in 

Part VI.A.7., the final rule provides 

exemptions for trading activity 

conducted by an insurance company 

that is a banking entity either in the 

general account or in a separate account 

of customers in § 75.6(d). As explained 

below, the statute specifically exempts 

trading activity that is conducted by a 

regulated insurance company engaged 

in the business of insurance for the 

general account of the company if 

conducted in accordance with 

applicable state law and if not 

prohibited by the appropriate Federal 

banking agencies.1458 Unlike activity for 

the general account of an insurance 

company, investments made by 

regulated insurance companies in 

separate accounts in accordance with 

applicable state law are made on behalf 

of and for the benefit of customers of the 

insurance company.1459 Also unlike 


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or charged against the account without regard to 

other income, gains or losses of the insurance 

company. See final rule § 75.2(z) (definition of 

‘‘separate account’’). Thus, the final rule no longer 

references ‘‘owners of the insurance policies 

supported by the separate account.’’ The Agencies 

note, however, that the final rule requires exempted 

separate account transactions to be ‘‘conducted in 

compliance with, and subject to, the insurance 

company investment laws, regulations, and written 

guidance of the State or jurisdiction in which such 

insurance company is domiciled.’’ See final rule 

§ 75.6(d)(3). 

1460See 12 U.S.C. 1851(d)(1)(F). 

1461See 12 U.S.C. 1851(d)(1)(D). 

1462See proposed rule §§ 75.6(b)(2)(iii), 75.6(c). 

1463See proposed rule § 75.3(c)(6). 

1464See proposed rule § 75.2(z). 

1465The Agencies noted in the proposal they 

would not consider profits to inure to the benefit 

of the banking entity if the banking entity were 

solely to receive payment, out of separate account 

profits, of fees unrelated to the investment 

performance of the separate account. 

1466The proposed rule provided definitions of the 

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

insurance regulator.’’ See proposed rule § 75.3(c)(4), 

(13). 

1467See, e.g., Alfred Brock; Chris Barnard; Fin. 

Services Roundtable (Feb. 3, 2012); Sutherland (on 

behalf of Comm. of Annuity Insurers); TIAA–CREF; 

NAMIC. 

1468See, e.g., ACLI (Jan. 2012); Fin. Services 

Roundtable (Feb. 3, 2012); Country Fin. et al.; 

Sutherland (on behalf of Comm. of Annuity 

Insurers). 

general accounts (which are supported 

by all of the assets of the insurance 

company), a separate account is 

supported only by the assets in that 

account and does not have call on the 

other assets of the company. The 

customer benefits (or loses) based solely 

on the performance of the assets in the 

separate account. These arrangements 

are the equivalent for insurance 

companies of fiduciary accounts at 

banks. For these reasons, the final rule 

recognizes that separate accounts at 

regulated insurance companies 

maintained in accordance with 

applicable state insurance laws are 

exempt from the prohibitions in section 

13 as acquisitions on behalf of 

customers. 

7. Section 75.6(d): Permitted Trading by 

a Regulated Insurance Company 

Section 13(d)(1)(F) permits a banking 

entity that is a regulated insurance 

company acting for its general account, 

or an affiliate of an insurance company 

acting for the insurance company’s 

general account, to purchase or sell a 

financial instrument subject to certain 

conditions (the ‘‘general account 

exemption’’).1460 Section 13(d)(1)(D) 

permits a banking entity to purchase or 

sell a financial instrument on behalf of 

customers.1461 In the proposed rule, the 

Agencies viewed Section 13(d)(1)(D) as 

permitting an insurance company to 

purchase or sell a financial instrument 

for certain separate accounts (the 

‘‘separate account exemption’’). The 

proposal implemented both these 

exemptions with respect to activities of 

insurance companies, in each case 

subject to the restrictions discussed 

below.1462

Section 75.6(c) of the proposed rule 

implemented the general account 

exemption by generally restating the 

statutory requirements of the exemption 

that: 

• The insurance company directly 

engage in the business of insurance and 

be subject to regulation by a State 

insurance regulator or foreign insurance 

regulator; 

• The insurance company or its 

affiliate purchase or sell the financial 

instrument solely for the general 

account of the insurance company; 

• The purchase or sale be conducted 

in compliance with, and subject to, the 

insurance company investment laws, 

regulations, and written guidance of the 

State or jurisdiction in which such 

insurance company is domiciled; and 

• The appropriate Federal banking 

agencies, after consultation with the 

Council and the relevant insurance 

commissioners of the States, must not 

have jointly determined, after notice 

and comment, that a particular law, 

regulation, or written guidance 

described above is insufficient to protect 

the safety and soundness of the banking 

entity or of the financial stability of the 

United States. 

The proposed rule defined the term 

‘‘general account’’ to include all of the 

assets of the insurance company that are 

not legally segregated and allocated to 

separate accounts under applicable 

State law.1463

As noted above in Part VI.A.6.a., 

§ 75.6(b)(iii) of the proposed rule 

provided an exemption for a banking 

entity that is an insurance company 

when it acted through a separate 

account for the benefit of insurance 

policyholders. The proposed rule 

defined a ‘‘separate account’’ as an 

account established or maintained by a 

regulated insurance company subject to 

regulation by a State insurance regulator 

or foreign insurance regulator under 

which income, gains, and losses, 

whether or not realized, from assets 

allocated to such account, are, in 

accordance with the applicable contract, 

credited to or charged against such 

account without regard to other income, 

gains, or losses of the insurance 

company.1464

To limit the potential for abuse of the 

separate account exemption, the 

proposed rule included requirements 

designed to ensure that the separate 

account trading activity is subject to 

appropriate regulation and supervision 

under insurance laws and not structured 

so as to allow gains or losses from 

trading activity to inure to the benefit or 

detriment of the banking entity.1465 In 

particular, the proposed rule provided 

that a purchase or sale of a financial 

instrument qualified for the separate 

account exemption only if: 

• The banking entity is an insurance 

company directly engaged in the 

business of insurance and subject to 

regulation by a State insurance regulator 

or foreign insurance regulator; 1466

• The banking entity purchases or 

sells the financial instrument solely for 

a separate account established by the 

insurance company in connection with 

one or more insurance policies issued 

by that insurance company; 

• All profits and losses arising from 

the purchase or sale of the financial 

instrument are allocated to the separate 

account and inure to the benefit or 

detriment of the owners of the insurance 

policies supported by the separate 

account, and not the banking entity; and 

• The purchase or sale is conducted 

in compliance with, and subject to, the 

insurance company investment and 

other laws, regulations, and written 

guidance of the State or jurisdiction in 

which such insurance company is 

domiciled. 

The proposal explained that the 

proposed separate account exception 

represented transactions on behalf of 

customers because the insurance-related 

transactions are generally customerdriven and do not expose the banking 

entity to gains or losses on the value of 

separate account assets, even though the 

banking entity may be treated as the 

owner of those assets for certain 

purposes. 

Commenters generally supported the 

general account exemption and the 

separate account exemption for 

regulated insurance companies as 

consistent with both the statute and 

Congressional intent to accommodate 

the business of insurance.1467 For 

instance, commenters argued that the 

statute was designed to appropriately 

accommodate the business of insurance, 

subject to regulation in accordance with 

relevant insurance company investment 

laws, in recognition that insurance 

company investment activities are 

already subject to comprehensive 

regulation and oversight.1468

A few commenters expressed 

concerns about the definition of 

‘‘general account’’ and ‘‘separate 


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1469See, e.g., Fin. Services Roundtable (Feb. 3, 

2012); ACLI (Jan. 2012); Sutherland (on behalf of 

Comm. of Annuity Insurers). 

1470See Sutherland (on behalf of Comm. of 

Annuity Insurers). 

1471See ACLI (Jan. 2012); NAMIC. 

1472See Fin. Services Roundtable (Feb. 3, 2012); 

ACLI (Jan. 2012); NAMIC; see also Nationwide. 

1473See Fin. Services Roundtable (Feb. 3, 2012); 

ACLI (Jan. 2012); NAMIC; Sutherland (on behalf of 

Comm. of Annuity Insurers); see also Nationwide. 

1474See Fin. Services Roundtable (Feb. 3, 2012); 

ACLI (Jan. 2012). 

1475See USAA. 

1476See HSBC Life. 

1477See Sens. Merkley & Levin (Feb. 2012). 

1478See ACLI (Jan. 2012); Fin. Services 

Roundtable (Feb. 3, 2012); Mutual of Omaha; 

NAMIC. 

1479See final rule § 75.2(p), (bb). Some 

commenters expressed concerns about the proposed 

definitions of ‘‘general account’’ and ‘‘separate 

account,’’ including that the proposed definition of 

‘‘separate account’’ excluded some legitimate 

separate account activities that do not fall within 

the proposed general account definition. See, e.g., 

ACLI (Jan. 2012); NAMIC; Sutherland (on behalf of 

Comm. of Annuity Insurers). See also proposed rule 

§§ 75.2(z), 75.3(c)(5). 

1480The Federal banking agencies have not at this 

time determined, as part of the final rule, that the 

insurance company investment laws, regulations, 

and written guidance of any particular State or 

jurisdiction are insufficient to protect the safety and 

soundness of the banking entity, or of the financial 

stability of the United States. The Federal banking 

agencies expect to monitor, in conjunction with the 

FSOC, the insurance company investment laws, 

regulations, and written guidance of States or 

jurisdictions to which exempt transactions are 

subject and make such determinations in the future, 

where appropriate. The Agencies believe the final 

approach addresses one commenter’s request that 

the Agencies consult with the foreign insurance 

supervisor of an insurance company regulated 

outside of the United States before finding that an 

insurance activity conducted by the foreign 

company was inconsistent with the safety and 

soundness or financial stability. See HSBC Life. 

account.’’ 1469 One commenter argued 

the definition of general account was 

unclear.1470 A few commenters 

expressed concern that the proposed 

definition of separate account 

inappropriately excluded some separate 

accounts, such as certain insurance 

company investment activities such as 

guaranteed investment contracts, which 

would also not fall within the proposed 

definition of general account.1471

Several commenters argued that the 

final rule should be modified so that all 

insurance company investment activity 

permitted under applicable insurance 

laws would qualify for either the general 

account exemption or the separate 

account exemption.1472

Some commenters argued that the 

prohibition in the proposed definition 

of separate account against any profits 

or losses from activity in the account 

inuring to the benefit (or detriment) of 

the insurance company would exclude 

some activity permitted by insurance 

regulation in separate accounts.1473 For 

example, commenters contended that an 

insurer may allocate its own funds to a 

separate account as ‘‘seed money’’ and 

the profits and losses on those funds 

inure to the benefit or detriment of the 

insurance company.1474

Some commenters expressed specific 

concerns about the scope or 

requirements of the proposal. For 

instance, one commenter argued that the 

final rule should provide that a trade is 

exempt if the trade is made by an 

affiliate of the insurance company in 

accordance with state insurance law.1475

Another commenter urged that the 

Agencies consult with the foreign 

insurance supervisor of an insurance 

company regulated outside of the 

United States before finding that an 

insurance activity conducted by the 

foreign insurance company was 

inconsistent with the safety and 

soundness or financial stability.1476

One commenter suggested that 

insurance company affiliates of banking 

entities should expressly be made 

subject to data collection and reporting 

requirements to prevent possible 

evasion of the restrictions of section 13 

and the final rule using their insurance 

affiliates.1477 By contrast, other 

commenters argued that the reporting 

and recordkeeping and compliance 

requirements of the rule should not 

apply to permitted insurance company 

investment activities.1478 These 

commenters argued that insurance 

companies are already subject to 

comprehensive regulation of the kinds 

and amounts of investments they can 

make under insurance laws and 

regulations and that additional 

recordkeeping obligations would 

impose unnecessary compliance 

burdens on these entities without 

producing significant offsetting benefits. 

After considering the comments 

received and the language and purpose 

of the statute, the final rule has been 

modified to better account for the 

language of the statute and more 

appropriately accommodate the 

business of insurance. 

As explained in the proposal, section 

13(d)(1)(F) of the BHC Act specifically 

and broadly exempts the purchase, sale, 

acquisition, or disposition of securities 

and other instruments by a regulated 

insurance company engaged in the 

business of insurance for the general 

account of the company (and by an 

affiliate solely for the general account of 

the regulated insurance company). 

Section 13(d)(1)(D) of the statute also 

specifically exempts the same activity 

when done on behalf of customers. As 

explained in the proposal, separate 

accounts managed and maintained by 

insurance companies as part of the 

business of insurance are generally 

customer-driven and do not expose the 

banking entity to gains or losses on the 

value of assets held in the separate 

account, even though the banking entity 

may be treated as the owner of the assets 

for certain purposes. Unlike the general 

account of the insurance company, 

separate accounts are managed on 

behalf of specific customers, much as a 

bank would manage a trust or fiduciary 

account. 

For these reasons, the final rule 

retains both the general account 

exemption and the separate account 

exemption. The final rule removes any 

gap between the definition of general 

account and the definition of separate 

account by defining the general account 

to be all of the assets of an insurance 

company except those allocated to one 

or more separate accounts.1479

The final rule also combines the 

general account exemption and the 

separate account exemption into a 

single section. This makes clear that 

both exemptions are available only: 

• If the insurance company or its 

affiliate purchases or sells the financial 

instruments solely for the general 

account of the insurance company or a 

separate account of the insurance 

company; 

• The purchases or sales of financial 

instruments are conducted in 

compliance with, and subject to, the 

insurance company investment laws, 

regulations, and written guidance of the 

State or jurisdiction in which such 

insurance company is domiciled; and 

• The appropriate Federal banking 

agencies, after consultation with the 

Financial Stability Oversight Council 

and the relevant insurance 

commissioners of the States and 

relevant foreign jurisdictions, as 

appropriate, have not jointly 

determined, after notice and comment, 

that a particular law, regulation, or 

written guidance regarding insurance is 

insufficient to protect the safety and 

soundness of the banking entity, or the 

financial stability of the United 

States.1480

Like section 13(d)(1)(F) of the BHC 

Act, the final rule permits an affiliate of 

an insurance company to purchase and 

sell financial instruments in reliance on 

the general account exemption, so long 

as that activity is for the general account 

of the insurance company. Similarly, 

the final rule implements section 

13(d)(1)(D) and permits an affiliate of an 

insurance company to purchase and sell 

financial instruments for a separate 

account of the insurance company, so 

long as the separate account is 


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1481Although one commenter requested that the 

final rule exempt a trade as long as the trade is 

made by an affiliate of the insurance company in 

accordance with state insurance law, the Agencies 

believe the final approach properly implements the 

statute. See USAA. 

1482See 12 U.S.C. 1851(e)(1) (requiring that the 

Agencies issue regulations regarding ‘‘internal 

controls and recordkeeping, in order to insure 

compliance with this section’’). 

1483Section 13(d)(1)(H) of the BHC Act provides 

an exemption to the prohibition on proprietary 

trading for trading conducted by a foreign banking 

entity pursuant to paragraph (9) or (13) of section 

4(c) of the BHC Act, if the trading occurs solely 

outside of the United States, and the banking entity 

is not directly or indirectly controlled by a banking 

entity that is organized under the laws of the United 

States or of one or more States. See 12 U.S.C. 

1851(d)(1)(H). 

1484This section’s discussion of the concept 

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

solely for purposes of the rule’s implementation of 

section 13(d)(1)(H) of the BHC Act, and does not 

affect a banking entity’s obligation to comply with 

additional or different requirements under 

applicable securities, banking, or other laws. 

1485See proposed rule § 75.6(d). 

1486See, e.g., IIB/EBF; ICI Global; ICI (Feb. 2012); 

Wells Fargo (Prop. Trading); BoA. 

1487See IIB/EBF; Ass’n. of Banks in Malaysia; 

EBF; Credit Suisse (Seidel); Cadwalader (on behalf 

of Thai Banks). 

1488See BaFin/Deutsche Bundesbank; ICSA; IIB/ 

EBF; Allen & Overy (on behalf of Canadian Banks); 

Credit Suisse (Seidel); George Osbourne. 

1489See ICE; ICI Global; BoA; Citigroup (Feb. 

2012); British Bankers’ Ass’n.; IIB/EBF. 

1490See BaFin/Deutsche Bundesbank; 

Norinchukin; IIF; Allen & Overy (on behalf of 

Canadian Banks); ICFR; BoA; Citigroup (Feb. 2012). 

As discussed below in Part VI.C. of this 

SUPPLEMENTARY INFORMATION, other parts of the final 

rule address commenters’ concerns regarding the 

compliance burden on foreign banking entities. 

1491See Norinchukin; Cadwalader (on behalf of 

Thai Banks); Barclays; EBF; Commissioner Barnier; 

Ass’n. of German Banks; Socie ́te ́ Ge ́ne ́rale; Chamber 

(Dec. 2012). 

1492See Sens. Merkley & Levin (Feb. 2012) 

(arguing that the final rule’s foreign trading 

exemption should not exempt foreign affiliates of 

U.S. banking entities when they engage in trading 

activity abroad); see also Occupy; Alfred Brock. 

established and maintained at the 

insurance company. 

Importantly, the final rule applies 

only to covered trading activity in a 

general or separate account of a licensed 

insurance company engaged in the 

business of insurance under the 

supervision of a State or foreign 

insurance regulator. As in the statute, an 

affiliate of an insurance company may 

not rely on this exemption for activity 

in any account of the affiliate (unless it, 

too, meets the definition of an insurance 

company). An affiliate may rely on the 

exemption to the limited extent that the 

affiliate is acting solely for the account 

of the insurance company.1481

As noted above, one commenter 

requested that the final rule impose 

special data and reporting obligations 

on insurance companies. Other 

commenters argued that insurance 

companies are already subject to 

comprehensive regulation under 

insurance laws and regulations and that 

additional recordkeeping obligations 

would impose unnecessary compliance 

burdens on these entities without 

producing significant offsetting benefits. 

In accordance with the statute,1482 the 

Agencies expect insurance companies to 

have appropriate compliance programs 

in place for any activity subject to 

section 13 of the BHC Act. 

The final rule contains a number of 

other related definitions that are 

intended to help make clear the 

limitations of the insurance company 

exemption, including definitions of 

foreign insurance regulator and State 

insurance regulator. 

8. Section 75.6(e): Permitted Trading 

Activities of a Foreign Banking Entity 

Section 13(d)(1)(H) of the BHC 

Act 1483 permits certain foreign banking 

entities to engage in proprietary trading 

that occurs solely outside of the United 

States (the ‘‘foreign trading 

exemption’’).1484 The statute does not 

define when a foreign banking entity’s 

trading occurs solely outside of the 

United States. 

The proposed rule defined both the 

type of foreign banking entity that is 

eligible for the exemption and activity 

that constitutes trading solely outside of 

the United States. The proposed rule 

effectively precluded a foreign banking 

entity from engaging in proprietary 

trading through a transaction that had 

any connection with the United States, 

including: Trading with any party 

located in the United States; allowing 

U.S. personnel of the foreign banking 

entity to be involved in the purchase or 

sale; or executing any transaction in the 

United States (on an exchange or 

otherwise).1485

In general, commenters emphasized 

the importance of and supported an 

exemption for foreign trading activities 

of foreign banking entities. However, a 

number of commenters expressed 

concerns that the proposed foreign 

trading exemption was too narrow and 

would not be effective in permitting 

foreign banking entities to engage in 

foreign trading activities.1486 For 

instance, many commenters stated that 

the proposal’s prohibition on trading 

activities that have any connection to 

the U.S. was not consistent with the 

purpose of section 13 of the BHC Act 

where the risk of the trading activity is 

taken or held outside of the United 

States and does not implicate the U.S. 

safety net.1487 These commenters argued 

that, since one of the principal purposes 

of section 13 of the BHC Act is to limit 

the risk posed by prohibited proprietary 

trading to the Federal safety net, the 

safety and soundness of U.S. banking 

entities, and the financial stability of the 

United States, the exemption for foreign 

trading activity should similarly focus 

on whether the trading activity involves 

principal risk being taken or held by the 

foreign banking entity inside the United 

States.1488

Many commenters argued that the 

proposal’s transaction-based approach 

to implementing the foreign trading 

exemption would harm U.S. markets 

and U.S. market participants. For 

example, some commenters argued that 

the proposed exemption would cause 

foreign banks to exit U.S. markets or 

shrink their U.S.-based operations, 

thereby resulting in less liquidity and 

greater fragmentation in markets 

without producing any significant 

offsetting benefit.1489 Commenters also 

asserted that the proposal would impose 

significant compliance costs on the 

foreign operations of foreign banking 

entities and would lead to foreign firms 

refusing to trade with U.S. 

counterparties, including the foreign 

operations of U.S. entities, to avoid 

compliance costs associated with 

relying on another exemption under the 

proposed rule.1490 Additionally, 

commenters argued that the proposal 

represented an improper extraterritorial 

application of U.S. law that could be 

found to violate international treaty 

obligations of the United States, such as 

those under the North American Free 

Trade Agreement, and might result in 

retaliation by foreign countries in their 

treatment of U.S. banking entities 

abroad.1491

a. Foreign Banking Entities Eligible for 

the Exemption 

The statutory language of section 

13(d)(1)(H) provides that, in order to be 

eligible for the foreign trading 

exemption, the banking entity must not 

be directly or indirectly controlled by a 

banking entity that is organized under 

the laws of the United States or of one 

or more States. The proposed rule 

limited the scope of the exemption to 

banking entities that are organized 

under foreign law and, as applicable, 

controlled only by entities organized 

under foreign law. 

Commenters generally supported this 

aspect of the proposal.1492 However, 

some commenters requested that the 

final rule be modified to allow U.S. 

banking entities’ affiliates or branches 

that are physically located outside of the 

United States (‘‘foreign operations of 

U.S. banking entities’’) to engage in 

proprietary trading outside of the 

United States pursuant to this 


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1493See Citigroup (Feb. 2012); Sen. Carper; IIF; 

ABA (Keating); Wells Fargo (Prop. Trading); Abbot 

Labs. et al. (Feb. 14, 2012). 

1494See Citigroup (Feb. 2012). 

1495See 12 U.S.C. 1851(d)(1)(H). 

1496See final rule § 75.6(e)(1)(ii). 

1497Section 75.6(e)(2) addresses only when a 

transaction will be considered to have been 

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

Act. Although the statute also references section 

4(c)(13) of the BHC Act, the Board has to date 

applied the general authority contained in that 

section solely to the foreign activities of U.S. 

banking organizations which, by the express terms 

of section 13(d)(1)(H) of the BHC Act, are unable 

to rely on the foreign trading exemption. 

1498See 12 U.S.C. 1843(c)(9). 

1499See 12 CFR 211.20 et seq. 

1500Commenters noted that the Board’s 

Regulation K contains a number of limitations that 

may not be appropriate to include as part of the 

requirements of the foreign trading exemption. See 

Allen & Overy (on behalf of Foreign Bank Group); 

HSBC Life. Accordingly, the final rule does not 

retain the proposal’s requirement that the activity 

be conducted in compliance with subpart B of the 

Board’s Regulation K (12 CFR 211.20 through 

211.30). However, the exemption in section 

13(d)(1)(H) of the BHC Act and the final rule 

operates as an exemption and is not a separate grant 

of authority to engage in an otherwise 

impermissible activity. To the extent a banking 

entity is a foreign banking organization, it remains 

subject to the Board’s Regulation K and must, as a 

separate matter, comply with any and all applicable 

rules and requirements of that regulation. 

1501See 12 CFR 211.23(a), (c), and (e). The 

proposed rule referenced only the qualifying test 

under section 211.23(a) of the Board’s Regulation K; 

however, because there are two other methods by 

which a foreign banking organization may meet the 

requirements to be considered a qualified foreign 

banking organization, the final rule incorporates a 

reference to those provisions as well. 

1502This modification to the definition of foreign 

banking organization is necessary because, under 

the International Banking Act and the Board’s 

Regulation K, depository institutions that are 

located in, or organized under the laws of a 

commonwealth, territory, or possession of the 

United States, are foreign banking organizations. 

However, for purposes of the Federal securities 

laws and certain banking statutes, such as section 

2(c)(1) of the BHC Act and section 3 of the FDI Act, 

these same entities are defined to be and treated as 

domestic entities. For instance, these entities act as 

domestic broker-dealers under U.S. securities laws 

and their deposits are insured by the FDIC. Because 

one of the purposes of section 13 is to protect 

insured depository institutions and the U.S. 

financial system from the perceived risks of 

proprietary trading and covered fund activities, the 

Agencies believe that these entities should be 

considered to be located within the United States 

for purposes of section 13. The final rule includes 

within the definition of State a commonwealth, 

territory or possession of the United States, the 

District of Columbia, the Commonwealth of Puerto 

Rico, the Commonwealth of the Northern Mariana 

Islands, American Samoa, Guam, or the United 

States Virgin Islands. 

1503This 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. 

1504See final rule § 75.6(e)(2)(ii)(B). For purposes 

of determining whether, on a fully consolidated 

basis, it meets the requirements under 

§ 75.6(e)(2)(ii)(B), a foreign banking entity that is 

not a foreign banking organization should base its 

calculation on the consolidated global assets, 

revenues, and income of the top-tier affiliate within 

the foreign banking entity’s structure. 

1505See 12 U.S.C. 1843(c)(9); 12 CFR 211.23(a), 

(c), and (e); final rule § 75.6(e)(2)(ii)(B). 

exemption.1493 These commenters 

argued that, unless foreign operations of 

U.S. banking entities are provided 

similar authority to engage in 

proprietary trading outside of the 

United States, foreign operations of U.S. 

banking entities would be at a 

competitive disadvantage abroad with 

respect to foreign banking entities. One 

commenter also asserted that, unless 

foreign operations of U.S. banking 

entities were able to effectively access 

foreign markets, they could be shut out 

of those markets and would be unable 

to effectively manage their risks in a safe 

and sound manner.1494

As noted above, section 13(d)(1)(H) of 

the BHC Act specifically provides that 

its exemption is available only to a 

banking entity that is not ‘‘directly or 

indirectly’’ controlled by a banking 

entity that is organized under the laws 

of the United States or of one or more 

States.1495 Because of this express 

statutory threshold requirement, a 

foreign subsidiary controlled, directly or 

indirectly, by a banking entity organized 

under the laws of the United States or 

one of its States, and a foreign branch 

office of a banking entity organized 

under the laws of the United States or 

one of the States, may not take 

advantage of this exemption. 

Like the proposal, the final rule 

incorporates the statutory requirement 

that the banking entity conduct its 

trading activities pursuant to sections 

4(c)(9) or 4(c)(13) of the BHC Act.1496

The final rule retains the tests in the 

proposed rule for determining when a 

banking entity would meet that 

requirement. The final rule provides 

qualifying criteria for both a banking 

entity that is a qualifying foreign 

banking organization under the Board’s 

Regulation K and a banking entity that 

is not a foreign banking organization for 

purposes of Regulation K.1497

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

to any company organized under the 

laws of a foreign country the greater part 

of whose business is conducted outside 

the United States, if the Board by 

regulation or order determines that, 

under the circumstances and subject to 

the conditions set forth in the regulation 

or order, the exemption would not be 

substantially at variance with the 

purposes of the BHC Act and would be 

in the public interest.1498 The Board has 

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

subpart B of the Board’s Regulation 

K,1499 which specifies a number of 

conditions and requirements that a 

foreign banking organization must meet 

in order to act pursuant to that 

authority.1500 The qualifying conditions 

and requirements include, for example, 

that the foreign banking organization 

demonstrate that more than half of its 

worldwide business is banking and that 

more than half of its banking business 

is outside the United States.1501 Under 

the final rule a banking entity that is a 

qualifying foreign banking organization 

for purposes of the Board’s Regulation 

K, other than a foreign bank as defined 

in section 1(b)(7) of the International 

Banking Act of 1978 that is organized 

under the laws of any commonwealth, 

territory, or possession of the United 

States, will qualify for the exemption for 

proprietary trading activity of a foreign 

banking entity.1502

Section 13 of the BHC Act also 

applies to foreign companies that 

control a U.S. insured depository 

institution but that are not currently 

subject to the BHC Act generally or to 

the Board’s Regulation K—for example, 

because the foreign company controls a 

savings association or an FDIC-insured 

industrial loan company. Accordingly, 

the final rule also provides that a foreign 

banking entity that is not a foreign 

banking organization would be 

considered to be conducting activities 

‘‘pursuant to section 4(c)(9)’’ for 

purposes of this exemption 1503 if the 

entity, on a fully-consolidated basis, 

meets at least two of three requirements 

that evaluate the extent to which the 

foreign banking entity’s business is 

conducted outside the United States, as 

measured by assets, revenues, and 

income.1504 This test largely mirrors the 

qualifying foreign banking organization 

test that is made applicable under 

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

section 211.23(a), (c), or (e) of the 

Board’s Regulation K, except that the 

test does not require the foreign entity 

to demonstrate that more than half of its 

banking business is outside the United 

States.1505 This difference reflects the 

fact that foreign entities subject to 

section 13 of the BHC Act, but not the 

BHC Act generally, are likely to be, in 

many cases, predominantly commercial 

firms. A requirement that such firms 

also demonstrate that more than half of 

their banking business is outside the 

United States would likely make the 

exemption unavailable to such firms 

and subject their global activities to the 

prohibition on proprietary trading. 

b. Permitted Trading Activities of a 

Foreign Banking Entity 

As noted above, the proposed rule 

laid out a transaction-based approach to 


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1506See proposed rule § 75.6(d). 

1507See BoA; Citigroup (Feb. 2012); British 

Bankers’ Ass’n.; Credit Suisse (Seidel); George 

Osbourne; IIB/EBF. 

1508See Cadwalader (on behalf of Singapore 

Banks); Ass’n. of Banks in Malaysia; Cadwalader 

(on behalf of Thai Banks); IIF; ICE; Banco de 

Me ́xico; ICFR; Australian Bankers Ass’n. (Feb. 

2012); BAROC. 

1509See ICE. 

1510See, e.g., RBC. 

1511See, e.g., IIF; ICE; Socie ́te ́ Ge ́ne ́rale; Mexican 

Banking Comm’n.; Australian Bankers Ass’n. (Feb. 

2012); Banco de Me ́xico; OSFI. In addition, a few 

commenters argued that Canadian and Mexican 

financial firms frequently use U.S. infrastructure to 

conduct their trading activities in Canada or 

Mexico. See, e.g., OSFI; Banco de Me ́xico; Mexican 

Banking Comm’n. 

1512See, e.g., ICE; Socie ́te ́ Ge ́ne ́rale (arguing that 

the requirement would impair capital raising efforts 

of many U.S. companies); Australian Bankers Ass’n. 

(Feb. 2012); Canadian Minister of Fin.; Ass’n. of 

German Banks. 

1513See IIB/EBF. 

1514See Bank of Canada; Banco de Me ́xico; Allen 

& Overy (on behalf of Canadian Banks). 

1515See Allen & Overy (on behalf of Candian 

Banks). 

1516See IIF. 1517See BaFin/Deutsche Bundesbank; ICSA; IIB/ 

EBF; Allen & Overy (on behalf of Canadian Banks); 

Credit Suisse (Seidel); George Osbourne. 1518See IIB/EBF. 1519See IIB/EBF. 1520See 12 U.S.C. 1851(d)(1)(J). 

implementing the foreign trading 

exemption and provided that a 

transaction would be considered to 

qualify for the exemption only if (i) the 

transaction was conducted by a banking 

entity not organized under the laws of 

the United States or of one or more 

States; (ii) no party to the transaction 

was a resident of the United States; (iii) 

no personnel of the banking entity that 

was directly involved in the transaction 

was physically located in the United 

States; and (iv) the transaction was 

executed wholly outside the United 

States.1506

Many commenters objected to the 

proposed exemption, arguing that it was 

unworkable and would have 

unintended consequences. For example, 

commenters argued that prohibiting a 

foreign banking entity from conducting 

a proprietary trade with a resident of the 

United States, including a subsidiary or 

branch of a U.S. banking entity, 

wherever located, would likely cause 

foreign banking entities to be unwilling 

to enter into permitted trading 

transactions with foreign subsidiaries or 

branches of U.S. firms.1507 In addition, 

some commenters represented that it 

would be difficult to determine and 

track whether a party is a resident of the 

United States or that this requirement 

would require non-U.S. banking entities 

to inefficiently bifurcate their activities 

into U.S.-facing and non-U.S.-facing 

trading desks.1508 For example, one 

commenter noted that trading on many 

exchanges and platforms is anonymous 

(i.e., each party to the trade is unaware 

of the identity of the other party to the 

trade), so a foreign banking entity would 

likely have to avoid U.S. trading 

platforms and exchanges entirely to 

avoid transactions with any resident of 

the United States.1509 Further, 

commenters stated that the proposed 

rule could deter foreign banking entities 

from conducting business with U.S. 

parties outside of the United States, 

which could also incentivize foreign 

market centers to limit participation by 

U.S. parties on their markets.1510

Commenters also expressed concern 

about the requirement that transactions 

be executed wholly outside of the 

United States in order to qualify for the 

proposed foreign trading exemption. 

Commenters represented that foreign 

banking entities currently use U.S. 

trading platforms to trade in certain 

products (such as U.S.-listed securities 

or a variety of derivatives contracts), to 

take advantage of robust U.S. 

infrastructure, and for time zone 

reasons.1511 Commenters indicated that 

the proposed requirement could harm 

the competitiveness of U.S. trading 

platforms and the liquidity available on 

such facilities.1512 Some commenters 

stated that this requirement would 

effectively result in most foreign 

banking entities moving their trading 

operations and personnel outside of the 

United States and executing 

transactions on exchanges outside of the 

United States.1513 These commenters 

stated that the relocation of these 

activities would reduce trading activity 

in the United States that supports the 

financial stability and efficiency of U.S. 

markets. Moreover, these commenters 

argued that, if foreign banking entities 

relocate their personnel from the United 

States to overseas, this would diminish 

U.S. jobs with no concomitant benefit. 

They also contended that the proposal 

was at cross purposes with other parts 

of the Dodd-Frank Act and would 

hinder growth of market infrastructure 

being developed under the requirements 

of Title VII of that Act, including use of 

swap execution facilities and securitybased swap execution facilities to 

enhance transparency in the swaps 

markets and use of central 

clearinghouses to reduce counterparty 

risk for the parties to a swap 

transaction.1514 For example, one 

commenter represented that the 

proposed exemption could make it 

difficult for non-U.S. swap entities to 

comply with potential mandatory 

execution requirements under Title VII 

of the Dodd-Frank Act and could cause 

market fragmentation across borders 

through the creation of parallel 

execution facilities outside of the 

United States, which would result in 

less transparency and greater systemic 

risk.1515 In addition, another commenter 

stated that the proposed requirement 

would force issuers to dually list their 

securities to permit trading on non-U.S. 

exchanges and, further, clearing and 

settlement systems would have to be set 

up outside of the United States, which 

would create inefficiencies, operational 

risks, and potentially systemic risk by 

adding needless complexity to the 

financial system.1516

Instead of the proposal’s transactionbased approach to implementing the 

foreign trading exemption, many 

commenters suggested the final rule 

adopt a risk-based approach.1517 These 

commenters noted that a risk-based 

approach would prohibit or 

significantly limit the amount of 

financial risk from such activities that 

could be transferred to the United States 

by the foreign trading activity of foreign 

banking entities.1518 Commenters also 

noted that foreign trading activities of 

most foreign banking entities are already 

subject to activities limitations, capital 

requirements, and other prudential 

requirements of their home-country 

supervisor(s).1519

The Agencies have carefully 

considered these comments and have 

determined to modify the approach in 

the final rule. The Agencies believe that 

the revisions mitigate the potential 

adverse impacts of the proposed 

approach while still remaining faithful 

to the overall purpose of section 

13(d)(1)(H). Also, the Agencies believe 

that section 13(d)(1)(J) of the BHC Act, 

which authorizes the Agencies to 

provide an exemption from the 

prohibition on proprietary trading for 

any activity the Agencies determine by 

rule ‘‘would promote and protect the 

safety and soundness of the banking 

entity and the financial stability of the 

United States,’’ 1520 supports allowing 

foreign banking entities to use U.S. 

infrastructure and trade with certain 

U.S. counterparties in certain 

circumstances, which will promote and 

protect the safety and soundness of 

banking entities and U.S. financial 

stability. 

Overall, the comments illustrated that 

both the mechanical steps of the 

specified transactions to purchase or 

sell various instruments (e.g., execution, 

clearing), and the identity of the entity 

for whose trading account the specified 

trading is conducted are important.1521

Consistent with the comments described 

above, the Agencies believe that the 


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1522See, e.g., 12 U.S.C. 1851(b)(1) (directing the 

FSOC to study and make recommendations on 

implementing section 13 so as to, among other 

things, protect taxpayers and consumers and 

enhance financial stability by minimizing the risk 

that insured depository institutions and the 

affiliates of insured depository institutions will 

engage in unsafe and unsound activities). 

1523See, e.g., 156 Cong. Rec. S5897 (daily ed. July 

15, 2010) (statement of Sen. Merkley) (stating that 

the foreign trading exemption ‘‘recognize[s] rules of 

international comity by permitting foreign banks, 

regulated and backed by foreign taxpayers, in the 

course of operating outside of the United States to 

engage in activities permitted under relevant 

foreign law.’’). 

1524 12 U.S.C. 1851(d)(1)(J). 

1525The proposed rule also contained a definition 

of ‘‘resident of the United States’’ that was designed 

to capture the scope of U.S. counterparties that, if 

involved in the transaction, would preclude that 

transaction from being considered to have occurred 

solely outside the United States. The final rule 

addresses this point by including a definition, for 

purposes of § 75.6(e) only, of the term ‘‘U.S. entity.’’ 

1526Personnel that arrange, negotiate, or execute 

a purchase or sale conducted under the exemption 

for trading activity of a foreign banking entity must 

be located outside of the United States. Thus, for 

example, personnel in the United States cannot 

solicit or sell to or arrange for trades conducted 

under this exemption. Personnel in the United 

States also cannot serve as decision makers in 

transactions conducted under this exemption. 

Personnel that engage in back-office functions, such 

as clearing and settlement of trades, would not be 

considered to arrange, negotiate, or execute a 

purchase or sale for purposes of this provision. 

1527This provision is not intended to restrict the 

ability of a U.S. branch or affiliate of a foreign 

banking entity to provide funds collected in the 

United States to its foreign parent for general 

purposes. 

1528 ‘‘U.S. entity’’ is defined for purposes of this 

provision as any entity that is, or is controlled by, 

or is acting on behalf of, or at the direction of, any 

other entity that is, located in the United States or 

organized under the laws of the United States or of 

any State. See final rule § 75.6(e)(4). 

1529This provision would generally allow market 

intermediaries to engage in market-making, 

underwriting or similar market intermediation 

functions. 

application of section 13(d)(1)(H) and 

their exemptive authority under section 

13(d)(1)(J) should focus on both how the 

transaction occurs and which entity will 

bear the risk of those transactions. 

Although the statute does not define 

expressly what it means to act ‘‘as a 

principal’’ (acting as principal 

ordinarily means acting for one’s own 

account), the combination of references 

to engaging as principal and to a trading 

account focuses on an entity’s incurring 

risks of profit and loss through taking 

ownership of securities and other 

instruments. Thus, the final rule 

provides an exemption for trading 

activities of foreign banking entities that 

addresses both the location of the 

facilities that effect the acquisition, 

holding, and disposition of such 

positions, and the location of the 

banking entity that incurs such risks 

through acquisition, holding, and 

disposition of such positions. 

The Agencies believe this approach is 

consistent with one of the principal 

purposes of section 13, which is to limit 

risks that proprietary trading poses to 

the U.S. financial system.1522 Further, 

the purpose of section 13(d)(1)(H) is to 

limit the extraterritorial application of 

section 13 as it applies to foreign 

banking entities.1523

In addition, prohibiting foreign 

banking entities from using U.S. 

infrastructure or trading with all U.S. 

counterparties could cause certain 

trading activities to move offshore, with 

corresponding negative impacts on U.S. 

market participants, including U.S. 

banking entities. For example, 

movement of trading activities offshore, 

particularly in U.S. financial 

instruments, could result in bifurcated 

markets for these instruments that are 

less efficient and less liquid and could 

reduce transparency for oversight of 

trading in these instruments. In 

addition, reducing access to foreign 

counterparties for U.S. instruments 

could concentrate risks in the United 

States and to its financial system. 

Moreover, the statute provides separate 

exemptions for U.S. banking entities to 

engage in underwriting and market 

making-related activities, subject to 

certain requirements, and there is no 

evidence that limiting the range of 

potential customers for these entities 

would further the purposes of the 

statute. In fact, it is possible that 

limiting the customer bases of U.S. 

banking entities, as well as other U.S. 

firms that are not banking entities, could 

reduce their ability to effectively 

manage their inventories and risks and 

could also result in concentration risk. 

These potential effects of the 

approach taken in the proposal appear 

to be inconsistent with the statute’s 

goals, including the promotion and 

protection of the safety and soundness 

of banking entities and U.S. financial 

stability. To the contrary, the exemptive 

approach taken in the final rule appears 

to be more consistent with the goals of 

the statute and would promote and 

protect the safety and soundness of 

banking entities and U.S. financial 

stability by limiting the risks of foreign 

banking entities’ proprietary trading 

activities to the U.S. financial system, 

while also allowing U.S. markets to 

continue to operate efficiently in 

conjunction with foreign markets (rather 

than creating incentives to establish 

barriers between U.S. and foreign 

markets).1524

Thus, in response to commenter 

concerns, the final rule has been 

modified to better reflect the text and 

achieve the overall purposes of the 

statute (by ensuring that the principal 

risks of proprietary trading by foreign 

banking entities allowed under the 

foreign trading exemption remain solely 

outside of the United States) while 

mitigating potentially adverse effects on 

competition.1525 In order to ensure these 

risks remain largely outside of the 

United States, and to limit potential risk 

that could flow to the U.S. financial 

system through trades by foreign 

banking entities with or through U.S. 

entities, the final rule includes several 

conditions on the availability of the 

exemption. Specifically, in addition to 

limiting the exemption to foreign 

banking entities, the final rule provides 

that the exemption for the proprietary 

trading activity of a foreign banking 

entity is available only if: 

• The banking entity engaging as 

principal in the purchase or sale 

(including any personnel of the banking 

entity or its affiliate that arrange, 

negotiate or execute such purchase or 

sale) is not located in the United States 

or organized under the laws of the 

United States or of any State; 1526

• The banking entity (including 

relevant personnel) that makes the 

decision to purchase or sell as principal 

is not located in the United States or 

organized under the laws of the United 

States or of any State; 

• The purchase or sale, including any 

transaction arising from risk-mitigating 

hedging related to the instruments 

purchased or sold, is not accounted for 

as principal directly or on a 

consolidated basis by any branch or 

affiliate that is located in the United 

States or organized under the laws of 

the United States or of any State; 

• No financing for the banking 

entity’s purchase or sale is provided, 

directly or indirectly, by any branch or 

affiliate that is located in the United 

States or organized under the laws of 

the United States or of any State; 1527

• The purchase or sale is not 

conducted with or through any U.S. 

entity,1528 other than: 

Æ A purchase or sale with the foreign 

operations of a U.S. entity, if no 

personnel of such U.S. entity that are 

located in the United States are 

involved in the arrangement, 

negotiation or execution of such 

purchase or sale. 

The Agencies believe it is appropriate 

to exercise their exemptive authority 

under section 13(d)(1)(J) to also allow, 

under clause (vi) of the final rule, the 

following types of purchases or sales 

conducted with a U.S. entity: 

Æ A purchase or sale with an 

unaffiliated market intermediary acting 

as principal,1529 provided the purchase 


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5928 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

1530See final rule § 75.6(e)(5). 

1531See, e.g., 156 Cong. Rec. S5897 (daily ed. July 

15, 2010) (statement of Sen. Merkley) (‘‘However, 

these subparagraphs are not intended to permit a 

U.S. banking entity to avoid the restrictions on 

proprietary trading simply by setting up an offshore 

subsidiary or reincorporating offshore, and 

regulators should enforce them accordingly.’’). 

1532See final rule § 75.6(e)(1)(i). 

1533A number of commenters also requested that 

the foreign trading exemption permit proprietary 

trading of foreign sovereign debt or similar 

obligations of foreign governments. As discussed in 

Part VI.A.5.b. of this SUPPLEMENTARY INFORMATION, 

the final rule addresses banking entities’ ability to 

engage in transaction in these types of instruments 

in § 75.6(b). 

1534See final rule § 75.6(e)(5). For example, under 

this definition, a bank that is exempt from 

registration as a swap dealer under the de minimis 

exception to swap dealer registration requirements 

could be a market intermediary for transactions in 

swaps. See 17 CFR 1.3(ggg)(4). 

or sale is promptly cleared and settled 

through a clearing agency or derivatives 

clearing organization acting as a central 

counterparty; or 

Æ A purchase or sale through an 

unaffiliated market intermediary, 

provided the purchase or sale is 

conducted anonymously (i.e. each party 

to the purchase or sale is unaware of the 

identity of the other party(ies) to the 

purchase or sale) on an exchange or 

similar trading facility and promptly 

cleared and settled through a clearing 

agency or derivatives clearing 

organization acting as a central 

counterparty. 

The requirements are designed to 

ensure that any foreign banking entity 

engaging in trading activity under this 

exemption does so in a manner that 

ensures the risk, decision-making, 

arrangement, negotiation, execution and 

financing of the activity resides solely 

outside the United States and limits the 

risk to the U.S. financial system from 

trades by foreign banking entities with 

or through U.S. entities. 

The final rule specifically recognizes 

that, for purposes of the exemption for 

trading activity of a foreign banking 

entity, a U.S. branch, agency, or 

subsidiary of a foreign bank, or any 

subsidiary thereof, is located in the 

United States; however, a foreign bank 

that operates or controls that branch, 

agency, or subsidiary is not considered 

to be located in the United States solely 

by virtue of operation of the U.S. 

branch, agency, or subsidiary.1530 This 

provision helps give effect to the 

statutory language limiting the foreign 

trading exemption to activities of 

foreign banking entities that occur 

solely outside of the United States by 

clarifying that the U.S. operations of 

foreign banking entities may not 

conduct proprietary trading based on 

this exemption. 

The Agencies have considered 

whether the concerns raised by 

commenters that the foreign operations 

of U.S. banking entities would be 

disadvantaged in competing outside the 

United States warrant an exemption 

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

that extends to foreign operations of 

U.S. banking entities. The 

competitiveness of U.S. banking entities 

outside the United States often 

improves the potential for the 

operations of U.S. firms outside the 

United States to succeed and be 

profitable, and thereby, often improves 

the safety and soundness of the entity 

and financial stability in the United 

States. 

However, Congress has determined to 

generally prohibit U.S. banking entities 

(including foreign branches and 

subsidiaries thereof) from engaging in 

proprietary trading because of the 

perceived risks of those activities to 

banking entities and the U.S. 

economy.1531 Allowing U.S. banking 

entities to conduct, through branches or 

subsidiaries that are physically located 

outside the United States, the same 

proprietary trading activities those U.S. 

firms are expressly prohibited from 

conducting directly through their 

operations located within the United 

States would subject U.S. banking 

entities and the U.S. economy to the 

very risks section 13 is designed to 

avoid. The risks of proprietary trading 

would continue to be borne by the U.S. 

banking entity whether the activity is 

conducted by the U.S. banking entity 

through units physically located inside 

or outside of the United States. 

Moreover, the robust trading markets 

that exist overseas could allow U.S. 

banking entities to shift their prohibited 

proprietary trading activities to 

branches or subsidiaries that are 

physically located outside the United 

States under such an exemption, 

without achieving a meaningful 

elimination of risk. Accordingly, the 

Agencies have not exercised their 

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

this time to allow U.S. banking entities 

to conduct otherwise prohibited 

proprietary trading activities through 

operations located outside the United 

States. As a consequence, and consistent 

with the statutory language and purpose 

of section 13(d)(1)(H) of the BHC Act, 

the final rule provides that the 

exemption is available only if the 

banking entity is not organized under, 

or directly or indirectly controlled by a 

banking entity that is organized under, 

the laws of the United States or of one 

or more States.1532

As discussed above, many 

commenters requested that the final rule 

permit a foreign banking entity to 

engage in proprietary trading 

transactions with a greater variety of 

counterparties, including counterparties 

that are located in or organized and 

incorporated under the laws of the 

United States or of one or more 

States.1533 These commenters also 

requested that the final rule not require 

that any purchase or sale under the 

exemption be executed wholly outside 

of the United States. 

As described above and in response to 

commenters’ concerns, the final rule 

provides that a foreign banking entity 

generally may engage in trading activity 

under the exemption with U.S. entities, 

provided the transaction is with the 

foreign operations of an unaffiliated 

U.S. firm (whether or not the U.S. firm 

is a banking entity subject to section 13 

of the BHC Act) and does not involve 

any personnel of the U.S. entity that are 

in the United States and involved in the 

arrangement, negotiation, or execution 

of the transaction. The Agencies have 

also exercised their exemptive authority 

under section 13(d)(1)(J) to allow foreign 

banking entities to engage in a 

transaction that is either through an 

unaffiliated market intermediary and 

executed anonymously on an exchange 

or similar trading facility (regardless of 

whether the ultimate counterparty is a 

U.S. entity or not) or is executed with 

a U.S. entity that is an unaffiliated 

market intermediary acting as principal, 

provided in either case that the 

transaction is promptly cleared and 

settled through a clearing agency or 

derivatives clearing organization acting 

as a central counterparty. 

For purposes of the final rule, market 

intermediary is defined as an 

unaffiliated entity, acting as an 

intermediary, that is: (i) A broker or 

dealer registered with the SEC under 

section 15 of the Exchange Act or 

exempt from registration or excluded 

from regulation as such; (ii) a swap 

dealer registered with the CFTC under 

section 4s of the Commodity Exchange 

Act or exempt from registration or 

excluded from regulation as such; (iii) a 

security-based swap dealer registered 

with the SEC under section 15F of the 

Exchange Act or exempt from 

registration or excluded from regulation 

as such; or (iv) a futures commission 

merchant registered with the CFTC 

under section 4f of the Commodity 

Exchange Act or exempt from 

registration or excluded from regulation 

as such.1534

These provisions of the final rule, 

viewed as a whole, prevent the 


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1535See final rule § 75.6(e)(3)(v)(A). 

1536The Agencies believe that this provision 

should address commenters’ concerns that the 

proposed rule could cause foreign banking entities 

to avoid conducting business with U.S. firms 

outside the United States or could incentivize 

foreign market places to restrict access to U.S. firms. 

See, e.g., RBC. 

1537Under the final rule, ‘‘anonymous’’ means 

that each party to a purchase or sale is unaware of 

the identity of the other party(ies) to the purchase 

or sale. See final rule § 75.3(e)(1). 

1538See, e.g., 15 U.S.C. 78f(c)(1) (providing that 

a national securities exchange shall deny 

membership to (A) any person, other than a natural 

person, which is not a registered broker or dealer 

or (B) any natural person who is not, or is not 

associated with, a registered broker or dealer). 

1539See final rule § 75.3(e)(6) (defining the term 

‘‘exchange’’). The rule refers to an ‘‘exchange or 

similar trading facility.’’ A similar trading facility 

for these purposes may include, for example, an 

alternative trading system. 

1540 In addition, allowing a foreign banking entity 

to trade directly with a U.S. end user customer 

under the foreign trading exemption could give the 

foreign banking entity a competitive advantage over 

U.S. banking entities with respect to trading in the 

United States. 

exemption for trading of foreign banking 

entities from weakening U.S. trading 

markets and U.S. firms that are either 

not subject to the provisions of section 

13 or that conduct activities in 

compliance with other parts of section 

13. For instance, the final rule permits 

a foreign banking entity to trade under 

the exemption with the foreign 

operations of a U.S. firm, so long as the 

purchase or sale does not involve any 

personnel of the U.S. firm who are 

located in the United States and 

involved in arranging, negotiating or 

executing the trade.1535 Transactions 

that occur outside of the United States 

between foreign operations of U.S. 

entities and foreign banking entities 

improve access to and functioning of 

liquid markets without raising the 

concerns for increased risk to banking 

entities in the U.S. that motivated 

enactment of section 13 of the BHC Act. 

The final rule permits a foreign banking 

entity to engage in transactions with the 

foreign operations of both U.S. nonbanking and U.S. banking entities. 

Among other things, this approach will 

ensure that the foreign operations of 

U.S. banking entities continue to be able 

to access foreign markets.1536 The 

language of the exemption expressly 

requires that trading with the foreign 

operations of a U.S. entity may not 

involve the use of personnel of the U.S. 

entity who are located in the United 

States for purposes of arranging, 

negotiating, or executing transactions. 

Under the final rule, the exemption in 

no way exempts the U.S. or foreign 

operations of the U.S. banking entities 

from having to comply with the 

restrictions and limitations of section 

13. Thus, the U.S. and foreign 

operations of a U.S. banking entity that 

is engaged in permissible market 

making-related activities or other 

permitted activities may engage in those 

transactions with a foreign banking 

entity that is engaged in proprietary 

trading in accordance with the 

exemption under § 75.6(e) of the final 

rule. Importantly, the final rule does not 

impose a duty on the foreign banking 

entity or the U.S. banking entity to 

ensure that its counterparty is 

conducting its activity in conformance 

with section 13 of the BHC Act and the 

final rule. Rather, that burden is at all 

times on each party subject to section 13 

to ensure that it is conducting its 

activities in accordance with section 13 

and this implementing rule. 

The final rule also permits, pursuant 

to section 13(d)(1)(J), a foreign banking 

entity to trade through an unaffiliated 

market intermediary if the trade is 

conducted anonymously on an 

exchange or similar trading facility and 

is promptly cleared and settled through 

a clearing agency or derivatives clearing 

organization.1537 Allowing foreign 

banking entities to generally conduct 

anonymous proprietary trades on U.S. 

exchanges and similar anonymous 

trading facilities allows these exchanges 

and facilities—which are generally not 

subject to section 13 and do not take the 

risks section 13 is designed to address— 

to serve the widest possible range of 

counterparties. This prevents the 

potential adverse impacts from possible 

reductions in competitiveness of or 

liquidity available on these regulated 

exchanges and facilities, which could 

also harm other U.S. market participants 

who trade on these exchanges and 

facilities. In addition, the Agencies 

recognize that anonymous trading on 

exchanges and similar anonymous 

trading facilities promotes transparency 

and that prohibiting foreign banking 

entities from trading on U.S. exchanges 

and similar anonymous trading facilities 

under this exemption would likely 

reduce transparency for trading in U.S. 

financial instruments. All of these 

considerations support the Agencies’ 

exercise of their exemptive authority 

under section 13(d)(1)(J) to allow such 

trading by foreign banking entities. 

The final rule requires that foreign 

banking entities trade through an 

unaffiliated market intermediary to 

access a U.S. exchange or trading 

facility in recognition that existing laws 

and regulations generally require this 

structure.1538 For purposes of this 

exemption, an exchange would include, 

unless the context otherwise requires, 

any designated contract market, swap 

execution facility, or foreign board of 

trade registered with the CFTC, and any 

exchange or security-based swap 

execution facility, as such terms are 

defined under the Exchange Act.1539

This provision of the final rule 

requires that foreign banking entities 

trade anonymously and that the trade be 

centrally cleared and settled. The 

Agencies understand that in these 

circumstances, the foreign banking 

entity would not have any prior 

information regarding its counterparty 

to the trade. Requiring that the trade be 

executed anonymously preserves the 

benefits of allowing U.S. entities to 

participate in such trades, while 

reducing the potential for evasion of 

section 13 that could occur if foreign 

banking entities directly arranged 

purchases and sales with U.S. 

entities.1540 The final rule specifies that 

a trade is anonymous if each party to the 

purchase or sale is unaware of the 

identity of the other party(ies) to the 

purchase or sale. That is, it is lack of 

knowledge of the identity of the 

counterparty(ies) to the trade that is 

relevant. The final rule does not 

prohibit foreign banking entities from 

accessing a trading facility through an 

unaffiliated U.S. market intermediary 

(which the foreign banking entity would 

necessarily know), so long as the foreign 

banking entity is not aware of the 

identity of the counterparty to the 

transaction. 

Similarly, also pursuant to section 

13(d)(1)(J), the final rule allows a foreign 

banking entity to trade with an 

unaffiliated market intermediary acting 

in a principal capacity and effecting a 

market intermediation function, in a 

transaction that is not conducted on an 

exchange or similar anonymous trading 

facility, as long as the trade is promptly 

cleared and settled through a clearing 

agency or derivatives clearing 

organization. This provision recognizes 

that not all financial instruments are 

traded on an exchange or similar 

anonymous trading facility and, thus, 

allows foreign banking entities to trade 

and contribute to market liquidity in all 

types of U.S. financial instruments 

without requiring separate market 

infrastructure to be developed outside 

the U.S. for such trading activity, which 

could result in inefficiencies and reduce 

U.S. market liquidity. Market 

intermediaries can serve the same 

general purpose as exchanges or similar 

trading facilities in intermediating 

between buyers and sellers, particularly 

in asset classes that do not generally 

trade on these exchanges or facilities, 

although this intermediation function 


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1541 In addition, allowing a foreign banking entity 

to trade through or with a U.S. affiliate under the 

exemption for trading activity of a foreign banking 

entity could give the foreign banking entity a 

competitive advantage over U.S. banking entities 

that are subject to limitations on their trading 

activities. Thus, the Agencies are not permitting a 

foreign banking entity to trade through a U.S. 

affiliate as agent, as requested by some commenters. 

See, e.g., IIB/EBF. However, the Agencies recognize 

that, with respect to trading anonymously, there is 

no way to know the identity of the counterparty to 

the trade. Thus, a foreign banking entity would not 

be in violation of this rule if it traded through an 

unaffiliated market intermediary on an exchange, in 

accordance with the exemption for trading activity 

of a foreign banking entity, and the counterparty to 

its trade happened to be an affiliated entity. 

1542As discussed above, centralized clearing 

redistributes counterparty risk among members of a 

clearing agency or derivatives clearing organization 

through mutualization of losses, reducing the 

likelihood of sequential counterparty failure and 

contagion. See supra note 271 and accompanying 

text. 

1543Section 75.8 of the proposed rule regarding 

limitations on permitted trading activities is 

consistent with § 75.17 of the proposed rule 

regarding other limitations on permitted covered 

funds activities. Accordingly, the discussion 

regarding proposed rule § 75.8 and final rule § 75.7 

in this part also pertain to § 75.17 of the proposed 

rule and § 75.16 of the final rule. See also Part 

VI.B.6., infra. 

1544See 12 U.S.C. 1851(d)(2). 

1545See, e.g., Sens. Merkley & Levin (Feb. 2012); 

Public Citizen; Paul Volcker. 

1546See Alfred Brock. 

1547See IIB/EBF; Ass’n. of German Banks. 

may not be as immediate in the case of 

market intermediaries. 

In either case (i.e., for either an 

anonymous trade or a trade with an 

unaffiliated market intermediary), if the 

U.S. counterparty to the transaction is a 

banking entity subject to section 13 and 

these rules, it must comply with an 

exemption to the prohibition on 

proprietary trading, such as the marketmaking exemption or the exemption for 

riskless principal transactions. Allowing 

foreign banking entities to trade with 

unaffiliated U.S. market intermediaries, 

including banking entities engaged in 

permitted market making-related 

activities, expands the range of potential 

buyers and sellers for which the U.S. 

entities can trade and may result in 

more efficient and timely matching of 

trades, reducing inventory risks to the 

U.S. market intermediary. At the same 

time, this exemption does not permit a 

U.S. market intermediary that is subject 

to section 13 of the BHC Act to conduct 

trading activities other than in 

compliance with the provisions of 

section 13. Thus, the Agencies believe it 

is appropriate to allow foreign banking 

entities to conduct such trading under 

the exemption in section 13(d)(1)(J). 

To reduce risks to U.S. entities and 

the potential for evasion, the provisions 

allowing trading with U.S. entities 

include two additional protections. 

First, the final rule does not allow a 

foreign banking entity to trade through 

an affiliated U.S. entity under the 

exemption out of concern that it could 

increase the risk of evasion.1541 Second, 

a foreign banking entity’s trades 

conducted through an unaffiliated 

market intermediary on an exchange or 

conducted directly with an unaffiliated 

market intermediary must be promptly 

cleared and settled through a clearing 

agency or derivatives clearing 

organization acting as central 

counterparty. Consistent with the goals 

of section 13 to reduce risk to banking 

entities and the U.S. financial system, 

this requirement is designed to reduce 

risk to U.S. entities arising from foreign 

banking entities’ proprietary trading 

activity, particularly counterparty risk, 

and preclude foreign banking entities 

from relying on the exemption for 

trading that creates exposure of U.S. 

counterparties pursuant to bilateral, 

uncleared transactions, which poses 

heightened counterparty credit risks.1542

This condition is also consistent with 

the systemic risk benefits of central 

clearing and may incentivize the use of 

central clearing for trading by foreign 

banking entities and foreign affiliates of 

U.S. banking entities. The Agencies 

believe this approach is consistent with 

and reinforces the goals of the central 

clearing framework of Title VIII of the 

Dodd-Frank Act. 

The final rule does not allow a foreign 

banking entity to trade with a broader 

range of U.S. entities under the 

exemption because the Agencies are 

concerned such an approach may result 

in adverse competitive impacts between 

U.S. banking entities and foreign 

banking entities with respect to their 

trading in the United States, which 

could harm the safety and soundness of 

banking entities and U.S. financial 

stability. For example, such an approach 

could allow foreign banking entities to 

act as market makers for U.S. customers 

under the exemption in § 75.6(e) of the 

final rule so long as the foreign banking 

entity held the risk of its market-making 

trades outside the United States. In turn, 

this could give foreign banking entities 

a competitive advantage over U.S. 

banking entities with respect to U.S. 

market-making activities because 

foreign banking entities could trade 

directly with U.S. non-banking entities 

without incurring the additional costs, 

or being subject to the limitations, 

associated with the market-making or 

other exemptions under the rule. This 

competitive disparity in turn could 

create a significant potential for 

regulatory arbitrage. The Agencies do 

not believe this result was intended by 

the statute. Instead, the final rule seeks 

to alleviate the concern that an overly 

broad approach to the exemption (e.g., 

permitting trading with all U.S. 

counterparties) may result in 

competitive impacts and increased risks 

to the U.S. financial system, while 

mitigating the concern that an overly 

narrow approach to the exemption (e.g., 

prohibiting trading with any U.S. 

counterparty) may cause market 

bifurcations, reduce the efficiency and 

liquidity of markets, and harm U.S. 

market participants. 

9. Section 75.7: Limitations on 

Permitted Trading Activities 

Section 75.8 of the proposed rule 

implemented section 13(d)(2) of the 

BHC Act,1543 which provides that a 

banking entity may not engage in certain 

exempt activities (e.g., permitted market 

making-related activities, risk-mitigating 

hedging, etc.) if the activity would 

involve or result in a material conflict 

of interest between the banking entity 

and its clients, customers, or 

counterparties; result, directly or 

indirectly, in a material exposure by the 

banking entity to a high-risk asset or a 

high-risk trading strategy; or pose a 

threat to the safety and soundness of the 

banking entity or U.S. financial 

stability.1544 The Agencies sought 

comment on proposed definitions of the 

terms ‘‘material conflict of interest,’’ 

‘‘high-risk asset,’’ and ‘‘high-risk trading 

strategy’’ for these purposes. 

With respect to general comments 

regarding the proposed rule, 

commenters generally agreed on the 

need to limit banking entities’ 

proprietary trading activities so as to 

avoid material conflicts of interest and 

material exposures to high-risk trading 

strategies and high-risk assets.1545 One 

commenter expressed support for the 

Agencies’ proposed approach, stating 

that the proposed rule was clear and 

structured in such a manner so that it 

should remain effective even as 

financial markets evolve and 

change.1546 As discussed in greater 

detail below, most commenters 

suggested amendments, clarification, or 

alternative approaches. For example, 

some commenters expressed concern 

regarding the application of the 

prudential backstops to the activities of 

foreign banking entities.1547 The 

Agencies did not receive any comments 

on the prohibition against transactions 

or activities that pose a threat to the 

safety or soundness of the banking 

entity or the financial stability of the 

United States. 

As explained in detail below, the 

Agencies have carefully reviewed 


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1548The Agencies note that proposed Appendix 

C, which required banking entities to describe how 

they comply with these provisions, will be adopted 

as Appendix B with similar requirements regarding 

compliance with the limitations on permitted 

activities. 

1549Section 75.17(b) of the proposed rule defined 

the scope of material conflicts of interest which, if 

arising in connection with permitted covered fund 

activities, are prohibited. 

1550See, e.g., U.S. Senate Permanent 

Subcommittee on Investigations, Wall Street and 

the Financial Crisis: Anatomy of a Financial 

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

hsgac.senate.gov/public/_files/Financial_Crisis/

FinancialCrisisReport.pdf. 

1551See Joint Proposal, 76 FR at 68893. 

1552See proposed rule § 75.8(b)(1). 

1553See Joint Proposal, 76 FR at 68893. 

1554See id. 

1555See proposed rule § 75.8(b)(1)(B). 

comments on the proposed rule’s 

implementation of the prudential 

backstops under section 13(d)(2) of the 

BHC Act, including commenters’ 

suggestions for expanding, contracting, 

or revising the proposed rule. After 

carefully considering these comments, 

the Agencies continue to believe the 

expansive scope of section 13 of the 

BHC Act supports a similarly inclusive 

approach focusing on the facts and 

circumstances of each potential conflict 

or high-risk activity. Therefore, and in 

consideration of all issues discussed 

below, the Agencies are adopting the 

final rule substantially as proposed.1548

The Agencies intend to develop 

additional guidance regarding best 

practices for addressing potential 

material conflicts of interest, high-risk 

assets and trading strategies and 

practices that pose significant risks to 

safety and soundness and to the U.S. 

financial system as the Agencies and 

banking entities gain experience with 

implementation of the requirements and 

limitations in section 13 of the BHC Act 

and this rule, which are all generally 

designed to limit risky behavior in 

trading and investment activities. 

a. Scope of ‘‘Material Conflict of 

Interest’’ 

1. Proposed Rule 

Section 75.8(b) of the proposed rule 

defined the scope of material conflicts 

of interest which, if arising in 

connection with a permitted trading 

activity, were prohibited under the 

proposal.1549 As noted in the proposal, 

conflicts of interest may arise in a 

variety of circumstances related to 

permitted trading activities. For 

example, a banking entity may acquire 

substantial amounts of nonpublic 

information about the financial 

condition of a particular company or 

issuer through its lending, underwriting, 

investment advisory or other activities 

which, if improperly transmitted to and 

used in trading operations, would 

permit the banking entity to use such 

information to its customers’, clients’ or 

counterparties’ disadvantage. Similarly, 

a banking entity may conduct a 

transaction that places the banking 

entity’s own interests ahead of its 

obligations to its customers, clients or 

counterparties, or it may seek to gain by 

treating one customer involved in a 

transaction more favorably than another 

customer involved in that transaction. 

Concerns regarding conflicts of interest 

are likely to be elevated when a 

transaction is complex, highly 

structured or opaque, involves illiquid 

or hard-to-value instruments or assets, 

requires the coordination of multiple 

internal groups (such as multiple 

trading desks or affiliated entities), or 

involves a significant asymmetry of 

information or transactional data among 

participants.1550 In all cases, the 

existence of a material conflict of 

interest depends on the specific facts 

and circumstances.1551

To address these types of material 

conflicts of interest, § 75.8(b) of the 

proposed rule specified that a material 

conflict of interest between a banking 

entity and its clients, customers, or 

counterparties exists if the banking 

entity engages in any transaction, class 

of transactions, or activity that would 

involve or result in the banking entity’s 

interests being materially adverse to the 

interests of its client, customer, or 

counterparty with respect to such 

transaction, class of transactions, or 

activity, unless the banking entity has 

appropriately addressed and mitigated 

the conflict of interest, and subject to 

specific requirements provided in the 

proposal, through either (i) timely and 

effective disclosure, or (ii) information 

barriers.1552 Unless the conflict of 

interest is addressed and mitigated in 

one of the two ways specified in the 

proposal, the related transaction, class 

of transactions or activity would be 

prohibited under the proposed rule, 

notwithstanding the fact that it may be 

otherwise permitted under §§ 75.4 

through 75.6 of the proposed rule.1553

However, the Agencies determined 

that while these conflicts may be 

material for purposes of the proposed 

rule, the mere fact that the buyer and 

seller are on opposite sides of a 

transaction and have differing economic 

interests would not be deemed a 

‘‘material’’ conflict of interest with 

respect to transactions related to bona 

fide underwriting, market making, riskmitigating hedging or other permitted 

activities, assuming the activities are 

conducted in a manner that is consistent 

with the proposed rule and securities, 

derivatives, and banking laws and 

regulations. 

Section 75.8(b)(1) of the proposed rule 

described the two requirements that 

must be met in cases where a banking 

entity addresses and mitigates a material 

conflict of interest through timely and 

effective disclosure. First, 

§ 75.8(b)(1)(A)(i) of the proposed rule 

required that the banking entity, prior to 

effecting the specific transaction or class 

or type of transactions, or engaging in 

the specific activity, for which a conflict 

may arise, make clear, timely and 

effective disclosure of the conflict or 

potential conflict of interest, together 

with any other necessary information. 

This would also require such disclosure 

to be provided in reasonable detail and 

in a manner sufficient to permit a 

reasonable client, customer, or 

counterparty to meaningfully 

understand the conflict of interest.1554

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, § 75.8(b)(1)(ii) of the 

proposed rule required that the 

disclosure be made explicitly and 

effectively, and in a manner that 

provides the client, customer, or 

counterparty the opportunity to negate, 

or substantially mitigate, any materially 

adverse effect on the client, customer, or 

counterparty that was created or would 

be created by the conflict or potential 

conflict.1555

The Agencies noted that, in order to 

provide the requisite opportunity for the 

client, customer or counterparty to 

negate or substantially mitigate the 

disadvantage created by the conflict, the 

disclosure would need to be provided 

sufficiently close in time to the client’s, 

customer’s, or counterparty’s decision to 

engage in the transaction or activity to 

give the client, customer, or 

counterparty an opportunity to 

meaningfully evaluate and, if necessary, 

take steps that would negate or 

substantially mitigate the conflict. 

Disclosure provided far in advance of a 

particular transaction, such that the 

client, customer, or counterparty is 

unlikely to take that disclosure into 

account when evaluating the 

transaction, would not suffice. 

Conversely, disclosure provided 

without a sufficient period of time for 

the client, customer, or counterparty to 

evaluate and act on the information it 


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1556See, e.g., 15 U.S.C. 78c(a)(4)(B)(i)(I)–(IV) 

(finding that disclosure and physical separation of 

personnel and activities addresses the potential that 

consumers might be misled by the broker-dealer 

activities of banks). 15 U.S.C. 80b–6(3) (‘‘It shall be 

unlawful for any investment adviser, by use of the 

mails or any means or instrumentality of interstate 

commerce, directly or indirectly . . . acting as 

principal for his own account, knowingly to sell 

any security to or purchase any security from a 

client, or acting as broker for a person other than 

such client, knowingly to effect any sale or 

purchase of any security for the account of such 

client, without disclosing to such client in writing 

before the completion of such transaction the 

capacity in which he is acting and obtaining the 

consent of the client to such transaction.’’). See also 

Form ADV, the form used by investment advisers 

to register with the Securities and Exchange 

Commission and state securities authorities, and, in 

particular, Form ADV Part 2: Uniform Requirements 

for the Investment Adviser Brochure and Brochure 

Supplements. A registered investment adviser 

generally must deliver the Form ADV brochure, 

which contains disclosure about conflicts of 

interest, to its prospective and existing clients. See 

17 CFR 275.204–3; Amendments to Form ADV, 

Investment Advisers Act Release No. 3060 (July 28, 

2010) 75 FR 49234 (Aug. 12, 2010) (‘‘We are 

adopting a requirement that investment advisers 

registered with us provide prospective and existing 

clients with a narrative brochure written in plain 

English . . . We believe these amendments will 

greatly improve the ability of clients and 

prospective clients to evaluate firms offering 

advisory services and the firms’ personnel, and to 

understand relevant conflicts of interest that the 

firms and their personnel face and their potential 

effect on the firms’ services.’’). 

1557See proposed rule § 75.8(b)(2). 

1558See Joint Proposal, 76 FR at 68894. 

1559See 12 U.S.C. 1851(g)(3). 

1560See Alfred Brock. 

receives, or disclosure provided after 

the fact, would also not suffice under 

the proposal. The Agencies note that the 

proposed definition would not prevent 

or require disclosure with respect to 

transactions or activities that align the 

interests of the banking entity with its 

clients, customers, or counterparties or 

that otherwise do not involve ‘‘material’’ 

conflicts of interest as discussed above. 

The proposed disclosure standard 

reflected the fact that some types of 

conflicts may be appropriately resolved 

through the disclosure of clear and 

meaningful information to the client, 

customer, or counterparty that provides 

such party with an informed 

opportunity to consider and negate or 

substantially mitigate the conflict. 

However, in the case of a conflict in 

which a client, customer, or 

counterparty does not have sufficient 

information and opportunity to negate 

or mitigate the materially adverse effect 

on the client, customer, or counterparty 

created by the conflict, the existence of 

that conflict of interest would prevent 

the banking entity from availing itself of 

any exemption (e.g., the underwriting or 

market-making exemptions) with 

respect to the relevant transaction, class 

of transactions, or activity. The 

Agencies note that the proposed 

disclosure provisions were provided 

solely for purposes of the proposed 

rule’s definition of material conflict of 

interest, and did not affect a banking 

entity’s obligation to comply with 

additional or different disclosure or 

other requirements with respect to a 

conflict under applicable securities, 

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

of the Securities Act, which governs 

conflicts of interest relating to certain 

securitizations; section 206 of the 

Investment Advisers Act of 1940, which 

governs conflicts of interest between 

investment advisers and their clients; or 

12 CFR 9.12, which applies to conflicts 

of interest in the context of a national 

bank’s fiduciary activities). 

Section 75.8(b)(2) of the proposed rule 

described the requirements that must be 

met in cases where a banking entity uses 

information barriers that are reasonably 

designed to prevent a material conflict 

of interest from having a materially 

adverse effect on a client, customer or 

counterparty. Information barriers can 

be used to restrict the dissemination of 

information within a complex 

organization and to prevent material 

conflicts by limiting knowledge and 

coordination of specific business 

activities among units of the entity. 

Examples of information barriers 

include, but are not limited to, 

restrictions on information sharing, 

limits on types of trading, and greater 

separation between various functions of 

the firm. Information barriers may also 

require that banking entity units or 

affiliates have no common officers or 

employees. Such information barriers 

have been recognized in Federal 

securities laws and rules as a means to 

address or mitigate potential conflicts of 

interest or other inappropriate 

activities.1556

In order to address and mitigate a 

conflict of interest through the use of 

the information barriers pursuant to 

§ 75.8(b)(2) of the proposed rule, a 

banking entity would be required to 

establish, maintain, and enforce 

information barriers that are 

memorialized in written policies and 

procedures, including physical 

separation of personnel, functions, or 

limitations on types of activity, that are 

reasonably designed, taking into 

consideration the nature of the banking 

entity’s business, to prevent the conflict 

of interest from involving or resulting in 

a materially adverse effect on a client, 

customer, or counterparty. Importantly, 

the proposed rule also provided that, 

notwithstanding a banking entity’s 

establishment of such information 

barriers if the banking entity knows or 

should reasonably know that a material 

conflict of interest arising out of a 

specific transaction, class or type of 

transactions, or activity may involve or 

result in a materially adverse effect on 

a client, customer, or counterparty, the 

banking entity may not rely on those 

information barriers to address and 

mitigate any conflict of interest. In such 

cases, the transaction or activity would 

be prohibited, unless the banking entity 

otherwise complied with the 

requirements of proposed 

§ 75.8(b)(1).1557 This aspect of the 

proposal was intended to make clear 

that, in specific cases in which a 

banking entity has established an 

information barrier but knows or should 

reasonably know that it has failed or 

will fail to prevent a conflict of interest 

arising from a specific transactions or 

activity that disadvantages a client, 

customer, or counterparty, the 

information barrier is insufficient to 

address that conflict and the transaction 

would be prohibited, unless the banking 

entity is otherwise able to address and 

mitigate the conflict through timely and 

effective disclosure under the 

proposal.1558

The proposed definition of material 

conflict of interest did not address 

instances in which a banking entity has 

made a material misrepresentation to its 

client, customer, or counterparty in 

connection with a transaction, class of 

transactions, or activity, as such 

transactions or activity appears to 

involve fraud rather than a conflict of 

interest. This is because such 

misrepresentations are generally illegal 

under a variety of Federal and State 

regulatory schemes (e.g., the Federal 

securities laws).1559 In addition, the 

Agencies noted that any activity 

involving a material misrepresentation 

to, or other fraudulent conduct with 

respect to, a client, customer, or 

counterparty would not be permitted 

under the proposed rule in the first 

instance. 

2. Comments on the Proposed 

Limitation on Material Conflicts of 

Interest 

Commenters expressed a variety of 

views regarding the treatment of 

material conflicts of interest under the 

proposal, including the manner in 

which conflicts may be mitigated or 

eliminated. One commenter believed 

that the proposed material conflict of 

interest provisions would be 

effective.1560 Another commenter stated 

that conflicts of interest were 

unavoidable but that the final rule 

should ensure that institutional 

investors have confidence that the 

banking entities they are dealing with 


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1561See Paul Volcker. 

1562See Public Citizen; Sens. Merkley & Levin; 

Occupy; AFR et al. (Feb. 2012). 

1563See Public Citizen. 

1564See, e.g., Occupy; AFR et al. (Feb. 2012); 

Sens. Merkley & Levin (Feb. 2012). 

1565See Occupy. 

1566See, e.g., Lynda Aiman-Smith; AFR et al. 

(Feb. 2012); Sens. Merkley & Levin (Feb. 2012). 

1567See Rep. Blumenauer et al.; Sens. Merkley & 

Levin (Feb. 2012). 

1568See IIB/EBF; EBF. 

1569See ASF (Conflicts) (Feb. 2012); SIFMA et al. 

(Prop. Trading) (Feb. 2012); SIFMA (Securitization) 

(Feb. 2012); LSTA (Feb. 2012); Sens. Merkley & 

Levin (Feb. 2012). 

1570See BDA (Feb. 2012). 

1571See Occupy. 

1572See Occupy; ISDA (Apr. 2012); Better 

Markets (Feb. 2012); SIFMA et al. (Prop. Trading) 

(Feb. 2012); ICFR. 

1573See Occupy. 

1574See Public Citizen; see also AFR et al. (Feb. 

2012). 

1575See SIFMA et al. (Prop. Trading) (Feb. 2012) 

1576See Occupy. 

1577See, e.g., Occupy. 

1578See ISDA (Apr. 2012); Arnold & Porter. 

1579See SIFMA et al. (Prop. Trading) (Feb. 2012); 

ISDA (Apr. 2012). 

1580See ISDA (Apr. 2012). 

1581See SIFMA et al. (Prop. Trading) (Feb. 2012); 

1582See Sens. Merkley & Levin (Feb. 2012); ICFR 

(questioning the effectiveness of enforcement 

mechanisms if oral disclosure permitted under the 

rule); Occupy. 

1583See ICFR. 

are not operating at a conflict with 

investors’ goals.1561

Other commenters expressed differing 

views on whether the proposed rule’s 

provisions for addressing conflicts of 

interest through disclosure or 

information barriers were appropriate. A 

few commenters stated there is no 

statutory basis for allowing conflicts of 

interest in connection with exempted 

activities even if banking entities 

provide disclosure or establish 

information barriers, and the rule 

should prohibit banking entities from 

engaging in permitted activities if 

material conflicts of interest exist.1562

One commenter believed the definition 

did not appear to address issues of 

customer favoritism, in which a bank is 

financially incentivized to treat one 

customer more favorably than another 

(typically less sophisticated) 

customer.1563 Some commenters 

believed that the proposed definition of 

material conflict of interest was too 

vague or narrow and suggested it should 

be strengthened by either expanding the 

types of transactions that may result in 

a material conflict of interest or by 

imposing additional limitations or 

restrictions on transactions.1564 For 

instance, one commenter suggested the 

final rule consider depositors of a 

banking entity to be ‘‘customers’’ for the 

purpose of this provision, impose a 

fiduciary duty on any banking entity 

conducting an exempt activity pursuant 

to section 13(d)(1) of the BHC Act, and 

impose size restrictions on any banking 

entity engaging in proprietary trading 

under an exemption. This commenter 

also stated that a banking entity 

inherently has a material conflict of 

interest with its customer when it takes 

the opposite side of a transaction and, 

therefore, that the final rule should 

require a banking entity to disgorge all 

principal gains from transactions 

conducted pursuant to any exemption 

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

including market-making, trading in 

U.S. government obligations, insurance 

company activities and other exempt 

activities.1565 In addition, a few 

commenters stated that, if disclosure or 

information barriers were permitted to 

mitigates conflicts under the final rule, 

clients of the banking entity must be 

required to acknowledge in writing that 

they understand the potential conflicts 

of interest present in order for any 

disclosure to be effective in mitigating a 

conflict of interest.1566

Some commenters believed that the 

Agencies should consider issuing 

additional guidance regarding the 

definition of material conflicts of 

interest, high-risk assets, and high-risk 

trading strategies.1567 One commenter 

stated that the final rule should limit the 

extraterritorial impact of section 13 by 

only applying the restrictions of section 

13(d)(2) of the BHC Act to the U.S. 

operations or activities of foreign 

banking entities and that the regulation 

of safety and soundness of the foreign 

operations and activities of foreign 

banking entities should be left to the 

home country regulator or supervisor of 

a foreign banking entity.1568

Some commenters provided general 

suggestions on enhancing compliance 

with the prohibition on material 

conflicts of interest. A common 

suggestion among industry participants 

was to implement the prohibition on 

material conflicts of interest under these 

rules in a manner consistent with the 

implementation of section 621 of DoddFrank.1569 One commenter suggested 

that trading in government obligations 

should not be subject to the material 

conflict of interest provision because 

government obligations are broadly 

traded and do not present the types of 

conflicts addressed by the proposed 

rule.1570 In contrast, one commenter 

stated banking entities should be 

required to receive pre-trade clearance 

from the Federal Reserve for trading in 

certain government obligations like 

municipal bonds and mortgage-backed 

securities, due to their role in the 2008 

financial crisis.1571

a. Disclosure 

Some commenters expressed concern 

about potential difficulties associated 

with the proposed disclosure provision 

and provided suggestions to address 

these difficulties. For example, a few 

commenters noted the difficulty in 

determining what constitutes effective 

disclosure,1572 especially in relation to 

the volume of disclosure or the impact 

of information asymmetry in illiquid 

markets.1573 One commenter stated that 

unless the rule requires full disclosure 

of a banking entity’s trading strategy and 

the rationale behind it, allowing 

disclosure will permit the banking 

entity to protect itself without 

adequately mitigating the harm of the 

conflict. This commenter also noted the 

practical difficulties associated with 

disclosing anticipated future conflicts 

and conflicts in the context of block 

trading.1574 Another commenter stated 

market participants understand inherent 

conflicts of interest and believed 

disclosure in such situations would be 

burdensome and unnecessary.1575 One 

commenter stated that the rule should 

require a banking entity to negate, not 

just permit the client, customer, or 

counterparty to substantially mitigate, 

the materially adverse effect of the 

conflict.1576

A few commenters disagreed with the 

disclosure provision, noting that 

Congress specifically considered and 

rejected disclosure as a mitigation 

method for purposes of section 621 of 

the Dodd-Frank Act and that this 

indicates the Agencies should not 

permit a material conflict of interest to 

be mitigated through disclosure for 

purposes of section 13 of the BHC 

Act.1577

Commenters were in disagreement as 

to the extent and timing of disclosure 

that should be required under the rule. 

Some commenters stated the disclosure 

provisions would slow trading, and 

suggested the rule require only one-time 

disclosure at the inception of the 

business relationship 1578 or periodic 

disclosures to address ongoing 

conflicts.1579 One of these commenters 

noted that extensive trade-by-trade 

disclosure requirements create the risk 

of unintended breaches of 

confidentiality.1580 Other commenters 

requested the Agencies provide 

additional guidance, such as when 

transaction-specific disclosure is 

necessary,1581 whether disclosure 

should be written,1582 and what 

constitutes ‘‘reasonable detail.’’ 1583


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5934 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

1584See, e.g., Arnold & Porter; Sens. Merkley & 

Levin (Feb. 2012); Better Markets (Feb. 2012); 

Public Citizen; AFR et al. (Feb. 2012); Lynda 

Aiman-Smith. 

1585See Public Citizen; Sens. Merkley & Levin 

(Feb. 2012); Better Markets (Feb. 2012). 

1586See Arnold & Porter. 

1587See Arnold & Porter. 

1588See Alfred Brock (stating there is no such 

thing as a ‘‘sophisticated party’’). 

1589See ICFR. 

1590See Alfred Brock. 

1591See Better Markets (Feb. 2012); Occupy; 

Public Citizen. 

1592See Occupy. 

1593See Public Citizen (contending that this 

would undermine the Dodd-Frank Act’s 

requirement to promote sound management, ensure 

financial stability, and reduce systemic risk). 

1594See AFR et al. (Feb. 2012). 

1595See SIFMA et al. (Prop. Trading) (Feb. 2012). 

1596See ISDA (Apr. 2012) (arguing that its 

suggested guidance was derived from prior SEC and 

self-regulatory organization guidance on 

information barriers). 

1597The Agencies note that the definition of 

material conflict of interest and the disclosure 

provisions related to that definition apply solely for 

purposes of the rule’s definition of material conflict 

of interest, and does not affect the scope of that term 

in other contexts or a banking entity’s obligation to 

comply with additional or different requirements 

with respect to a conflict under applicable 

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

of the Securities Act, which governs conflicts of 

interest relating to certain securitizations; section 

206 of the Investment Advisers Act of 1940, which 

applies to conflicts of interest between investment 

advisers and their clients; or 12 CFR 9.12, which 

applies to conflicts of interest in the context of a 

national bank’s fiduciary activities). 

1598See 12 U.S.C. 1851(g)(3). 

1599See Occupy. 

1600See Occupy. 

1601See Occupy. 

1602See Public Citizen; Sens. Merkley & Levin 

(Feb. 2012); Occupy; AFR et al. (Feb. 2012). 

In addition, some commenters 

provided suggestions on whether parties 

should be required to acknowledge 

receipt of disclosures 1584 or 

affirmatively consent to the conflict.1585

One commenter proposed allowing a 

majority of a committee of independent 

board members to approve consent to 

waivers of conflicts of interest.1586 One 

commenter believed disclosure and 

consent by a sophisticated investor 

ought to be sufficient to serve as a 

waiver to most types of conflict of 

interest.1587 In contrast, another 

commenter asserted general disclosure 

or waivers of conflicts should never be 

allowed, and the Agencies should not 

provide any additional guidance as to 

the extent, timing, frequency, or scope 

of disclosure appropriate in any given 

situation.1588 Similarly, one commenter 

asserted the Agencies should not 

provide guidance on what issues can be 

addressed by disclosure, as such 

guidance would be ‘‘dangerously 

prescriptive and would introduce moral 

hazards.’’ 1589

b. Information Barriers 

A few commenters addressed the 

information barriers provision of the 

proposed rule. One commenter 

expressed support for the proposed 

approach,1590 while three commenters 

stated this provision was ineffective.1591

A few commenters opposed the 

information barriers provision because 

they believed information barriers 

would make conflict mitigation more 

difficult 1592 or would effectively 

mandate that no single officer be aware 

of a banking entity’s collective 

operations.1593

A few commenters also requested the 

Agencies provide guidance regarding 

the use of information barriers. One 

commenter requested the Agencies 

specify the type and nature of 

information barriers and where they are 

practical to implement.1594 Another 

commenter believed that the Agencies 

should view information barriers 

favorably. This commenter stated that 

information barriers should be 

permitted for addressing conflicts of 

interest unless the banking entity 

knows, or should reasonably know, that 

the information barrier would not be 

effective in restricting the spread of 

information that could lead to the 

conflict.1595 To provide greater clarity, 

another commenter recommended the 

Agencies provide guidance on certain 

elements that may be used to determine 

the reasonableness of information 

barriers, such as memorialization of 

procedures and documentation of 

actions taken pursuant to such 

procedures.1596

3. Final Rule 

After considering carefully comments 

received on the proposal as well as the 

purpose and language of section 13 of 

the BHC Act, the Agencies have adopted 

the final rule largely as proposed. Under 

the final rule, a banking entity that 

engages in any transaction, class of 

transactions, or activity that would 

involve or result in the banking entity’s 

interests being materially adverse to the 

interests of its client, customer, or 

counterparty with respect to the 

transaction, class of transactions, or 

activity, must address and mitigate the 

conflict of interest, where possible, 

through either timely and effective 

disclosure or informational barriers.1597

This requirement is in addition to, and 

does not supplant, any limitations or 

prohibitions contained in other laws. 

For example, a material 

misrepresentation by a banking entity to 

its client, customer, or counterparty in 

connection with market-making 

activities may involve fraud and is 

generally illegal under a variety of 

Federal and State regulatory schemes 

(e.g., the Federal securities laws) 1598 as 

well as being prohibited under section 

13 of the BHC Act. 

The Agencies believe that certain of 

commenters’ suggested modifications to 

the proposed rule are outside the scope 

of the Agencies’ statutory authority. For 

example, the Agencies do not believe 

section 13 of the BHC Act provides 

statutory authority to directly impose 

limits on the size of banking entities 1599

or to implement specific fiduciary 

standards on banking entities.1600 In 

addition, the Agencies do not believe it 

is appropriate to expand the definition 

of ‘‘customer’’ to include individuals 

and entities that solely make use of the 

bank’s traditional banking services 

because section 13 is focused on the 

trading activities and investment in 

which banking entities may be 

involved.1601

The final rule recognizes that a 

banking entity may address or 

substantially mitigate a potential 

conflict of interest by making adequate 

disclosures or creating and enforcing 

informational barriers. Some 

commenters argued that the legislative 

history of the Dodd-Frank Act suggests 

that disclosure or informational barriers 

are not adequate to address a material 

conflict of interest.1602 However, section 

13 of the BHC Act directs the Agencies 

to define ‘‘material conflict of interest’’ 

and gives the Agencies discretion to 

determine how to define this term for 

purposes of the rule. Under the final 

rule, a material conflict of interest exists 

when the banking entity engages in 

transactions or activities that cause its 

interests to be materially adverse to the 

interests of its client, customer, or 

counterparty. At the same time, the final 

rule provides banking entities the 

opportunity to take certain actions to 

address the conflict, such that the 

conflict does not have a materially 

adverse effect on that client, customer, 

or counterparty. Under the final rule, a 

banking entity may address a conflict by 

establishing, maintaining, and enforcing 

information barriers reasonably 

designed to avoid a conflict’s materially 

adverse effect, or by disclosing the 

conflict in a manner that allows the 

client, customer, or counterparty to 

substantially mitigate or negate any 

materially adverse effect created by the 

conflict of interest. The Agencies 

believe that, to the extent the materially 

adverse effect of a conflict has been 

substantially mitigated, negated, or 

avoided, it is appropriate to allow the 


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1603See, e.g., Arnold & Porter. 

1604See Occupy. 

1605See ISDA (Apr. 2012). 

1606See Better Markets (Feb. 2012) (suggesting 

that a disclosure regime can facilitate abuse by 

enabling market participants to point to obscure 

and meaningless disclosure as a shield against 

liability); Occupy (arguing that a large volume of 

disclosed information can be difficult to understand 

or can serve to hide relevant information). 

1607See final rule § 75.7(b)(1)(i) and final rule 

§ 75.16(b)(1)(i). 

1608See, e.g., 15 U.S.C. 78c(a)(4)(B)(i)(I)—(IV) 

(finding that disclosure and physical separation of 

personnel and activities addresses the potential that 

consumers might be misled by the broker-dealer 

activities of banks); 15 U.S.C. 80b–6(3) (‘‘It shall be 

unlawful for any investment adviser, by use of the 

mails or any means or instrumentality of interstate 

commerce, directly or indirectly . . . acting as 

principal for his own account, knowingly to sell 

any security to or purchase any security from a 

client, or acting as broker for a person other than 

such client, knowingly to effect any sale or 

purchase of any security for the account of such 

client, without disclosing to such client in writing 

before the completion of such transaction the 

capacity in which he is acting and obtaining the 

consent of the client to such transaction.’’). See also 

Form ADV, the form used by investment advisers 

to register with the Securities and Exchange 

Commission and state securities authorities, and, in 

particular, Form ADV Part 2: Uniform Requirements 

for the Investment Adviser Brochure and Brochure 

Supplements. A registered investment adviser 

generally must deliver the Form ADV brochure, 

which contains disclosure about conflicts of 

interest, to its prospective and existing clients. See 

17 CFR 275.204–3; Amendments to Form ADV, 

Investment Advisers Act Release No. 3060 (July 28, 

2010) 75 FR 49234 (Aug. 12, 2010) (‘‘We are 

adopting a requirement that investment advisers 

registered with us provide prospective and existing 

clients with a narrative brochure written in plain 

English . . . We believe these amendments will 

greatly improve the ability of clients and 

prospective clients to evaluate firms offering 

advisory services and the firms’ personnel, and to 

understand relevant conflicts of interest that the 

firms and their personnel face and their potential 

effect on the firms’ services.’’). 

1609See Public Citizen; see also AFR et al. (Feb. 

2012). 

transaction, class of transaction, or 

activity under the final rule. Continuing 

to view the conflict as a material 

conflict of interest under these 

circumstances would not appear to 

benefit the banking entity’s client, 

customer, or counterparty. The 

disclosure standard under the final rule 

requires clear and meaningful 

information be provided to the client, 

customer, or counterparty in a manner 

that provides such party the opportunity 

to negate or substantially mitigate, any 

materially adverse effects on such party 

created by the conflict. 

Some commenters suggested that 

obtaining consent to or waiver of 

disclosed conflicts should be sufficient 

to comply with the rule.1603 The 

Agencies do not believe that consent or 

waivers alone are sufficient to address 

material conflicts of interest, and 

continue to believe that any banking 

entity using disclosure to address a 

conflict of interest should be required to 

provide any client, customer, or 

counterparty with whom the banking 

entity has a conflict with the 

opportunity to negate or substantially 

mitigate the materially adverse effect of 

the conflict on the client, customer, or 

counterparty. The Agencies believe this 

approach, which applies equally to all 

types of clients, customers, or 

counterparties, will reduce the potential 

for unintended or differing impacts on 

certain types of clients, customers, or 

counterparties. In response to one 

commenter’s suggestion that the final 

rules require full negation of the 

materially adverse effect on the client, 

customer, or counterparty, the Agencies 

continue to believe it is appropriate to 

allow a transaction or activity to 

continue if the client, customer, or 

counterparty is provided an opportunity 

to substantially mitigate the materially 

adverse effect.1604 The Agencies are 

concerned that requiring the conflict’s 

impact to be fully negated under all 

circumstances could prevent a banking 

entity from providing a service to a 

particular customer despite that 

customer’s knowledge of the conflict 

and ability to substantially reduce the 

effect of the conflict on that customer. 

With regards to commenters’ 

statements that information barriers and 

disclosure will not work to address the 

harm caused by conflicts, the Agencies 

emphasize that under the final rule, like 

the proposed rule, a banking entity may 

use disclosure or information barriers to 

address a conflict only in those 

instances where the disclosure provides 

the client, customer, or counterparty 

with the opportunity to negate or 

substantially mitigate any materially 

adverse effect of the conflict on that 

entity or the information barriers are 

reasonably designed to prevent the 

conflict of interest from involving or 

resulting in a materially adverse effect 

on a client, customer, or counterparty. If 

the banking entity is unable to 

effectively use disclosure or information 

barriers in a way that meets the rule’s 

requirements, then the banking entity is 

prohibited from engaging in the 

conflicted transaction, class of 

transaction, or activity. Additionally, 

the Agencies note that the material 

conflict of interest provisions in the 

final rule do not preempt any duties 

owed to parties outside the transaction, 

including any duty of 

confidentiality.1605

In response to commenters’ 

statements that the volume of 

information included in a disclosure or 

the manner in which the disclosure is 

presented may make it difficult for a 

customer to identify and understand the 

relevant information regarding the 

conflict,1606 the Agencies note that the 

final rule requires disclosure of the 

conflict or potential conflict be clear, 

timely, and effective and that the 

disclosure includes any other necessary 

information. Disclosure is also required 

to be provided in reasonable detail and 

in a manner sufficient to permit a 

reasonable client, customer, or 

counterparty to meaningfully 

understand the conflict of interest.1607

Thus, disclosure that is only general or 

generic, that omits details or other 

information that would be necessary to 

a reasonable client’s, customer’s, or 

counterparty’s understanding of the 

conflict of interest, or that is hidden in 

a large volume of needless information 

would not meet this standard. The 

Agencies believe these provisions of the 

final rule are designed to ensure that 

customers receive sufficient information 

about the conflict of interest so that they 

are well informed and, as required by 

the rule, able to negate or substantially 

mitigate any materially adverse effect of 

the conflict. 

In addition to requiring that 

customers are provided with detailed 

information about the conflict, the final 

rule, like the proposal, requires that 

disclosure is made prior to effecting the 

specific transaction or class or type of 

transactions, or engaging in the specific 

activity, for which a conflict may arise 

and is otherwise timely. As a result, 

under § 75.7(b)(2)(i), disclosure must be 

provided sufficiently close in time to 

the client’s, customer’s, or 

counterparty’s decision to engage in the 

transaction or activity to give the client, 

customer, or counterparty an 

opportunity to meaningfully evaluate 

and take steps that would negate or 

substantially mitigate the conflict. This 

approach is similar to the approach 

permitted by a variety of consumer 

protection statutes and regulations for 

addressing potential conflicts of interest 

in consumer transactions.1608

Some commenters requested that the 

final rule permit a conflict to be negated 

or substantially mitigated through 

generic or periodic disclosures, such as 

at the beginning of a trading 

relationship or on an annual basis. 

Other commenters stated that some 

conflicts, such as anticipated future 

conflicts or those that arise in the 

context of block trading, may require the 

banking entity to provide disclosure in 

advance of the actual conflict in order 

to allow the client, customer, or 

counterparty the opportunity to mitigate 

the materially adverse effect.1609 The 


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1610See Sens. Merkley & Levin (Feb. 2012); ICFR; 

Occupy; Alfred Brock. 

1611See, e.g., Arnold & Porter; Sens. Merkley & 

Levin (Feb. 2012); Better Markets (Feb. 2012); 

Public Citizen; AFR et al. (Feb. 2012); Lynda 

Aiman-Smith. 

1612See SIFMA et al. (Prop. Trading) (Feb. 2012); 

but see Occupy. 

1613See Joint Proposal, 76 FR at 68893. Thus, the 

Agencies are not adopting one commenter’s 

suggestion that the final rule consider all 

transactions by a banking entity to involve a 

material conflict of interest because the banking 

entity is necessarily on the opposite side of a 

transaction with its client, customer, or 

counterparty. See Occupy. 

1614See SIFMA et al. (Prop. Trading) (Feb. 2012). 

1615The Agencies note examples of information 

barriers that may address or substantially mitigate 

a material conflict of interest include restrictions on 

information sharing, limits on types of trading, 

prohibitions on common officers or employees 

between functions. Such information barriers have 

been recognized in Federal securities laws as a 

means to address or mitigate potential conflicts of 

interest or other inappropriate activities. See, e.g., 

17 U.S.C. 78o(g). 

1616See Public Citizen. 

1617The Agencies note that a banking entity 

subject to Appendix B of the final rule must 

implement a compliance program that includes, 

among other things, policies and procedures that 

explain how the banking entity monitors and 

prohibits conflicts of interest with clients, 

customers, and counterparties. As part of 

maintaining and enforcing information barriers, a 

banking entity should have processes to review, 

test, and modify information barriers on a 

continuing basis. In addition, banking entities 

should have ongoing monitoring to maintain and to 

enforce information barriers, for example by 

identifying whether such barriers have not 

prevented unauthorized information sharing and 

addressing instances in which the barriers were not 

effective. This may require both remediating any 

identified breach as well as updating the 

information barriers to prevent further breaches, as 

necessary. Periodic assessment of the effectiveness 

of information barriers and periodic review of the 

written policies and procedures are also important 

to the maintenance and enforcement of effective 

information barriers and reasonably designed 

policies and procedures. Such assessments can be 

done either (i) internally by a qualified employee 

or (ii) externally by a qualified independent party. 

See Part VI.C.2.e., infra. 

1618 If a conflict occurs to the detriment of a 

client, customer, or counterparty despite an 

information barrier, the Agencies would also expect 

the banking entity to review the effectiveness of its 

information barrier and make adjustments, as 

necessary, to avoid future occurrences, or review 

whether such information barrier is appropriate for 

that type of conflict. 

1619See, e.g., U.S. Senate Permanent 

Subcommittee on Investigations, Wall Street and 

the Financial Crisis: Anatomy of a Financial 

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

hsgac.senate.gov/public/_files/Financial_Crisis/

FinancialCrisisReport.pdf. 

Agencies emphasize, however, that 

disclosure provided far in advance of a 

particular transaction, such that the 

client, customer, or counterparty is 

unlikely to take that disclosure into 

account when evaluating the 

transaction, would not suffice. At the 

same time, disclosure provided without 

a sufficient period of time for the client, 

customer, or counterparty to evaluate 

and act on the information it receives, 

or disclosure provided after the fact, 

would also not be permissible 

disclosure under the final rules. The 

Agencies believe that, in considering the 

effectiveness of disclosures, the type, 

timing and frequency of disclosures 

depends significantly on the customer 

relationship, the type of transaction, and 

the matter that creates the potential 

conflict. Therefore, while written 

disclosures may be appropriate in 

certain circumstances, the Agencies are 

not requiring banking entities to provide 

written disclosure,1610 or obtain 

documentation showing that disclosure 

was received,1611 because the Agencies 

believe it is more important that 

disclosure is timely than documented. 

For example, if disclosure were required 

to be in writing, this might slow a 

banking entity’s ability to provide the 

disclosure to the relevant customer, 

which could impede the customer’s 

ability to consider the disclosed 

information and take steps to negate or 

substantially mitigate the conflict’s 

effect on the customer. The Agencies 

further note that the final rule does not 

prevent or require disclosure with 

respect to transactions or activities that 

align the interests of the banking entity 

with its clients, customers, or 

counterparties. 

As noted above, one commenter 

expressed concern about the burdens of 

disclosing inherent conflicts and stated 

such disclosure is unnecessary because 

market participants understand inherent 

conflicts of interest.1612 As noted in the 

proposal, certain inherent conflicts, 

such as the mere fact that the buyer and 

seller are on opposite sides of a 

transaction and have differing economic 

interests, would not be deemed a 

‘‘material’’ conflict of interest with 

respect to permitted activities.1613

The Agencies continue to believe that 

information barriers can be an effective 

means of addressing conflicts of interest 

that may arise through, for example, the 

spread of information among trading 

desks engaged in different trading 

activities that may result in potentially 

inappropriate informational advantage. 

The Agencies are not adopting one 

commenter’s suggestion that the final 

rule specify the particular types of 

scenarios where information barriers 

may be effective 1614 because, as 

discussed below, the Agencies believe 

banking entities are better positioned to 

determine when information barriers 

may be effective given their trading 

activities and business structure.1615 In 

response to one commenter’s concern 

that information barriers may result in 

the banking entity’s management not 

being aware of the firm’s collective 

operations,1616 the Agencies note that 

information barriers do not require this 

result. Rather, information barriers 

would be established between relevant 

personnel or functions while other 

personnel, including senior managers, 

internal auditors, and compliance 

personnel, would have access to each 

group separated by the barrier. 

The final rule continues to recognize 

that a banking entity may address or 

substantially mitigate a conflict of 

interest through use of information 

barriers. In order to address and mitigate 

a conflict of interest through the use of 

the information barriers, a banking 

entity is required to establish, maintain, 

and enforce information barriers that are 

memorialized in written policies and 

procedures, including physical 

separation of personnel, functions, or 

limitations on types of activity, that are 

reasonably designed, taking into 

consideration the nature of the banking 

entity’s business, to prevent the conflict 

of interest from involving or resulting in 

a materially adverse effect on a client, 

customer or counterparty.1617

Importantly, the final rule also provides 

that, notwithstanding a banking entity’s 

establishment of such information 

barriers, if the banking entity knows or 

should reasonably know that a material 

conflict of interest arising out of a 

specific transaction, class or type of 

transactions, or activity may involve or 

result in a materially adverse effect on 

a client, customer, or counterparty, the 

banking entity may not rely on those 

information barriers to address and 

mitigate any conflict of interest. In such 

cases, the transaction or activity would 

be prohibited, unless the banking entity 

otherwise complied with the 

requirements of § 75.7(b)(2)(i).1618

While some commenters requested 

that the final rule include additional 

limitations as part of implementing the 

material conflict of interest provisions 

in section 13(d)(2), the Agencies do not 

believe additional restrictions are 

appropriate at this time. Concerns 

regarding conflicts of interest are likely 

to be elevated when a transaction is 

complex, highly structured or opaque, 

involves illiquid or hard-to-value 

instruments or assets, requires the 

coordination of multiple internal groups 

(such as multiple trading desks or 

affiliated entities), or involves a 

significant asymmetry of information or 

transactional data among 

participants.1619 In all cases, the 

question of whether a material conflict 

of interest exists will depend on an 

evaluation of the specific facts and 

circumstances. For example, certain 


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1620See SIFMA et al. (Prop. Trading) (Feb. 2012). 1621See Occupy; ISDA (Apr. 2012); Better 

Markets (Feb. 2012); SIFMA et al. (Prop. Trading) 

(Feb. 2012); ICFR; Alfred Brock; Public Citizen; 

AFR et al. (Feb. 2012); Arnold & Porter; Sens. 

Merkley & Levin (Feb. 2012). 1622For a full discussion of the final rule’s 

compliance requirements, including a discussion of 

the specific compliance requirements applicable to 

different banking entities, see Part VI.C. of this 

SUPPLEMENTARY INFORMATION, infra. 

1623See Joint Proposal, 76 FR at 68894. The 

Agencies noted that a banking entity subject to 

proposed Appendix C must implement a 

compliance program that includes, among other 

things, policies and procedures that explain how 

the banking entity monitors and prohibits exposure 

to high-risk assets and high-risk trading strategies, 

and identifies a variety of assets and strategies (e.g., 

assets or strategies with significant embedded 

leverage). See Joint Proposal, 76 FR at 68894 n.215. 

1624See Alfred Brock. 

1625See AFR et al. (Feb. 2012); Japanese Bankers 

Ass’n.; Investure; AllianceBernstein; Comm. on 

Capital Markets Regulation. 

1626See Obaid Syed. 

1627See Sens. Merkley & Levin (Feb. 2012); 

Johnson & Prof. Stiglitz; Occupy. 

1628See Alfred Brock. 

1629See Japanese Bankers Ass’n.; Sens. Merkley & 

Levin (Feb. 2012); Occupy; Public Citizen. 

1630See Japanese Bankers Ass’n. 

1631See Sens. Merkley & Levin (Feb. 2012). 

1632See Sens. Merkley & Levin (Feb. 2012). 

1633See Sens. Merkley & Levin (Feb. 2012). 

simple transactions may implicate 

conflicts of interest that cannot be 

mitigated by disclosure or restricted by 

information barriers. On the other hand, 

certain highly structured and complex 

transactions may involve conflicts of 

interest that can be mitigated by 

disclosure or restricted by information 

barriers. 

The Agencies believe that conflicts of 

interest must be determined and 

addressed in accordance with the 

specific facts and circumstances 

presented. One commenter suggested 

that the proposed rule be modified so 

that a banking entity could conclusively 

rely on information barriers unless it 

knows or has reason to know that 

policies, procedures, and controls 

establishing barriers would not be 

effective in restricting the spread of 

information.1620 By focusing on whether 

a banking entity knows or has reason to 

know that its policies and procedures 

would not be effective, rather than on 

what the banking entity knows or 

should reasonably know about a conflict 

of interest that may involve or result in 

a material adverse effect on a client, 

customer, or counterparty, the 

commenter’s suggestion has the 

potential to allow a banking entity to 

engage in transactions that involve a 

material conflict of interest. Therefore, 

the Agencies have determined not to 

adopt the commenter’s suggested 

approach. Similarly, the Agencies are 

rejecting some commenters’ suggestions 

that the final rule prescribe the method, 

scope, or specific content of 

disclosures.1621 The Agencies believe 

that specific guidance on disclosure 

may provide an incentive for banking 

entities to consider the form of 

disclosure provided, rather than 

whether disclosure can address the 

substance of the conflict as determined 

by the specific facts and circumstances 

at hand. Moreover, the Agencies believe 

banking entities are in the best position 

to identify and evaluate the conflicts 

present in their business as well as the 

most effective method of disclosing 

such conflicts. Banking entities must 

tailor their compliance programs to 

identify, monitor, and evaluate potential 

conflicts based on their business 

structure and specific activities and 

customer relationships.1622

Finally, some commenters requested 

that the final rule specifically address 

the conflict of interest provisions related 

to asset-backed securitizations 

contained in section 621 of the DoddFrank Act. As explained below in Part 

VI.B.1., some securitizations are subject 

to the final rule, and others such as 

securitizations of loans are not subject 

to section 13 of the BHC Act. For any 

securitization that meets the definition 

of covered fund under the final rule, 

relationships with and transactions by a 

banking entity involving those 

securitizations remain subject to the 

requirements of section 13, including 

the requirements of section 13(d)(2). In 

addition, the banking entity would be 

subject to the limitations contained in 

section 621 of the Dodd-Frank Act and 

any rules regarding conflicts of interest 

relating to securitizations implemented 

under that section. The final rule in no 

way limits the application of section 

621 of that Act with respect to an assetbacked security that is subject to that 

section. 

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

‘‘High-Risk Trading Strategy’’ 

1. Proposed Rule 

Section 75.8(c) of the proposed rule 

defined ‘‘high-risk asset’’ and ‘‘high-risk 

trading strategy’’ for purposes of the 

proposed limitations on permitted 

trading activities. Proposed § 75.8(c)(1) 

defined a ‘‘high-risk asset’’ as an asset 

or group of assets that would, if held by 

the banking entity, significantly increase 

the likelihood that the banking entity 

would incur a substantial financial loss 

or would fail. Proposed § 75.8(c)(2) 

defined a ‘‘high-risk trading strategy’’ as 

a trading strategy that would, if engaged 

in by the banking entity, significantly 

increase the likelihood that the banking 

entity would incur a substantial 

financial loss or would fail.1623

2. Comments on Proposed Limitations 

on High-Risk Assets and Trading 

Strategies 

With respect to the prohibition on 

transactions or activities that expose 

banking entities to high-risk assets or 

high-risk trading strategies, one 

commenter stated the provisions were 

effective,1624 while other commenters 

stated the proposed rule was too 

vague 1625 and implied that banking 

entities may be required to exit 

positions in periods of market stress, 

further reducing liquidity.1626 A few 

commenters suggested the Agencies 

identify and prohibit certain types of 

high-risk assets or high-risk trading 

strategies under the rule.1627 In contrast, 

one commenter asserted the Agencies 

should not specify certain classes of 

assets or trading strategies as ‘‘high 

risk.’’ 1628 A few commenters requested 

greater clarity on the proposed 

definitions and suggested the Agencies 

provide additional guidance.1629 One of 

these commenters suggested the 

Agencies simplify compliance by 

establishing safe harbors, setting predetermined risk limits within risk-based 

approaches, or allowing individual 

banking entities to set practical riskbased standards that the Agencies can 

review.1630

One commenter suggested integrating 

the ban on high-risk activities 

throughout the rule and stated that, 

given the evolving nature of financial 

markets, regulators should have the 

flexibility to update criteria for 

identifying high-risk assets or high-risk 

trading strategies.1631 This commenter 

stated the definition of high-risk trading 

strategies was appropriately broad and 

flexible, but suggested improving the 

rule by encompassing trading strategies 

that are so complex the risk or value 

thereof cannot be reliably and 

objectively determined.1632 The 

commenter also suggested that the 

quantitative measurements collected 

under proposed Appendix A could be 

utilized to help inform whether a highrisk asset or trading strategy exists.1633

One commenter stated that in large 

concentrations, all assets can be high 

risk. This commenter suggested 

evaluating transactions on a case-bycase basis and believed all activity 

exempted under section 13(d)(1) of the 

BHC Act should be viewed as ‘‘highrisk’’ absent prior regulatory approval. 

This commenter further suggested that 

high-risk assets or trading strategies be 

defined to include any asset or trading 

strategy that would have forced a 


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1634See Occupy. 

1635See BDA (Feb. 2012); Japanese Bankers Ass’n. 

1636See Occupy. 

1637See Occupy. 

1638See § 75.20 and Appendix B of the final rule, 

also discussed in Part VI.C., infra. 

1639See 12 U.S.C. 1851(a)(1)(B). 

1640See final rule §§ 75.10(b)–(c). The term 

banking entity is defined in final rule § 75.2(c). 

banking entity to exit the market during 

the 2008 financial crisis, and that 

leverage, rehypothecation, 

concentration limits, and high 

frequency trading should be viewed as 

indicia of high-risk trading strategies. 

Finally, this commenter suggested the 

Agencies require banking entity CEOs to 

certify that their institution’s activities 

do not result in a material exposure to 

high-risk assets or high-risk trading 

strategies.1634

3. Final rule 

After considering carefully the 

comments received, the Agencies have 

modified the final rule to provide that 

a high-risk asset means an asset or group 

of assets that would, if held by a 

banking entity, significantly increase the 

likelihood that the banking entity would 

incur a substantial financial loss or 

would pose a threat to the financial 

stability of the United States. Similarly, 

the final rule defines high-risk trading 

strategy to include any strategy that 

would, if engaged in by a banking 

entity, significantly increase the 

likelihood that the banking entity would 

incur a substantial financial loss or 

would pose a threat to the financial 

stability of the United States. 

Importantly, under the final rule, 

banking entities that engage in activities 

pursuant to an exemption must have a 

reasonably designed compliance 

program in place to monitor and 

understand whether it is exposed to 

high-risk assets or trading strategies. For 

instance, any banking entity engaged in 

activity pursuant to the market-making 

exemption in § 75.4(b) must, as part of 

its compliance program, have 

reasonably designed written policies 

and procedures, internal controls, 

analysis and independent testing 

regarding the limits for each trading 

desk, including limits on the level of 

exposures to relevant risk factors that 

the trading desk may incur. These 

policies and procedure and any activity 

conducted pursuant to the final rule 

will be evaluated by the Agencies, as 

appropriate, as part of ensuring the 

safety and soundness of banking entities 

and monitoring for exposures to highrisk activities or assets. 

While some commenters stated that 

the definition of high risk asset or 

trading strategy should be more clearly 

defined, the Agencies believe that it is 

appropriate to include a broad 

definition of these terms that accounts 

for different facts and circumstances 

that may impact whether a particular 

asset or trading strategy is high-risk with 

respect to a banking entity. As stated by 

commenters, this framework is effective 

and flexible enough to be utilized by the 

Agencies in a variety of contexts. For 

instance, a trading strategy or asset may 

be high-risk to one banking entity but 

not another, or may be high-risk to a 

banking entity under some market 

conditions but not others. As part of 

evaluating whether a banking entity is 

exposed to a high-risk asset or trading 

strategy, the Agencies expect that a 

variety of factors will be considered, 

such as the presence of excess leverage, 

rehypothecation or excessively high 

concentration of assets, or unsafe and 

unsound trading strategies. 

We believe an approach limiting this 

provision’s applicability to certain 

permitted activities or creating a safe 

harbor for certain assets or trading 

strategies would be inconsistent with 

the statutory language, which prohibits 

any permitted activity that involves or 

results in a material exposure to a highrisk asset or high-risk trading 

strategy.1635 In addition, the Agencies 

decline to identify any particular assets 

or trading strategies as per se high-risk 

because a determination of the specific 

risk posed to a banking entity depends 

on the facts and circumstances.1636

Certain facts and circumstances may 

include, but are not limited to, the 

amount of capital at risk in a 

transaction, whether or not the 

transaction can be hedged, the amount 

of leverage present in the transaction, 

and the general financial condition of 

the banking entity engaging in the 

transaction. In response to one 

commenter’s recommendation that the 

Agencies adopt a CEO certification 

requirement specific to the high-risk 

provisions,1637 the Agencies believe 

such a requirement is unnecessary in 

light of the required management 

framework in the compliance program 

provision of § 75.20 of the final rule, as 

well as the CEO certification 

requirement included in the final 

rule.1638

c. Limitations on Permitted Activities 

That Pose a Threat to Safety and 

Soundness of the Banking Entity or the 

Financial Stability of the United States 

Finally, as the Agencies did not 

receive any comments on the proposed 

rule’s limitations on permitted activities 

that pose a threat to the safety and 

soundness of the banking entity or to 

the financial stability of the United 

States and the proposed approach 

mirrored the statutory language, the 

Agencies have determined no changes 

to final rule are necessary. 

B. Subpart C—Covered Fund Activities 

and Investments 

As noted above and except as 

otherwise permitted, section 13(a)(1)(B) 

of the BHC Act generally prohibits a 

banking entity from acquiring or 

retaining any ownership in, or acting as 

sponsor to, a covered fund.1639 Section 

13(d) of the BHC Act contains certain 

exemptions to this prohibition. Subpart 

C of the final rule implements these and 

other provisions of section 13 related to 

covered funds. Additionally, subpart C 

contains a discussion of the internal 

controls, reporting and recordkeeping 

requirements applicable to covered fund 

activities and investments, and 

incorporates by reference the minimum 

compliance standards for banking 

entities contained in subpart D of the 

final rule, as well as Appendix B, to the 

extent applicable. 

1. Section 75.10: Prohibition on 

Acquisition or Retention of Ownership 

Interests in, and Certain Relationships 

With, a Covered Fund 

Section 75.10 of the final rule defines 

the scope of the prohibition on the 

acquisition and retention of ownership 

interests in, and certain relationships 

with, a covered fund. It also defines a 

number of key terms, including the 

definition of covered fund. 

The term ‘‘covered fund’’ specifies the 

types of entities to which the 

prohibition contained in § 75.10(a) 

applies, unless the activity is 

specifically permitted under an 

available exemption contained in 

subpart C of the final rule.1640 The final 

rule modifies the proposed definition of 

covered fund in a number of key 

aspects. The Agencies have defined the 

term ‘‘covered fund’’ with reference to 

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

Investment Company Act of 1940 

(‘‘Investment Company Act’’) with some 

additions and subject to a number of 

exclusions, several of which have been 

modified from permitted activity 

exemptions included in the proposal. 

The Agencies have tailored the final 

definition to include entities of the type 

that the Agencies believe Congress 

intended to capture in its definition of 

private equity fund and hedge fund in 

section 13(h)(2) of the BHC Act by 

reference to section 3(c)(1) and 3(c)(7) of 


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1641See infra note 1726 and accompanying text 

regarding the meaning of the term ‘‘offer’’ as used 

in the final rule’s inclusion of certain commodity 

pools as covered funds. 

1642See final rule § 75.10(b)(1)(ii). 

1643See final rule § 75.10(d)(6), (8), (9), and (10). 

1644See, e.g., SIFMA et al. (Covered Funds) (Feb. 

2012); BoA; Goldman (Covered Funds); Rep. Himes; 

SVB; Scale. 

1645See final rule § 75.10(a). 

1646See proposed rule § 75.10(a); see also Joint 

Proposal, 76 FR at 68896. 

1647See, e.g., SIFMA et al. (Covered Funds) (Feb. 

2012); SIFMA et al. (Mar. 2012). 

1648See Credit Suisse (Williams); Arnold & 

Porter; UBS; Hong Kong Inv. Funds Ass’n. 

1649See, e.g., Credit Suisse (Williams); Arnold & 

Porter; UBS; NAB; Hong Kong Inv. Funds Ass’n; 

Australian Bankers Ass’n. (Feb. 2012). 

1650See, e.g., Arnold & Porter. 

1651See, e.g., SIFMA et al. (Covered Funds) (Feb. 

2012); LSTA (Feb. 2012). 

the Investment Company Act. Thus, the 

final definition focuses on the types of 

entities formed for the purpose of 

investing in securities or derivatives for 

resale or otherwise trading in securities 

or derivatives, and that are offered and 

sold in offerings that do not involve a 

public offering, but typically involve 

offerings to institutional investors and 

high-net worth individuals (rather than 

to retail investors). These types of funds 

are not subject to all of the securities 

law protections applicable with respect 

to funds that are registered with the SEC 

as investment companies, and the 

Agencies therefore believe that these 

types of entities may be more likely to 

engage in risky investment strategies. At 

the same time, the Agencies have 

tailored the definition to exclude 

entities that have more general 

corporate purposes and do not present 

the same risks for banking entities as 

those associated with the funds 

described above, as well as certain other 

entities as further discussed below. 

The final rule also contains a revised 

version of the proposal’s treatment of 

certain foreign funds as covered funds, 

which has been modified from the 

proposal and tailored to include only 

the types of foreign funds that the 

Agencies believe are intended to be the 

focus of the statute, such as certain 

foreign funds that are established by 

U.S. banking entities and not otherwise 

subject to the Investment Company Act. 

The Agencies have not included all 

commodity pools within the definition 

of covered fund as proposed. Instead, 

and as discussed in more detail below, 

the Agencies have included only 

commodity pools for which the 

commodity pool operator has claimed 

exempt pool status under section 4.7 of 

the CFTC’s regulations or that could 

qualify as exempt pools and which have 

not been publicly offered 1641 to persons 

who are not qualified eligible persons 

under section 4.7 of the CFTC’s 

regulations.1642 Qualified eligible 

persons are typically institutional 

investors, banking entities and high net 

worth individuals (rather than retail 

investors). This more tailored approach, 

together with the various exclusions 

from the covered fund definition in the 

final rule, is designed to include as 

covered funds those commodity pools 

that are similar to funds that rely on 

section 3(c)(1) or 3(c)(7) while not also 

including as covered funds entities, like 

commercial end-users or registered 

investment companies, whose activities 

do not implicate the concerns that 

section 13 was designed to address. 

Finally, other related terms, including 

‘‘ownership interest,’’ ‘‘resident of the 

United States,’’ ‘‘sponsor,’’ and 

‘‘trustee,’’ are also defined in § 75.10(d) 

of the final rule.1643 As explained 

below, these terms are largely defined in 

the same manner as in the proposal 

although with certain changes, 

including changes to help clarify the 

scope of these definitions as requested 

by commenters. Some of these terms 

and related provisions also have been 

reorganized to improve clarity. As 

explained in more detail below, the 

Agencies received a number of 

comments relating to some of the terms 

defined in § 75.10. Some comments 

directly relate to the scope of the 

proposed rule and the economic effects 

associated with the prohibitions on 

covered funds activities and 

investments, some of which 

commenters argued did not further the 

purposes of section 13.1644 The 

Agencies have carefully considered 

these and other comments when 

defining the key terms used in the 

statute and in providing certain 

exclusions to the definition of the term 

covered fund. The Agencies also have 

sought to provide guidance below, 

where appropriate, on how these key 

terms would operate in order to better 

enable banking entities to understand 

their obligations under section 13 and 

the final rule. 

a. Prohibition Regarding Covered Fund 

Activities and Investments 

Section 75.10(a) of the final rule 

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

BHC Act and prohibits a banking entity 

from, directly or indirectly, acquiring or 

retaining as principal an equity, 

partnership, or other ownership interest 

in, or acting as sponsor to, a covered 

fund, unless otherwise permitted under 

subpart C of the final rule.1645 This 

provision of the rule reflects the 

statutory prohibition. 

The general prohibition in § 75.10(a) 

of the proposed rule applied solely to 

the acquisition or retention of an 

ownership interest in, or acting as 

sponsor to, a covered fund, ‘‘as 

principal.’’ 1646 Commenters generally 

supported this approach, arguing that 

applying the prohibition related to 

covered fund activities and investments 

by a banking entity only to instances 

where the banking entity acts as 

principal is consistent with the statutory 

focus on principal activity.1647 The final 

rule takes this approach as discussed 

below. 

The proposed rule and preamble 

accompanying it described potential 

exemptions from the definition of 

ownership interest for a variety of 

interests, including interests related to 

employee benefit plans, interests held in 

the ordinary course of collecting a debt 

previously contracted, positions as 

trustee, or interests acquired as agent, 

broker or custodian. Commenters 

provided information on each of these 

types of ownership interests, and 

generally supported excluding each of 

these from the section’s prohibition on 

acquiring or retaining an ownership 

interest in a covered fund. 

A significant number of commenters 

focused on employee benefit plans. 

Commenters generally argued that the 

prohibition in section 13(a) of the BHC 

Act did not encompass interests held on 

behalf of employees through an 

employee benefit plan. While the 

proposed rule did not explicitly cover 

certain ‘‘qualified plans’’ under the 

Internal Revenue Code, a number of 

commenters argued that the prohibition 

should not cover activity or investments 

related to other types of employee 

benefit plans that are not a ‘‘qualified 

plan’’ under the Internal Revenue 

Code.1648 A significant number of 

commenters urged exclusion of interests 

in and relationships with foreign 

employee benefit plans.1649

Commenters argued that the risks of 

investments made through employee 

benefit plans are borne by the employee 

beneficiaries of these plans, and any 

decision to cover employee benefit 

plans or investments made by these 

plans under the prohibitions in section 

13 of the BHC Act would eliminate or 

severely restrict the availability of 

employee programs that are widely 

offered, regulated and endorsed under a 

system of Federal, state and foreign 

laws.1650

Commenters also supported the 

exemption under the proposed rule for 

holdings in satisfaction of a debt 

previously contracted in good faith.1651


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1652See proposed rule § 75.14(b). 

1653See, e.g., ABA (Keating). 

1654See, e.g., ABA (Keating); Arnold & Porter; 

NAB. 

1655See final rule § 75.3(d)(7)–(9). 

1656A banking entity acting as agent, broker, or 

custodian is not acting ‘‘as principal’’ under the 

final rule so long as the activity is conducted for 

the account of, or on behalf of, a customer and the 

banking entity does not have or retain beneficial 

ownership of such ownership interest, as noted 

above. This provision is consistent with the final 

rule’s treatment of banking entities acting on behalf 

of customers as trustee or in a fiduciary capacity. 1657The Agencies note that this provision does 

not permit joint investments between the banking 

entity and its employees. Rather, this provision is 

intended to enable banking entities to maintain 

deferred compensation and other similar plans 

formed for the benefit of employees. The Agencies 

recognize that, since it is possible an employee may 

forfeit its interest in such a plan, the banking entity 

may have a residual or reversionary interest in the 

assets referenced under the plan. However, other 

than such residual or reversionary interests, a 

banking entity may not rely on this provision to 

invest in a covered fund. 

1658See final rule § 75.10(a)(2). For instance, as 

part of engaging in its traditional trust company 

functions, a bank or savings association typically 

may act through an entity that is excluded from the 

definition of investment company under section 

3(c)(3) or 3(c)(11). This would be included within 

the scope of acting on behalf of customers as trustee 

or in a similar fiduciary capacity, provided that it 

meets the applicable requirements of the exclusion 

under the final rule. 

1659See 12 U.S.C. 1851(h)(2). 

1660 12 U.S.C. 1851(h)(2). Sections 3(c)(1) and 

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

part, provide two exclusions from the definition of 

‘‘investment company’’ for: (1) Any issuer whose 

outstanding securities are beneficially owned by not 

more than one hundred persons and which is not 

making and does not presently propose to make a 

public offering of its securities (other than shortterm paper); or (2) any issuer, the outstanding 

securities of which are owned exclusively by 

persons who, at the time of acquisition of such 

securities, are qualified purchasers, and which is 

not making and does not at that time propose to 

make a public offering of such securities. See 15 

U.S.C. 80a-3(c)(1) and (c)(7). 

1661See proposed rule § 75.10(b)(1). 

This provision of the proposal 

recognized that banking entities may 

acquire an ownership interest in or 

relationship with a covered fund as a 

result of a counterparty’s failure to 

repay a bona fide debt and without an 

intent to engage in those activities as 

principal.1652

Several commenters urged revision to 

the proposal to add a specific exclusion 

for investments held by a banking entity 

in the capacity of trustee (including as 

trustee for a charitable trust).1653 These 

commenters argued that failing to 

recognize and exempt these types of 

activities in the final rule would prevent 

banking entities that act as trustees from 

effectively meeting their trust and 

fiduciary obligations and from 

providing these services to customers. 

Commenters also argued that the 

exemption for trust activities should not 

be dependent on the duration of the 

trust because the law governing the 

duration of trusts is changing and varies 

across jurisdictions.1654

As with the proposed rule, the 

prohibition in § 75.10(a) of the final rule 

applies only to the acquisition or 

retention of an ownership interest in, or 

sponsorship of, a covered fund as 

principal. The Agencies continue to 

believe section 13 of the BHC Act was 

designed to address the risks attendant 

to principal activity and not those that 

are borne by customers of the banking 

entity or for which the banking entity 

lacks design or intent to take a 

proprietary interest as principal. 

In order to address commenter 

concerns regarding the types of activity 

that are subject to the prohibition, the 

Agencies have modified and 

reorganized the final rule to make the 

scope of acting ‘‘as principal’’ clear and 

more consistent with the proprietary 

trading restrictions under the final 

rule.1655 The final rule provides that the 

prohibition does not include acquiring 

or retaining an ownership interest in a 

covered fund by a banking entity: (1) 

Acting solely as agent, broker, or 

custodian, so long as the activity is 

conducted for the account of, or on 

behalf of, a customer, and the banking 

entity and its affiliates do not have or 

retain beneficial ownership of the 

ownership interest; 1656 (2) through a 

deferred compensation, stock-bonus, 

profit-sharing, or pension plan of the 

banking entity (or an affiliate thereof) 

that is established and administered in 

accordance with the law of the United 

States or a foreign sovereign, if the 

ownership interest is held or controlled 

directly or indirectly by a banking entity 

as trustee for the benefit of people who 

are or were employees of the banking 

entity (or an affiliate thereof); 1657 (3) in 

the ordinary course of collecting a debt 

previously contracted in good faith, 

provided that the banking entity divests 

the ownership interest as soon as 

practicable, and in no event may the 

banking entity retain such instrument 

for longer than such period permitted by 

the appropriate agency; or (4) on behalf 

of customers as trustee or in a similar 

fiduciary capacity for a customer that is 

not a covered fund, so long as the 

activity is conducted for the account of, 

or on behalf of, the customer, and the 

banking entity and its affiliates do not 

have or retain beneficial ownership of 

such ownership interest.1658

Because these activities do not 

involve the banking entity engaging in 

an activity intended or designed to take 

ownership interests in a covered fund as 

principal, they do not appear to be the 

types of activities that section 13 of the 

BHC Act was designed to address. 

However, the Agencies note that in 

order to prevent a banking entity from 

evading the requirements of section 13 

and the final rule, the exclusions for 

these activities do not permit a banking 

entity to engage in establishing, 

organizing and offering, or acting as 

sponsor to a covered fund in a manner 

other than as permitted elsewhere in the 

final rule. The Agencies intend to 

monitor these activities and investments 

for efforts to evade the restrictions in 

section 13 of the BHC Act and the final 

rule on banking entities’ investments in 

and relationships with covered funds. 

b. ‘‘Covered Fund’’ Definition 

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

defines hedge fund and private equity 

fund to mean an issuer that would be an 

investment company, but for section 

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

Company Act, or ‘‘such similar funds’’ 

as the Agencies determine by rule.1659

Given that the statute defines ‘‘hedge 

fund’’ and ‘‘private equity fund’’ 

without differentiation, the proposed 

rule and the final rule combine the 

terms into the definition of a ‘‘covered 

fund.’’ Sections 3(c)(1) and 3(c)(7) of the 

Investment Company Act are exclusions 

commonly relied on by a wide variety 

of entities that would otherwise be 

covered by the broad definition of 

‘‘investment company’’ contained in 

that Act.1660 The proposal included as 

a covered fund any entity that would be 

an investment company but for the 

exclusion from that definition contained 

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

Investment Company Act, any foreign 

entity that would also be an investment 

company but for those same exclusions 

were the foreign entity to be organized 

or offered in the United States, and a 

commodity pool as defined in section 

1a(10) of the Commodity Exchange 

Act.1661 The preamble to the proposal 

recognized that this definition was 

broad and specifically requested 

comment on whether and how the 

definition of covered fund should be 

modified for purposes of the final rule. 

Commenters contended that the 

definition of covered fund should not 

focus exclusively on whether an entity 

relies on section 3(c)(1) or 3(c)(7) of the 

Investment Company Act. Commenters 

argued that sections 3(c)(1) and 3(c)(7) 

of the Investment Company Act are 

exclusions commonly relied on by a 

wide variety of entities that would 

otherwise be covered by the broad 

definition of ‘‘investment company’’ 

contained in that Act. Under the 

Investment Company Act, any entity 

that holds investment securities (i.e., 


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1662 15 U.S.C. 80a-3(a)(1)(A) and (C). The 

definition of securities is very broad under the 

Investment Company Act and has been interpreted 

to include instruments such as loans, that would 

not be regarded as securities under the Securities 

Act of 1933 and the Securities Exchange Act of 

1934. In addition, the determination of what 

constitutes an ‘‘investment security’’ under the 

Investment Company Act requires complex analysis 

and consideration of a broad set of facts and 

circumstances. 

1663See, e.g., NVCA. 

1664See, e.g., SIFMA et al. (Covered Funds) (Feb. 

2012); BlackRock; AHIC; Sen. Carper et al.; Rep. 

Garrett et al. 

1665See ABA (Keating); ABA (Abernathy); SIFMA 

et al. (Covered Funds) (Feb. 2012); Allen & Overy 

(on behalf of Foreign Bank Group); Allen & Overy 

(on behalf of Canadian Banks); Deutsche Bank 

(Repackaging Transactions); ICI (Feb. 2012); 

Putnam; JPMC; GE (Feb. 2012); Chamber (Feb. 

2012); Rep. Himes; BOK; Ass’n. of Institutional 

Investors (Feb. 2012); Wells Fargo (Covered Funds); 

BoA; NAIB et al.; PNC; SunTrust; Nationwide; 

STANY; BNY Mellon et al.; RMA; Goldman 

(Covered Funds); Japanese Bankers Ass’n; IRSG; 

ISDA (Feb. 2012); IIB/EBF; Citigroup (Jan. 2012); 

SSgA (Feb. 2012); State Street (Feb. 2012); Eaton 

Vance; Fidelity; SBIA; River Cities; Ashurst; Sen. 

Hagan; Sen. Bennet. 

1666As discussed below, the Agencies have 

modified the final rule to include only certain 

commodity pools within the definition of covered 

fund. 

1667See NVCA; see also SIFMA et al. (Covered 

Funds) (Feb. 2012); ABA (Keating). 

1668See, e.g., ABA (Keating); ABA (Abernathy); 

Canaan (Young); Canaan (Ahrens); Canaan (Kamra); 

Growth Managers; River Cities; SVB; EVCA. 

1669See AFME et al.; Allen & Overy (on behalf of 

Foreign Bank Group); ASF (Feb. 2012); Cleary 

Gottlieb; Deutsche Bank (Repackaging 

Transactions); SIFMA (Securitization) (Feb. 2012). 

1670See SIFMA (Securitization) (Feb. 2012); Allen 

& Overy (on behalf of Foreign Bank Group); ASF 

(Feb. 2012); Cleary Gottlieb; Credit Suisse 

(Williams); JPMC; LSTA (Feb. 2012). 

1671See Allen & Overy (on behalf of Foreign Bank 

Group); ASF (Feb. 2012); Credit Suisse (Williams); 

Eaton Vance; Fidelity; GE (Feb. 2012); GE (Aug. 

2012); ICI (Feb. 2012); IIB/EBF; JPMC; PNC; RBC; 

SIFMA (Securitization) (Feb. 2012); AFME et al. 

1672See AFME et al.; SIFMA (Securitization) 

(Feb. 2012). 

1673See AFME et al.; ASF (Feb. 2012); Cleary 

Gottlieb; Credit Suisse (Williams); SIFMA 

(Securitization) (Feb. 2012); ABA (Keating). 

1674See, e.g., SIFMA et al. (Covered Funds) (Feb. 

2012); BlackRock; Credit Suisse (Williams); SSgA 

(Feb. 2012); State Street (Feb. 2012); Deutsche Bank 

(Repackaging Transactions); Allen & Overy (on 

behalf of Foreign Bank Group). 

1675See SIFMA et al. (Covered Funds) (Feb. 

2012); AFME et al.; Allen & Overy (on behalf of 

Foreign Bank Group); ASF (Feb. 2012); Ashurst; 

Barclays; BDA (Feb. 2012); Credit Suisse (Williams); 

Commercial Real Estate Fin. Council; Fidelity; ICI 

(Feb. 2012); ISDA (Feb. 2012); JPMC; Nuveen Asset 

Mgmt.; PNC; RBC; SIFMA et al. (Covered Funds) 

(Feb. 2012); SIFMA (Municipal Securities) (Feb. 

2012); SSgA (Feb. 2012); State Street (Feb. 2012); 

Vanguard; Wells Fargo (Covered Funds). 

1676See Ass’n. of Institutional Investors (Feb. 

2012); Barclays; JPMC; SIFMA et al. (Covered 

Funds) (Feb. 2012); see also FSOC study at 62–63 

(suggesting a characteristics-based approach 

considering compensation structure; trading/

investment strategy; use of leverage; investor 

composition); ABA (Keating); BNY Mellon et al.; 

Northern Trust, SSgA (Feb. 2012); State Street (Feb. 

2012); Deutsche Bank (Repackaging Transactions); 

T. Rowe Price; RMA (suggesting use of 

characteristics derived from the SEC’s Form PF for 

registration of investment advisers of private funds). 

1677See RBC (citing FSOC study). 

generally all securities other than U.S. 

government securities) representing at 

least 40 percent of the entity’s total 

assets would be an investment 

company.1662 According to commenters, 

this definition and the accompanying 

exclusions are part of a securities law 

and regulatory framework designed for 

purposes different than the prudential 

purpose that underlies section 13 of the 

BHC Act.1663

A number of comments received on 

the proposal argued that the proposed 

definition of covered fund was overly 

broad and would lead to anomalous 

results inconsistent with the words, 

structure, and purpose of section 13.1664

For instance, many commenters asserted 

that the proposed rule’s definition of 

covered fund would cause a number of 

commonly used corporate entities that 

are not traditionally thought of as hedge 

funds or private equity funds, such as 

wholly-owned subsidiaries, joint 

ventures, and acquisition vehicles, to be 

subject to the covered fund restrictions 

of section 13. These commenters argued 

that this interpretation of section 13 

would cause a disruption to the 

operations of banking entities and their 

closely related affiliates that does not 

relate to the intent of section 13 and 

therefore cause an unnecessary burden 

on banking entities. Commenters argued 

that the words, structure and purpose of 

section 13 allow the Agencies to adopt 

a more tailored definition of covered 

fund that focuses on vehicles used for 

investment purposes that were the target 

of section 13’s restrictions. 

In particular, commenters requested 

that the final rule exclude at least the 

following from the definition of covered 

fund: U.S. registered investment 

companies (including mutual funds); 

the foreign equivalent of U.S. registered 

investment companies; business 

development companies; wholly-owned 

subsidiaries; joint ventures; acquisition 

vehicles; financial market utilities; 

foreign pension or retirement funds; 

insurance company separate accounts; 

loan securitizations, including assetbacked commercial paper conduits; cash 

management vehicles or cash collateral 

pools; credit funds; real estate 

investment trusts; various securitization 

vehicles; tender option bond programs; 

and venture capital funds.1665

Commenters requested some of these 

exclusions in order to mitigate the 

impact of the proposal’s inclusion of 

commodity pools as part of the 

definition of covered fund.1666

Some commenters argued that the 

proposal failed to distinguish between 

different types of investment funds.1667

These commenters expressed the view 

that the statute provides the Agencies 

with the discretion to distinguish 

between investment funds generally and 

a subset of funds—hedge funds and 

private equity funds—that may engage 

in particularly risky trading and 

investment activities. For example, 

several commenters argued that the 

proposed rule’s restrictions on covered 

fund investments should not cover 

venture capital funds that provide 

investment capital to new 

businesses.1668 Others argued an 

exclusion for securitization vehicles 

such as securitizations that are backed, 

in whole or in part, by assets that are 

not loans, including corporate debt 

repackagings,1669 CLOs,1670 ABCP 

conduits,1671 insurance-linked 

securities,1672 and synthetic 

securitizations backed by 

derivatives.1673

As a potential solution to some of 

these concerns, a number of 

commenters argued that the Agencies 

should define covered fund by reference 

to characteristics that are designed to 

distinguish hedge funds and private 

equity funds from other types of entities 

that rely on section 3(c)(1) or 3(c)(7) of 

the Investment Company Act.1674

Commenters believed this approach 

would help exclude some of the 

corporate vehicles and funds mentioned 

above that they did not believe were 

intended by Congress to be included as 

hedge funds and private equity funds 

and therefore reduce costs that, in the 

commenters’ view, did not further the 

purposes of section 13.1675

These commenters proposed a 

number of different potential types of 

characteristics for defining hedge fund 

and private equity fund. Some 

commenters focused on certain 

structural or investment characteristics 

found in traditional private equity funds 

and hedge funds, such as investor 

redemption rights, performance 

compensation fees, leverage and the use 

of short-selling.1676 Another commenter 

argued that the characteristics used to 

define a covered fund should focus on 

the types of speculative behavior that 

the statute was intended to address, 

citing characteristics such as volatility 

of asset performance and high 

leverage.1677

In contrast to the majority of the 

commenters, one commenter urged that 

characteristics be used to expand the 

proposed definition to include any 


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1678See Occupy. 

1679See AFR et al. (Feb. 2012). 

1680See Sens. Merkley & Levin (Feb. 2012); AFR 

et al. (Feb. 2012); Alfred Brock. 

1681See Occupy (also arguing in favor of 

including entities that rely on rule 3a-1 (which 

provides an exemption for issuers that hold less 

than 45% of their assets in securities excluding 

government securities) or 3a-6 (which provides an 

exemption for foreign banks and insurance 

companies) to avoid being regulated as investment 

companies under the Investment Company Act). 

1682See, e.g., ABA (Keating). 

1683For instance, bank common trust and 

collective funds that qualify for the exclusion from 

the definition of investment company pursuant to 

section 3(c)(3) or 3(c)(11) of the Investment 

Company Act are not covered funds. See 15 U.S.C. 

78a-3(c)(3) and (c)(11). These funds are subject to 

supervision and regulation by a Federal banking 

agency, thus helping to distinguish them from 

traditional hedge funds and private equity funds 

which are generally not themselves subject to such 

supervision or regulation. 

1684See final rule § 75.10(c)(12). 

1685See 12 U.S.C. 1851(h)(2) (emphasis added). 

1686 In addition to the readings described above, 

one commenter argued that the section could be 

read to provide that both the reference to issuers 

covered by section 3(c)(1) or 3(c)(7) of the 

Investment Company Act in the first part of section 

13(h)(2) and the reference to similar funds in the 

second part of the section should be read as 

qualified by the clause ‘‘as the Agencies may by 

rule. . . determine.’’ Under this reading, Congress 

granted the Agencies authority to determine by rule 

whether an entity described by the first part would 

be covered and whether an issuer would be deemed 

to be a similar fund under the second part. See 

SIFMA et al. (Covered Funds) (Feb. 2012). 

issuer that exhibits characteristics of 

proprietary trading that the statute 

prohibits to be done by a banking 

entity.1678 According to this commenter, 

any fund engaging in more than 

minimal proprietary trading should be a 

covered fund and subject to the 

requirements of section 13. 

However, not all commenters 

supported a characteristics-based 

definition. One commenter opposed a 

characteristics-based definition, 

suggesting that the final rule rely only 

on the statutory reference to the 

Investment Company Act, and arguing 

that using characteristics to define a 

covered fund (e.g., leverage) could 

create opportunities for circumvention 

of the rule.1679 Commenters that 

generally supported the proposed 

definition argued that its broad scope 

prevented circumvention.1680

One commenter argued in favor of 

broadening the definition of covered 

fund to include entities that rely on an 

exclusion from the definition of 

investment company other than those 

contained in section 3(c)(1) and 3(c)(7), 

such as section 3(c)(2) (which provides 

an exclusion for underwriters and 

brokers) or 3(c)(6) (which provides an 

exclusion for entities engaged in a 

business other than investing in 

securities).1681 By contrast, other 

commenters argued that an entity 

should not be considered a covered 

fund if the entity relies on an exclusion 

or exemption contained in the 

Investment Company Act other than an 

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

3(c)(7) under that Act, such as the 

exclusion contained in section 3(c)(3) 

for bank collective investment 

funds.1682

The Agencies have carefully 

considered all of the comments related 

to the definition of covered fund. While 

the Agencies believe that the proposal 

reflected a reasonable interpretation of 

the statutory provision, on further 

review and in light of the comments the 

Agencies have determined to adopt a 

different approach. The Agencies have 

revised the final rule to address many of 

the concerns raised by commenters 

regarding the scope of the original 

proposal in a manner the Agencies 

believe is a better reading of the 

statutory provision because it is both 

consistent with the language, purpose 

and structure of section 13 and avoids 

unintended consequences of the less 

precise definitional approach of the 

proposal. 

In the final rule, the Agencies have 

joined the definitions of ‘‘hedge fund’’ 

and ‘‘private equity fund’’ into a single 

definition ‘‘covered fund’’ (as in the 

statute) and have defined this term as 

any issuer that would be an investment 

company as defined in the Investment 

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

3(c)(7) of that Act with a number of 

express exclusions and additions 

(explained below) as determined by the 

Agencies. Thus, for example, an entity 

that invests in securities and relies on 

any exclusion or exemption from the 

definition of ‘‘investment company’’ 

under the Investment Company Act 

other than the exclusion contained in 

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

would not be considered a covered fund 

so long as it satisfies the conditions of 

another Investment Company Act 

exclusion or exemption.1683 Such an 

entity would not be an investment 

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

3(c)(7), and the Agencies have modified 

the final rule to explicitly exclude such 

an entity.1684

The Agencies believe this definition is 

consistent with the words, structure, 

purpose and legislative history of 

section 13 of the BHC Act. As noted 

above, section 13(h)(2) provides that the 

terms ‘‘hedge fund’’ and ‘‘private equity 

fund’’ mean an issuer that would be an 

investment company as defined in the 

Investment Company Act (15 U.S.C. 

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

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

as the Agencies may, by rule, as 

provided in subsection (b)(2), 

determine.1685 The statutory provision 

contains two parts: A first part that 

refers to any issuer that is ‘‘an 

investment company, as defined in the 

Investment Company Act, but for 

section 3(c)(1) and 3(c)(7) of the Act’’; 

and a second part that covers ‘‘such 

similar funds as the [Agencies] may, by 

rule . . . determine.’’ The proposed rule 

offered a reading of this provision as a 

simple concurrent definition with two 

self-contained, supplementary parts. 

Under this approach, all entities 

covered by part one of the definition 

would be included in the definitions of 

‘‘hedge fund’’ and ‘‘private equity 

fund,’’ and the role of the Agencies 

under the second part was limited to 

considering whether and how to 

augment the scope of the primary 

statutory definition. 

As noted above, commenters argued 

that this interpretation led to 

unintended consequences that were not 

consistent with other provisions of 

section 13 or the purposes of section 13, 

and that other interpretations of the 

definition of covered fund were 

consistent with both the words and the 

purpose of the statute. Also as explained 

above, commenters offered multiple 

alternative interpretations of the 

definition of, the scope of the 

prohibition on ownership interests in, 

and relationships with, a covered 

fund.1686

The Agencies believe that the 

language of section 13(h)(2) can best be 

interpreted to provide two alternative 

definitions of the entities to be covered 

by the statutory terms ‘‘hedge fund’’ and 

‘‘private equity fund.’’ Under this 

reading, the first part of section 13(h)(2) 

contains a base definition that 

references the noted exclusions under 

the Investment Company Act (the 

‘‘default definition’’), while the second 

part grants the Agencies the authority to 

adopt an alternate definition that is 

triggered by agency action (the ‘‘tailored 

definition’’). Thus, if the Agencies do 

not act by rule, the definition is set by 

reference to the Investment Company 

Act and the relevant exclusions alone; if 

the Agencies act by rule, the definitions 

are set by the Agencies under that rule. 

As noted above, the Agencies have 

determined to exercise the authority 

under the second part of the statute to 

define ‘‘hedge fund’’ and ‘‘private equity 

fund’’ in the final rule. 

Relying on the Agencies’ authority to 

adopt an alternative, tailored definition 

of ‘‘hedge fund’’ and ‘‘private equity 

fund,’’ the final rule references funds 

that are similar to the funds in the base 


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1687See 156 Cong. Reg. S.5894–5895 (daily ed. 

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

1688The Agencies believe that the choice of the 

tailored definition is supported by the legislative 

history that suggests that Congress may have 

foreseen that its base definition could lead to 

unintended results and might be overly broad, too 

narrow, or otherwise off the mark. Part two of the 

statutory definition was not originally included in 

the bill reported by the Senate Committee on April 

30, 2010. While the addition of part two did not 

receive specific comment, Rep. Frank, a co-sponsor 

and principal architect of the Dodd-Frank Act, 

noted that the default definition ‘‘could technically 

apply to lots of corporate structures, and not just 

the hedge funds and private equity funds’’ and 

confirmed that ‘‘[w]e do not want these overdone.’’ 

See 156 Cong. Rec. H5226 (daily ed. June 30, 2010) 

(statement of Reps. Himes and Frank) (noting intent 

that subsidiaries or joint ventures not be included 

within the definition of covered fund); 156 Cong. 

Rec. S5904–05 (daily ed. July 15, 2010) (statement 

of Sens. Boxer and Dodd) (noting broad definition 

of hedge fund and private equity fund and 

recommending that the Agencies take steps to 

ensure definition is reasonably tailored). 

1689For example, the Dodd-Frank Act requires 

banking entities to serve as a source of financial 

strength to their insured depository institutions and 

requires certain banking entities to form 

intermediate holding companies to separate their 

financial and non-financial activities. See Sections 

167, 616(d) & 626 of the Dodd-Frank Act. These 

provisions would be severely undermined if the 

prohibitions on investments and activities 

contained in section 13 were applied to ownership 

of intermediate holding companies. For instance, a 

bank holding company would not be able to serve 

as a source of strength to an intermediate holding 

company (or any subsidiary thereof) that is a 

covered fund due to the transaction restrictions 

contained in section 13(f). See 12 U.S.C. 1851(f). As 

another example, the Agencies have made certain 

modifications to the final rule to make clear that it 

will not affect the resolution authority of the 

Federal Deposit Insurance Corporation, including 

by excluding from the covered fund definition 

issuers formed by or on behalf of the Corporation 

for the purpose of facilitating the disposal of assets 

acquired in the Corporation’s capacity as 

conservator or receiver. See § 75.10(c)(13). 

1690As discussed in Part VI.C.1 of this 

SUPPLEMENTARY INFORMATION regarding the 

compliance program requirements of the final rule, 

the Agencies will consider information maintained 

and provided by banking entities under the 

compliance program mandate to help monitor 

potential evasions of the prohibitions and 

restrictions of section 13. Additionally and 

consistent with the statute, the final rule permits 

the Agencies to jointly determine to include within 

the definition of covered fund any fund excluded 

from that definition. The Agencies expect that this 

authority may be used to help address situations of 

evasion. 

1691See, e.g., SIFMA et al. (Covered Funds) (Feb. 

2012). 

alternative provided in the first 

alternative definition—that is, an issuer 

that would be an investment company 

under the Investment Company Act but 

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

The additions and exclusions from that 

definition represent further 

determinations by the Agencies 

regarding the scope of that definition 

that were made in the course of a 

rulemaking conducted in accordance 

with section 13(b)(2) of the BHC Act. 

The Agencies believe that this reading 

of the statutory provision is consistent 

with the purpose of section 13. That 

purpose appears to be to limit the 

involvement of banking entities in highrisk proprietary trading, as well as their 

investment in, sponsorship of, and other 

connections with, entities that engage in 

investment activities for the benefit of 

banking entities, institutional investors 

and high-net worth individuals.1687

Further, the Agencies believe that the 

provision permits them to tailor the 

scope of the definition to funds that 

engage in the investment activities 

contemplated by section 13 (as opposed, 

for example, to vehicles that merely 

serve to facilitate corporate structures); 

doing so allows the Agencies to avoid 

the unintended results, some of which 

commenters identified, that might 

follow from a definition that is 

inappropriately imprecise.1688

The Agencies also note that nothing 

in the structure or history of the DoddFrank Act suggests that the definition of 

hedge fund and private equity fund was 

intended to necessitate a fundamental 

restructuring of banking entities by 

disallowing investments in common 

corporate vehicles such as intermediate 

holding companies, joint operating 

companies, acquisition vehicles and 

similar entities that do not engage in the 

types of investment activities 

contemplated by section 13. Moreover, 

other provisions of the Dodd-Frank Act 

and existing banking laws and 

regulations would be undermined or 

vitiated by a reading that restricts 

investments in these types of corporate 

vehicles and structures.1689

Based on the interpretive and policy 

considerations raised by commenters, 

the language of section 13(h)(2), and the 

language, structure, and purpose of the 

Dodd-Frank Act, the Agencies have 

adopted a tailored definition of covered 

fund in the final rule that covers issuers 

of the type that would be investment 

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

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

with exclusions for certain specific 

types of issuers in order to focus the 

covered fund definition on vehicles 

used for the investment purposes that 

were the target of section 13. The 

definition of covered fund under the 

final rule also includes certain funds 

organized and offered outside of the 

United States in order to address foreign 

fund structures and certain commodity 

pools that might otherwise allow 

circumvention of the restrictions of 

section 13. The Agencies also expect to 

exercise the statutory anti-evasion 

authority provided in section 13(e) of 

the BHC Act and other prudential 

authorities in order to address instances 

of evasion.1690

As discussed above, an alternative 

approach to defining a covered fund 

would be to reference fund 

characteristics. Commenters arguing for 

a characteristics-based approach stated 

that it would more precisely tailor the 

final rule to the intent of section 13 and 

limit the potential for undue burden on 

banking entities. A characteristics-based 

definition, however, could be less 

effective than the approach taken in the 

final rule as a means to prohibit banking 

entities, either directly or indirectly, 

from engaging in the covered fund 

activities limited or proscribed by 

section 13. A characteristics-based 

approach also could require more 

analysis by banking entities to apply 

those characteristics to every potential 

covered fund on a case-by-case basis, 

and create greater opportunity for 

evasion. As discussed below, the 

Agencies have sought to address some 

of the concerns raised by commenters 

suggesting a characteristics-based 

approach by tailoring the definition of 

covered fund to provide exclusions for 

certain entities that rely on section 

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

Company Act and otherwise would be 

treated as covered funds. 

Some commenters discussed the 

potential cost to banking entities to 

analyze the covered fund status of 

certain entities if the Agencies were to 

define the term covered fund by 

reference to sections 3(c)(1) and 3(c)(7), 

arguing that this analysis would be 

costly.1691 A characteristics-based 

approach could mitigate the costs 

associated with an investment company 

analysis but, depending on the 

characteristics, could result in 

additional compliance costs in some 

cases to the extent banking entities 

would be required to implement 

policies and procedures to prevent 

potential covered funds from having 

characteristics that would bring them 

within the covered fund definition. 

Furthermore, banking entities may 

currently rely on section 3(c)(1) and 

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

to avoid registering various entities 

under the Investment Company Act, and 

the costs to analyze the status of these 

entities under a statutory-based 

definition of covered fund are generally 

already included as part of the fund 

formation process and the costs of 

determining covered fund status may 

thus be mitigated, especially given the 

exclusions provided in the final rule. 

The entities excluded from the 

definition of covered fund are described 

in detail in section (c) below. 


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5944 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

1692See proposed rule § 75.10(b)(1)(iii). 

1693See SIFMA et al. (Covered Funds) (Feb. 

2012); BNY Mellon et al.; BlackRock; ABA 

(Keating); AFTI; AFG; ICI Global; Ass’n. of 

Institutional Investors (Feb. 2012); ICI (Feb. 2012); 

SSgA (Feb. 2012); State Street (Feb. 2012); JPMC; 

BoA; Goldman (Covered Funds); Bank of Montreal 

et al. (Jan. 2012); AGC; Cadwalader (on behalf of 

Thai Banks); ALFI; BVI; EBF; British Bankers 

Ass’n.; French ACP; AFME et al.; F&C; IIF; ICSA; 

IMA; EFAMA; UKRCBC; AIMA; AFMA; Australian 

Bankers Ass’n. (Feb. 2012); Allen & Overy (on 

behalf of Foreign Bank Group); IFIC; Allen & Overy 

(on behalf of Canadian Banks); RBC; French 

Treasury et al.; Hong Kong Inv. Funds Ass’n.; TCW; 

Govt. of Japan/Bank of Japan. 

1694See JPMC; see also Cadwalader (on behalf of 

Thai Banks); Cadwalader (on behalf of Singapore 

Banks); Ass’n. of Banks in Malaysia; Govt. of Japan/ 

Bank of Japan. 

1695UCITS are public limited companies that, 

under a series of directives issued by the EU 

Commission, coordinate distribution and 

management of unit trusts or collective investment 

schemes in financial instruments on a cross-border 

basis throughout the European Union on the basis 

of the authorization of a single member state. 

1696See Allen & Overy (on behalf of Foreign Bank 

Group); ABA (Keating); AFG; AFTI; BoA; French 

Banking Fed’n.; SIFMA et al. (Covered Funds) (Feb. 

2012); see also BNY Mellon et al.; BlackRock; ICI 

Global; Ass’n. of Institutional Investors (Feb. 2012); 

ICI (Feb. 2012); SSgA (Feb. 2012); State Street (Feb. 

2012); JPMC; BoA; Goldman (Covered Funds); Bank 

of Montreal et al. (Jan. 2012); AGC; Cadwalader (on 

behalf of Thai Banks); ALFI; BVI; EBF; British 

Bankers Ass’n.; French ACP; AFME et al.; F&C; IIF; 

ICSA; IMA; EFAMA; UKRCBC; AIMA; AFMA; 

Australian Bankers Ass’n. (Feb. 2012); Allen & 

Overy (on behalf of Foreign Bank Group); IFIC; 

Allen & Overy (on behalf of Canadian Banks); RBC; 

French Treasury et al.; Hong Kong Inv. Funds 

Ass’n.; HSBC Life; ICSA Ass’n. of Banks in 

Malaysia (arguing that foreign banking organization 

would have to determine how a fund would be 

regulated under U.S. law before making 

investments in funds in their home markets). 

1697See Allen & Overy (on behalf of Foreign Bank 

Group); ABA (Keating); SSgA (Feb. 2012); BoA; 

Goldman (Covered Funds). 

1698See Australian Bankers Ass’n. (Feb. 2012); 

BlackRock. 

1699See BlackRock; SIFMA et al. (Covered Funds) 

(Feb. 2012); JPMC; ABA (Keating); IIB/EBF. These 

commenters argued that the proposed definition of 

a covered fund could result in virtually every 

foreign fund being considered a covered fund, 

regardless of whether the fund is similar to a hedge 

fund or private equity fund. 

1700See, e.g., AGC; Ass’n. of Institutional 

Investors (Feb. 2012); ABA (Keating); Goldman 

(Covered Funds); BoA; GE (Feb. 2012); Japanese 

Bankers Ass’n.; EBF. 

1701See Australian Bankers Ass’n. (Feb. 2012); 

AFG; BNY Mellon et al.; BlackRock; Goldman 

(Covered Funds); IIB/EBF. 

1702See SIFMA et al. (Covered Funds) (Feb. 

2012); JPMC; Goldman (Covered Funds); Credit 

Suisse (Williams); ABA (Keating); IIB/EBF; 

Barclays; BoA; GE (Feb. 2012) (discussing the 

uncertainty with respect to foreign-based loan and 

securitization programs and whether they would be 

deemed covered funds). 

1. Foreign Covered Funds 

In order to prevent evasion of the 

prohibition and purposes of section 13, 

the proposal included within the 

definition of covered fund any issuer 

organized or offered outside of the 

United States (‘‘foreign covered fund’’) 

that would be a covered fund were it 

organized or offered in the United 

States.1692

Commenters expressed concern that 

the proposed treatment of foreign 

covered funds was overly broad, 

exceeded the Agencies’ statutory 

authority, was not consistent with 

principles of national treatment, and 

violated international treaties.1693

Commenters expressed concern about 

the difficulties of applying Investment 

Company Act concepts to foreign funds 

that are structured to comply with 

regulatory schemes under local laws 

outside the United States. They also 

argued that it would be burdensome and 

costly to require foreign banking entities 

to interpret and apply U.S. securities 

laws to foreign structures that are 

designed primarily to be offered and 

sold outside the United States.1694

Commenters also contended that foreign 

mutual fund equivalents, such as retail 

Undertakings for Collective Investments 

in Transferable Securities 

(‘‘UCITS’’),1695 would be treated as 

covered funds under the proposal even 

though they generally are similar to U.S. 

registered investment companies, which 

are not covered funds, meaning that 

under the proposal the scope of foreign 

funds captured was broader than the 

scope of domestic funds.1696 These 

commenters argued that a foreign fund 

organized and offered outside of the 

United States should not be treated as 

a covered fund simply because the 

foreign fund may (or could) rely on the 

exclusion under section 3(c)(1) or 3(c)(7) 

of the Investment Company Act were it 

to be offered in the United States.1697

Some commenters argued that the 

proposal did not clearly identify which 

foreign funds would be covered, thereby 

creating uncertainty about the scope of 

funds to which section 13 would 

apply.1698 Several commenters argued 

that the proposal’s foreign covered fund 

definition could be read to include a 

foreign fund, even if its securities were 

never offered and sold to U.S. persons, 

because the fund could theoretically be 

offered in the United States in reliance 

on section 3(c)(1) or 3(c)(7).1699

Commenters argued that the definition 

of foreign covered fund should be 

tailored.1700 Some commenters argued 

that foreign funds that are not made 

available for sale in the U.S. or actively 

marketed to U.S. investors should be 

specifically excluded from the 

definition of covered fund.1701 Several 

other commenters supported narrowing 

the definition of foreign covered fund to 

those foreign funds with characteristics 

similar to domestic hedge funds or 

private equity funds.1702

After considering the comments in 

light of the statutory provisions and 

purpose of section 13, the Agencies 

have modified the final rule to more 

effectively tailor the scope of foreign 

funds that would be covered funds 

under the rule and better implement the 

language and purpose of section 13. As 

noted above, section 13 of the BHC Act 

applies to the global operations of U.S. 

banking entities, and one of the 

purposes of section 13 is to reduce the 

risk to the U.S. financial system of 

activities with and investments in 

covered funds. The Agencies proposed 

to include foreign funds within the 

definition of covered fund in order to 

more effectively accomplish the purpose 

of section 13. In particular, the Agencies 

were concerned that a definition of 

covered fund that did not include 

foreign funds would allow U.S. banking 

entities to be exposed to risks and 

engage in covered fund activities 

outside the United States that are 

specifically prohibited in the United 

States. This result would undermine 

section 13 and pose risks to U.S. 

banking entities and the stability of the 

U.S. financial system that section 13 

was designed to prevent. 

At the same time, section 13 includes 

other provisions that explicitly limit its 

extra-territorial application to the 

activities of foreign banks outside the 

United States. As explained below, 

section 13 specifically exempts certain 

activities in covered funds conducted by 

foreign banking entities solely outside of 

the United States. 

Based on these considerations and the 

information provided by commenters, 

the Agencies have revised the definition 

of covered fund in the final rule to 

include certain foreign funds under 

certain circumstances. The final rule 

provides that a foreign fund is included 

within the definition of covered fund 

only for any banking entity that is, or is 

controlled directly or indirectly by a 

banking entity that is, located in or 

organized or established under the laws 

of the United States or of any State. 

Under this definition a foreign fund 

becomes a covered fund only with 

respect to the U.S. banking entity (or 

foreign affiliate of a U.S. banking entity) 

that acts as a sponsor to the foreign fund 

or has an ownership interest in the 

foreign fund. Under the rule, a foreign 

fund is any entity that: (i) Is organized 

or established outside the United States 

and the ownership interests of which 

are offered and sold solely outside the 

United States; (ii) is, or holds itself out 

as being, an entity or arrangement that 

raises money from investors primarily 

for the purpose of investing in securities 

for resale or other disposition or 


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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 5945 

1703See final rule § 75.10(b)(1)(iii). 

1704See also Goodwin, Procter & Hoar LLP, SEC 

Staff No-Action Letter (Feb. 28, 1997); Touche 

Remnant & Co., SEC Staff No-Action Letter (Aug. 

27, 1984). 

1705See final rule § 75.10(b)(2). Because any 

issuer that offers its securities under the U.S. 

securities laws that may rely on an exclusion or 

exemption from the definition of investment 

company other than the exclusions contained in 

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

Act would not be a covered fund, this exclusion is 

designed to provide equivalent treatment for foreign 

covered funds. 

1706See § 75.10(c)(1). 

1707See proposal rule § 75.10(b)(1)(ii). 1708Commodity interests include: (i) Commodity 

for future delivery, security futures product, or 

swap; (ii) agreement, contract, or transaction 

described in section 2(c)(2)(C)(i) or 2(c)(2)(D)(i) of 

the Commodity Exchange Act; (iii) commodity 

option authorized under section 4c of the 

Commodity Exchange Act; or (iv) leveraged 

transaction authorized under section 23 of the 

Commodity Exchange Act. See Joint Proposal, 76 

FR at 68897 n.224 and accompanying text. 

1709See, e.g., ABA (Keating) (citing see, e.g., 

CFTC Interpretative Letter No. 86–22, Comm. Fut. 

L. Rep. (CCH) ¶ 23,280 (Sept. 19, 1986)); SIFMA et 

al. (Covered Funds) (Feb. 2012); ICI (Feb. 2012); 

BlackRock; Goldman (Covered Funds); Wells Fargo 

(Covered Funds); BoA; EFAMA; TCW; ISDA (Feb. 

2012); Arnold & Porter; BNY Mellon et al.; SSgA 

(Feb. 2012); State Street (Feb. 2012); Credit Suisse 

(Williams); RMA; IIB/EBF. 

1710See Goldman (Covered Funds); TCW; IIB/

EBF. 

1711See, e.g., SIFMA et al. (Covered Funds) (Feb. 

2012); ICI (Feb. 2012); BlackRock. 

1712See, e.g., BoA. 

1713See, e.g., SIFMA et al. (Covered Funds) (Feb. 

2012); Goldman (Covered Funds); BlackRock; Wells 

Fargo (Covered Funds); BNY Mellon, et al.; SSgA 

(Feb. 2012); State Street (Feb. 2012); Credit Suisse 

(Williams); ABA (Keating); FIA; IIB/EBF; BoA. 

1714See Credit Suisse (Williams). 

1715See AFR et al. (Feb. 2012); Alfred Brock; 

Occupy; Sens. Merkley & Levin (Feb. 2012). 

1716See Sens. Merkley & Levin (Feb. 2012); 

Occupy; AFR et al. (Feb. 2012); Alfred Brock. 

1717See Sens. Merkley & Levin (Feb. 2012). 

1718See Occupy. 

otherwise trading in securities; and (iii) 

has as its sponsor the U.S. banking 

entity (or an affiliate thereof) or has 

issued an ownership interest that is 

owned directly or indirectly by the U.S. 

banking entity (or an affiliate 

thereof).1703 A foreign fund therefore 

may be a covered fund with respect to 

the U.S. banking entity that sponsors the 

fund, but not be a covered fund with 

respect to a foreign bank that invests in 

the fund solely outside the United 

States. 

This approach is designed to include 

within the definition of covered fund 

only foreign entities that would pose 

risks to U.S. banking entities of the type 

section 13 was designed to address. The 

Agencies note that any foreign fund, 

including a foreign fund sponsored or 

owned by a foreign banking entity, that 

is offered or sold in the United States in 

reliance on the exclusions in section 

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

Company Act would be included in the 

definition of covered fund under 

§ 75.10(b)(1)(i) of the final rule unless it 

meets the requirements of an exclusion 

from that definition as discussed 

below.1704 Thus, the rule is designed to 

provide parity—and no competitive 

advantages or disadvantages—between 

U.S. and non-U.S. funds sold within the 

United States. 

To further ensure that this approach 

to foreign funds is consistent with the 

scope of coverage applied within the 

United States, the final rule excludes 

from the definition of covered fund any 

foreign issuer that, were it subject to 

U.S. securities laws, would be able to 

rely on an exclusion or exemption from 

the definition of investment company 

other than the exclusions contained in 

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

Investment Company Act.1705

As explained below, the final rule 

also contains an exclusion for foreign 

public funds.1706 This is designed to 

prevent the extension of the definition 

of covered fund from including foreign 

funds that are similar to U.S. registered 

investment companies, which are by 

statute not covered by section 13. 

2. Commodity Pools 

Under the proposal, the Agencies 

proposed to use their authority to 

expand the definition of covered fund to 

include a commodity pool as defined in 

section 1a(10) of the Commodity 

Exchange Act.1707 A commodity pool is 

defined in the Commodity Exchange Act 

to mean any investment trust, syndicate, 

or similar form of enterprise operated 

for the purpose of trading in commodity 

interests.1708 The Agencies proposed to 

include commodity pools in the 

definition of covered fund because some 

commodity pools are managed and 

structured in a manner similar to a 

covered fund. 

Some commenters objected to this 

expansion of the definition of covered 

fund as beyond the scope of section 13. 

Commenters argued that covering 

commodity pools would extend section 

13 of the BHC Act to any entity that 

engages in a single commodity, futures 

or swap transaction, including entities 

that share few, if any, of the 

characteristics or risk associated with 

private equity funds or hedge funds.1709

For example, some commenters argued 

that many non-bank businesses that are 

not investment companies but that 

hedge risks using commodity interests 

would be treated as covered funds if all 

commodity pools were covered.1710 In 

addition, registered mutual funds, 

pension funds, and many investment 

companies that rely on exclusions or 

exceptions other than section 3(c)(1) or 

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

would be covered as commodity pools. 

Commenters argued that the CFTC has 

ample authority to regulate the activities 

of commodity pools and commodity 

pool operators, and nothing in section 

13 indicates that Congress intended 

section 13 to govern commodity pool 

activities or investments in commodity 

pools.1711 Commenters also argued that 

expanding the definition of covered 

fund to include commodity pools would 

have the unintended consequence of 

limiting all covered transactions 

between a banking entity sponsor or 

investor in a commodity pool and the 

commodity pool itself.1712 If a 

commercial end user is a commodity 

pool for example, this restriction could 

limit access to credit for that entity. 

Commenters that opposed the 

proposal’s inclusion of commodity 

pools generally asserted that, if 

commodity pools were nonetheless 

included as covered funds under the 

final rule, the definition of commodity 

pool should be modified so that it 

would include only those pools that 

engage ‘‘primarily’’ or ‘‘principally’’ in 

commodities trading and exhibit 

characteristics similar to those of 

conventional hedge funds and private 

equity funds.1713 Other commenters 

urged the Agencies to incorporate the 

exemptions from the commodity pool 

operator registration requirements under 

the Commodity Exchange Act (such as 

rule 4.13(a)(4)).1714

Some commenters supported 

including commodity pools within the 

definition of covered fund,1715 with 

some suggesting that this approach 

would be consistent with the goals of 

the statute.1716 One commenter asserted 

that including commodity pools would 

be necessary to prevent banking entities 

from indirectly engaging in prohibited 

proprietary trading through commodity 

pools.1717 Another commenter asserted 

that the inclusion of commodity pools 

was advisable because the CFTC has in 

the past viewed many commodity pools 

as similar to hedge funds.1718

After carefully considering these 

comments, the Agencies have 

determined not to include all 

commodity pools as covered funds as 

proposed. Instead, and taking into 

account commenters’ concerns, the 

Agencies have taken a more tailored 

approach that is designed to more 

accurately identify those commodity 

pools that are similar to issuers that 

would be investment companies as 

defined the Investment Company Act of 

1940 but for section 3(c)(1) or 3(c)(7) of 


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5946 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

1719See 7 U.S.C. 1a(10). 

1720 Id. The CFTC and its divisions have provided 

interpretative guidance with respect to the meaning 

of the definition of commodity pool. See, e.g., 46 

FR 26004, 26005 (May 8, 1981) (adopting the 

CFTC’s regulatory definition of commodity pool in 

17 CFR 4.10(d), which is substantively identical to 

the definition in section 1a(10) of the Commodity 

Exchange Act); 77 FR 11252, 11258 (Feb. 24, 2012) 

(explaining the need for swaps to be included in the 

de minimis exclusion and exemption in 17 CFR 4.5 

and 4.13); CFTC Staff Letter 12–13 (Oct. 11, 2012) 

(providing interpretative guidance to equity real 

estate investment trusts); and CFTC Staff Letters 

Nos. 12–14 (Oct. 11, 2012) and 12–45 (Dec. 7, 2012) 

(providing interpretative relief that certain 

securitization vehicles are not commodity pools). 

1721 17 CFR 4.7(a)(1)(iii). 

1722Although section 3(c)(1) itself does not limit 

the types of investors who may invest in a fund 

relying on that exclusion, section 3(c)(1) provides 

that the fund may not conduct a public offering. A 

fund relying on section 3(c)(1) therefore must offer 

and sell its interests in offerings that are not 

registered under the Securities Act of 1933, which 

offerings generally are limited to persons who meet 

certain qualification standards. 

1723See, e.g., CFTC regulations 3.10(c) and 4.13 

and CFTC Staff Letters Nos. 12–37 (Nov. 29, 2012) 

(relief from registration for operators of certain 

types of family office pools), 12–40 (Dec. 4, 2012) 

(relief from registration for operators of business 

development companies that meet certain 

conditions) and 12–44 (Dec. 7, 2012) (relief from 

registration for operators of mortgage real estate 

investment trusts that meet certain conditions). See 

also supra note 1720. 

1724 17 CFR 4.7(a)(2) and (a)(3). 

1725Although section 4.7 requires that all 

participation units be owned by qualified eligible 

persons, this element of the final rule has been 

modified to include pools for which ‘‘substantially 

all’’ participation units are owned by qualified 

eligible persons to prevent avoidance of covered 

fund status by distributing a small number of 

participation units to persons who are not qualified 

eligible persons. 

1726See 77 FR 9734, 9741 (Feb. 17, 2012) 

(describing the meaning of the term ‘‘offer’’ in the 

context of the business conduct standards for swap 

dealers and major swap participants with 

counterparties adopted by the CFTC). The term 

‘‘offered’’ as used in this section of the final rule 

is not intended to denote an ‘‘offer’’ for purposes 

of the Securities Act of 1933. 

that Act, consistent with section 

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

Under the final rule, as a threshold 

matter, a collective investment vehicle 

must determine whether it is a 

‘‘commodity pool’’ as that term is 

defined in section 1a(10) of the 

Commodity Exchange Act.1719 The 

Agencies note that collective investment 

vehicles need to make this 

determination for purposes of 

complying with the Commodity 

Exchange Act regardless of whether 

commodity pools are covered funds. 

Under section 1a(10), a commodity pool 

is ‘‘any investment trust, syndicate, or 

similar form of enterprise operated for 

the purpose of trading commodity 

interests.’’ 1720 If a collective investment 

vehicle meets that definition, the 

commodity pool would be considered a 

covered fund provided it meets one of 

two alternative tests and does not also 

qualify for an exclusion from the 

covered fund definition (e.g., the 

exclusion for registered investment 

companies). 

First, a commodity pool will be a 

covered fund if it is an ‘‘exempt pool’’ 

under section 4.7(a)(1)(iii) of the CFTC’s 

regulations,1721 meaning that it is a 

commodity pool for which a registered 

commodity pool operator has elected to 

claim the exemption provided by 

section 4.7 of the CFTC’s regulations. 

The Agencies believe that such 

commodity pools are appropriately 

considered covered funds because, like 

funds that rely on section 3(c)(1) or 

3(c)(7), these commodity pools sell their 

participation units in restricted offerings 

that are not registered under the 

Securities Act of 1933 and are offered 

only to investors who meet certain 

heightened qualification standards, as 

discussed above.1722 The Agencies 

therefore have determined that they 

properly are considered ‘‘such similar 

funds’’ as specified in section 13(h)(2) of 

the BHC Act. 

Alternatively, a commodity pool for 

which exempt pool status under section 

4.7 of the CFTC’s regulations has not 

been elected may also be a covered fund 

if the pool features certain elements that 

make the pool substantively similar to 

exempt pools under section 4.7. The 

Agencies are including the alternative 

definition of commodity pools that are 

covered funds because, if the Agencies 

had included only pools for which 

exempt pool status had been elected, 

covered fund status for pools in which 

banking entities are invested could 

easily be avoided merely by not electing 

exempt pool status under section 4.7. 

The following is a description of the 

elements of a pool that would cause a 

pool that is not an exempt pool under 

section 4.7 to be a covered fund. 

The first element is that a commodity 

pool operator for the pool is registered 

pursuant to the Commodity Exchange 

Act in connection with the operation of 

that commodity pool. This element is 

present for all pools that are exempt 

pools under section 4.7 because exempt 

pool status can only be elected by 

registered commodity pool operators. 

This element excludes from the 

definition of covered fund an entity that 

is a commodity pool, but for which the 

pool operator has been either exempted 

from registration as a commodity pool 

operator or excluded from the definition 

of commodity pool operator under the 

CFTC’s regulations or pursuant to a noaction letter issued by CFTC staff.1723

The second element under the 

alternative definition is that 

substantially all of the commodity 

pool’s participation units are owned 

only by qualified eligible persons under 

section 4.7(a)(2) and (a)(3).1724 This 

element is consistent with the 

requirement under section 4.7 that 

exempt pool status can only be claimed 

if the participation units in the pool are 

only offered or sold to qualified eligible 

persons.1725 Moreover, the inclusion of 

this element aligns the elements of the 

alternative test with features that define 

funds that rely on sections 3(c)(1) and 

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

of 1940. 

The assessment as to whether the 

commodity pool in question satisfies 

this condition must be made at the time 

that the banking entity is required to 

make the following determinations: 

whether it can obtain new participation 

units in the commodity pool, whether it 

can retain previously purchased 

participation units in the commodity 

pool, and whether it can act as the 

commodity pool’s sponsor. The 

Agencies believe this to be appropriate 

because it would require the banking 

entity to consider current information 

regarding the commodity pool and its 

participants rather than assess the 

composition of the pool’s participants 

over time even though its investments 

in or relationships with the pool do not 

change, which could be difficult 

depending upon the length of time that 

the pool has been in operation and the 

records available at the time of 

determination. 

Finally, the third element under the 

alternative definition is that the 

commodity pool participation units 

have not been publicly offered to 

persons other than qualified eligible 

persons. Consistent with CFTC 

regulations addressing the meaning of 

‘‘offer’’ in the context of the CFTC’s 

regulations, the term ‘‘offer’’ as used in 

§ 75.10(b)(1)(ii)(B) ‘‘has the same 

meaning as in contract law, such that, 

if accepted the terms of the offer would 

form a binding contract.’’ 1726 This 

aspect of the alternative definition is 

intended to limit the ability for 

commodity pools to avoid classification 

as covered funds through an offer, either 

in the past or currently ongoing, to nonqualified eligible persons ‘‘in name 

only’’ where there is no actual offer to 

non-qualified eligible persons. 

Accordingly, unless the pool operator 

can show that the pool’s participation 

units have been actively and publicly 

offered to non-affiliated parties that are 

not qualified eligible persons whereby 

such non-qualified eligible persons 

could in fact purchase a participation 

unit in the commodity pool, a pool that 

features the other elements listed in the 


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1727 17 CFR 4.24 (2013). 1728See, e.g., SIFMA et al. (Covered Funds) (Feb. 

2012); BlackRock; AHIC; Sen. Carper et al.; Rep. 

Garrett et al. 1729Funds relying on section 3(c)(7) must be 

owned exclusively by qualified purchasers, as 

defined in the Investment Company Act. The 

Agencies note in this regard that section 4.7 of the 

CFTC’s regulations use substantially the same 

definition of a qualified purchaser in defining the 

term qualified eligible person. 

1730Operators of commodity pools currently must 

consider whether they are required to register with 

the CFTC as commodity pool operators, and 

whether the pools have the characteristics that 

would make it possible for the operator to claim an 

exemption under section 4.7. These concepts thus 

should be familiar to commodity pools and their 

operators, and including these concepts in the final 

rule should allow banking entities more easily to 

determine if a particular commodity pools is a 

covered fund than if the Agencies were to develop 

new concepts solely for purposes of the final rule. 

1731See proposed rule § 75.10(b)(1). 

1732See, e.g., Arnold & Porter; BoA; Goldman 

(Covered Funds); ICI (Feb. 2012); Putnam; TCW; 

Vanguard. According to these commenters, a 

registered investment company may use security or 

commodity futures, swaps, or other commodity 

interests in various ways to manage its investment 

portfolio and be swept into the broad definition of 

‘‘commodity pool’’ contained in the Commodity 

Exchange Act. 

1733See Arnold & Porter; Goldman (Covered 

Funds); see also SIFMA et al. (Covered Funds) (Feb. 

2012); SIFMA et al. (Mar. 2012); ABA (Keating); 

BoA; ICI (Feb. 2012); JPMC; (requesting clarification 

that registered investment companies are not 

banking entities); TCW. 

alternative definition would be a 

covered fund. Such a showing will not 

turn solely on whether the commodity 

pool has filed a registration statement to 

offer its participation units under the 

Securities Act of 1933 or whether the 

commodity pool operator has prepared 

a disclosure document consistent with 

the provisions of section 4.24 of the 

CFTC’s regulations.1727 Rather, the pool 

operator would need to show that a 

reasonably active effort, based on the 

facts and circumstances, has been 

undertaken by brokers and other sales 

personnel to publicly offer the pool’s 

participation units to non-affiliated 

parties that are not qualified eligible 

persons. 

In taking this more tailored approach 

to commodity pools that will be covered 

funds, the Agencies are more closely 

aligning the types of commodity pools 

that will be covered funds under the 

final rule with section 13’s definition of 

a hedge fund and private equity fund by 

reference to section 3(c)(1) or section 

3(c)(7), and addressing concerns of 

commenters that the proposal was 

overly broad and would lead to 

outcomes inconsistent with the words, 

structure, and purpose of section 13.1728

The Agencies believe that the types of 

commodity pools described above 

generally are similar to funds that rely 

on section 3(c)(1) and 3(c)(7) in that, 

like funds that rely on section 3(c)(1) or 

3(c)(7), these commodity pools may be 

owned only by investors who meet 

certain heightened qualification 

standards, as discussed above.1729

Further, the Agencies believe that the 

final rule’s identification of the 

elements of a commodity pool that is a 

covered fund are clearly established and 

readily ascertainable such that once it is 

determined whether an entity is a 

commodity pool, an assessment that is 

already necessary to comply with the 

Commodity Exchange Act, then the 

further determination of whether an 

entity that is a commodity pool is also 

a covered fund can be made based on 

readily ascertainable information. 

In adopting this approach, the 

Agencies also are utilizing the current 

regulatory structure promulgated by the 

CFTC under the CEA. As the CFTC 

regulates commodity pools, commodity 

pool operators, and commodity trading 

advisors that advise commodity pools, 

the Agencies believe that it is beneficial 

to utilize an already established set of 

rules, regulations, and guidance. The 

Agencies considered alternative 

approaches provided by the 

commenters, but have adopted the 

approach taken in the final rule for the 

reasons discussed above and because 

the Agencies believe that the final rule, 

by incorporating concepts with which 

commodity pools and their operators are 

familiar, more clearly delineates the 

commodity pools that are covered 

funds.1730

The Agencies believe that the final 

rule’s tailored approach to commodity 

pools includes in the definition of 

covered fund commodity pools that are 

similar to funds that rely on section 

3(c)(1) and 3(c)(7). The Agencies also 

note in this regard that a commodity 

pool that would be a covered fund even 

under this tailored approach will not be 

a covered fund if the pool also qualifies 

for an exclusion from the covered fund 

definition, including the exclusion for 

registered investments companies. 

Accordingly, this approach excludes 

from covered funds entities like 

commercial end users and registered 

investment companies, whose activities 

do not implicate the concerns section 13 

was designed to address. Rather, the 

final rule limits the commodity pools 

that will be included as covered funds 

to those that are similar to other covered 

funds except that they are not generally 

subject to the Investment Company Act 

of 1940 due to the instruments in which 

they invest. For all of these reasons, the 

Agencies believe that the final rule’s 

approach to commodity pools addresses 

both the Agencies’ concerns about the 

potential for evasion and commenters’ 

concerns about the breadth of the 

proposed rule, and provides that the 

commodity pools captured as covered 

funds are ‘‘such similar funds,’’ 

consistent with section 13(h)(2) of the 

BHC Act. 

The Agencies acknowledge that as a 

result of including certain commodity 

pools in the definition of covered fund, 

the prohibitions under section 13(f) and 

§ 75.14 may result in certain structural 

changes in the industry. The Agencies 

note that these changes (e.g., bankaffiliated FCMs may not be able to lend 

money in certain clearing transactions 

to affiliated commodity pools that are 

covered funds) may result in certain 

changes in the way related entities do 

business with each other. However, the 

Agencies believe that because the 

industry is competitive with a 

significant number of alternative nonaffiliate competitors, the changes would 

not result in a less competitive 

landscape for investors in commodity 

pools. 

3. Entities Regulated Under the 

Investment Company Act 

The proposed rule did not specifically 

include registered investment 

companies (including mutual funds) or 

business development companies 

within the definition of covered 

fund.1731 As explained above, the 

statute references funds that rely on 

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

Investment Company Act. Registered 

investment companies and business 

development companies do not rely on 

either section 3(c)(1) or 3(c)(7) of the 

Investment Company Act and are 

instead registered or regulated in 

accordance with the Investment 

Company Act. 

Many commenters argued that 

registered investment companies and 

business development companies would 

be treated as covered funds under the 

proposed definition if commodity pools 

are treated as covered funds.1732 A few 

commenters argued that the final rule 

should specifically provide that all SECregistered funds are excluded from the 

definition of covered fund (and the 

definition of banking entity) to avoid 

any uncertainty about whether section 

13 applies to these types of funds.1733

Commenters also requested that the 

final rule exclude from the definition of 

covered fund entities formed to 

establish registered investment 

companies during the seeding period. 

These commenters contended that, 

during the early stages of forming and 

seeding a registered investment 

company, an entity relying on section 

3(c)(1) or (3)(c)(7) may be created to 


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1734See ICI (Feb. 2012); TCW. 

1735See final rule § 75.10(c)(12). 

1736See Joint Proposal, 76 FR at 68856. 

1737See final rule § 75.2(a) (defining ‘‘affiliate’’ for 

purposes of the final rule). 

1738See 12 U.S.C. 1841(a)(2); 12 CFR 225.2(e). 

1739See, e.g., 12 CFR 211.10(a)(11); 

225.28(b)(6)(i); 225.86(b)(3); Unicredito, 86 Fed. 

Res. Bull. 825 (2000); Societe Generale, 84 Fed. Res. 

Bull. 680 (1998); Commerzbank AG, 83 Fed. Res. 

Bull. 678 (1997); The Governor and Company of the 

Bank of Ireland, 82 Fed. Res. Bull. 1129 (1996); 

Mellon Bank Corp., 79 Fed. Res. Bull. 626 (1993); 

Bayerische Vereinsbank AG, 73 Fed. Res. Bull. 155 

(1987). 

1740See, e.g., Societe Generale, 84 Fed. Res. Bull. 

680 (1998) (finding that a bank holding company 

does not control a mutual fund for which it holds 

up to 5 percent of the voting shares and also 

provides investment advisory, administrative and 

other services, has directors or employees who 

comprise less than 25 percent of the board of 

directors of the fund (including the chairman of the 

board), and has three senior officer interlocks and 

a number of junior officer interlocks). 

1741See letter dated June 24, 1999, to H. Rodgin 

Cohen, Esq., Sullivan & Cromwell (First Union 

Corp.), from Jennifer J. Johnson, Secretary of the 

Board of Governors of the Federal Reserve System 

(finding that a bank holding company does not 

control a mutual fund for which it provides 

investment advisory and other services and that 

complies with the limitations of section 4(c)(7) of 

the BHC Act (12 U.S.C. 1843(c)(7)), so long as (i) 

the bank holding company reduces its interest in 

the fund to less than 25 percent of the fund’s voting 

shares after a six-month period, and (ii) a majority 

of the fund’s directors are independent of the bank 

holding company and the bank holding company 

cannot select a majority of the board) (‘‘First Union 

Letter’’); H.R. Rep. No. 106–434 at 153 (1999) (Conf. 

Rep.) (noting that the Act permits a financial 

holding company to sponsor and distribute all types 

of mutual funds and investment companies); see 

also 12 U.S.C. 1843(k)(1), (6). 

1742See, e.g., H.R. Rep. No. 106–434 at 153 (1999) 

(Conf. Rep.) (noting that the Act permits a financial 

holding company to sponsor and distribute all types 

of mutual funds and investment companies). 

1743See 12 U.S.C. 1843(k)(1); 12 CFR 225.86. 

facilitate the development of a track 

record for the registered investment 

company so that it may be marketed to 

unaffiliated investors.1734

The Agencies did not intend to 

include registered investment 

companies and business development 

companies as covered funds under the 

proposal. Section 13’s definition of 

private equity fund and hedge fund by 

reference to section 3(c)(1) and 3(c)(7) of 

the Investment Company Act appears to 

reflect Congress’ concerns about 

banking entities’ exposure to and 

relationships with investment funds 

that explicitly are excluded from SEC 

regulation as investment companies. 

The Agencies do not believe it would be 

appropriate to treat as a covered fund 

registered investment companies and 

business development companies, 

which are regulated by the SEC as 

investment companies. The Agencies 

believe that the proposed rule’s 

inclusion of commodity pools would 

have resulted in some registered 

investment companies and business 

development companies being covered 

funds, a result the Agencies did not 

intend. The Agencies, in addition to 

narrowing the commodity pools that 

will be included as covered funds as 

discussed above, have also modified the 

final rule to exclude SEC-registered 

investment companies and business 

development companies from the 

definition of covered fund.1735

The Agencies also recognize that an 

entity that becomes a registered 

investment company or business 

development company might, during its 

seeding period, rely on section 3(c)(1) or 

3(c)(7). The Agencies have determined 

to exclude these seeding vehicles from 

the covered fund definition for the same 

reasons the Agencies determined to 

exclude entities that are operating as 

registered investment companies or 

business development companies as 

discussed in more detail below in Part 

VI.B.1.c.12 of this SUPPLEMENTARY

INFORMATION. 

The Agencies also understand that 

registered investment companies may 

establish and hold subsidiary entities 

that rely on section 3(c)(1) or 3(c)(7) in 

order to trade in various financial 

instruments for the registered 

investment company parent. If a 

registered investment company were 

itself a banking entity, section 13 and 

the final rule would prohibit the 

registered investment company from 

sponsoring or investing in such an 

investment subsidiary. But a registered 

investment company would only itself 

be a banking entity if it is an affiliate of 

an insured depository institution. As 

explained in the proposal, a registered 

investment company, such as a mutual 

fund or exchange traded fund, or an 

entity that has made an effective 

election to be regulated as a business 

development company, would not be an 

affiliate of a banking entity for purposes 

of section 13 of that Act solely by virtue 

of being advised, or organized, 

sponsored and managed by a banking 

entity in accordance with the BHC Act 

(including section 13) and the Board’s 

Regulation Y.1736

Under the BHC Act, an entity 

(including a registered investment 

company) would generally be 

considered an affiliate of a banking 

entity, and therefore a banking entity 

itself, if it controls, is controlled by, or 

is under common control with an 

insured depository institution.1737

Pursuant to the BHC Act, a company 

controls another company if: (i) The 

company directly or indirectly or acting 

through one or more other persons 

owns, controls, or has power to vote 25 

per cent or more of any class of voting 

securities of the company; (ii) the 

company controls in any manner the 

election of a majority of the directors of 

trustees of the other company; or (iii) 

the Board determines, after notice and 

opportunity for hearing, that the 

company directly or indirectly exercises 

a controlling influence over the 

management or policies of the 

company.1738

The Board’s regulations and orders 

have long recognized that a bank 

holding company may organize, 

sponsor, and manage a mutual fund 

such as a registered investment 

company, including by serving as 

investment adviser to registered 

investment company, without 

controlling the registered investment 

company for purposes of the BHC 

Act.1739 For example, the Board has 

permitted a bank holding company to 

own up to 5 percent of the voting shares 

of a registered investment company for 

which the bank holding company 

provides investment advisory, 

administrative, and other services, and 

has a number of director and officer 

interlocks, without finding that the bank 

holding company controls the fund.1740

The Board has also permitted a bank 

holding company to own less than 25 

percent of the voting shares of a 

registered investment company and 

provide similar services without finding 

that the bank holding company controls 

the fund, so long as the fund limits its 

investments to those permissible for the 

holding company to make itself.1741

The BHC Act, as amended by the 

Gramm-Leach-Bliley Act, and the 

Board’s Regulation Y authorize a bank 

holding company that qualifies as a 

financial holding company to engage in 

a broader set of activities, and to have 

a broader range of relationships or 

investments with entities, than bank 

holding companies.1742 For instance, a 

financial holding company may engage 

in, or acquire shares of any company 

engaged in, any activity that is financial 

in nature or incidental to such financial 

activity, including any activity that a 

bank holding company is permitted to 

engage in or acquire by regulation or 

order.1743 In light of the foregoing, for 

purposes of section 13 of the BHC Act 

a financial holding company may own 

more than 5 percent (and less than 25 

percent) of the voting shares of a 

registered investment company for 

which the holding company provides 

investment advisory, administrative, 

and other services and has a number of 

director and officer interlocks, without 


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1744See First Union Letter (June 24, 1999); see 

also 12 CFR 225.86(b)(3) (authorizing a financial 

holding company to organize, sponsor, and manage 

a mutual fund so long as (i) the fund does not 

exercise managerial control over the entities in 

which the fund invests, and (ii) the financial 

holding company reduces its ownership in the 

fund, if any, to less than 25 percent of the equity 

of the fund within one year of sponsoring the fund 

or such additional period as the Board permits). 

1745See final rule §§ 75.10(c)(12) and 75.20(e). 

Under the final rule, these seeding vehicles also 

must comply with the limitations on leverage under 

the Investment Company Act that apply to 

registered investment companies and SEC-regulated 

business development companies. See final rule 

§ 75.10(c)(12). 

1746See final rule § 75.10(c). 

1747See 156 Cong. Rec. H5226 (daily ed. June 30, 

2010) (statement of Reps. Himes and Frank) (noting 

intent that subsidiaries or joint ventures not be 

included within the definition of covered fund); 

156 Cong. Rec. S5904–05 (daily ed. July 15, 2010) 

(statement of Sens. Boxer and Dodd) (noting broad 

definition of hedge fund and private equity fund 

and recommending that the Agencies take steps to 

ensure definition is reasonably tailored); see also 

FSOC study at 61–63. 

1748As discussed above, the proposed rule 

generally included in the covered fund definition 

a foreign fund that, were it organized or offered 

under the laws of the United States or offered to 

U.S. residents, would meet the definition of a 

domestic covered fund (i.e., would need to rely 

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

Act). Many commenters argued that this definition 

is too broad and could include as covered funds 

various types of foreign funds, like UCITS, that 

commenters argued should not be included. See, 

e.g., JPMC; BlackRock. 

1749See SIFMA et al. (Covered Funds) (Feb. 

2012); Hong Kong Inv. Funds Ass’n.; UBS; ICI 

Global; BlackRock; TCW; State Street (Feb. 2012); 

SSgA (Feb. 2012); IAA; JPMC; Goldman (Covered 

Funds); BoA; Credit Suisse (Williams); BNY 

Mellon, et al.; Union Asset; EFAMA; BVI; IRSG, 

SEB; IIB/EBF; GE (Feb. 2012) (commenting on the 

overbreadth of the definition because of the effect 

on foreign issuers of asset-backed securities); Allen 

& Overy (on behalf of Foreign Bank Group). 

1750See BlackRock; Vanguard. 

1751See BlackRock. 

1752See ASF (Feb. 2012). 

1753See Union Asset; EFAMA; BVI. 

1754See Goldman (Covered Funds). 

1755See AFMA. 

1756See BoA. 

1757See BVI. 

1758See Goldman (Covered Funds). 

See AFMA. 

See BoA. 

controlling the fund for purposes of the 

BHC Act.1744

So long as a bank holding company or 

financial holding company complies 

with these limitations, it would not, 

absent other facts and circumstances, 

control a registered investment 

company and the registered investment 

company for purposes of section 13 (and 

any subsidiary thereof) would not itself 

be a banking entity subject to the 

restrictions of section 13 of the BHC Act 

and any final implementing rules 

(unless the registered investment 

company itself otherwise controls an 

insured depository institution). Also 

consistent with the Board’s precedent 

regarding bank holding company 

control of and relationships with funds, 

a seeding vehicle that will become a 

registered investment company or SECregulated business development 

company would not itself be viewed as 

violating the requirements of section 13 

during the seeding period so long as the 

banking entity that establishes the 

seeding vehicle operates the vehicle 

pursuant to a written plan, developed in 

accordance with the banking entity’s 

compliance program, that reflects the 

banking entity’s determination that the 

vehicle will become a registered 

investment company or SEC-regulated 

business development company within 

the time period provided by section 

13(d)(4) and § 75.12 for seeding a 

covered fund.1745

c. Entities Excluded From Definition of 

Covered Fund 

As noted above, the final rule 

excludes a number of entities from the 

definition of covered fund.1746 As 

discussed in more detail below, these 

exclusions more effectively tailor the 

definition of covered fund to those types 

of entities that section 13 was designed 

to focus on. The exclusions thus are 

designed to provide certainty, mitigate 

compliance costs and other burdens, 

and address the potential over-breadth 

of the covered fund definition and 

related requirements without such 

exclusions by permitting banking 

entities to invest in and have other 

relationships with entities that do not 

relate to the statutory purpose of section 

13. These exclusions, described in more 

detail below, take account of 

information provided by many 

commenters regarding entities that 

would likely be included within the 

proposed definition of a covered fund, 

but that are not traditionally thought of 

as hedge funds or private equity 

funds.1747 Finally, the Agencies note 

that providing exclusions from the 

covered fund definition, rather than 

providing permitted activity exemptions 

as proposed in some cases, aligns the 

final rule with the statute in applying 

the restrictions imposed by section 13(f) 

on transactions with covered funds only 

to transactions with issuers that are 

defined as covered funds and thus raise 

the concerns section 13 was designed to 

address. 

The Agencies recognize, however, 

that the final rule’s definition of covered 

fund does not include certain pooled 

investment vehicles. For example, the 

definition of covered fund excludes 

business development companies, 

entities that rely on section 3(c)(5)(C), 

3(c)(3), or 3(c)(11) of the Investment 

Company Act, and certain foreign 

public funds that are subject to homecountry regulation. The Agencies expect 

that the types of pooled investment 

vehicles sponsored by the financial 

services industry will continue to 

evolve, including in response to the 

final rule, and the Agencies will be 

monitoring this evolution to determine 

whether excluding these and other types 

of entities remains appropriate. The 

Agencies will also monitor use of the 

exclusions for attempts to evade the 

requirements of section 13 and intend to 

use their authority where appropriate to 

prevent evasions of the rule. 

1. Foreign Public Funds 

As discussed above, under the 

proposal a covered fund was defined to 

include the foreign equivalent of any 

covered fund in order to address the 

potential for circumvention. Many 

commenters argued that the proposed 

definition could capture non-U.S. 

public retail funds, such as UCITS.1748

These commenters contended that nonU.S. public retail funds should be 

excluded from the definition of covered 

fund because they are regulated in their 

home jurisdiction; commenters noted 

that similar funds registered in the 

United States, such as mutual funds, are 

not covered funds.1749

Some commenters were concerned 

that the proposed definition could 

inadvertently capture exchange-traded 

funds trading in foreign 

jurisdictions,1750 separate accounts set 

up to fund foreign pension plans,1751

non-U.S. issuers of asset-backed 

securities,1752 and non-U.S. regulated 

funds specifically designed for 

institutional investors.1753 Commenters 

also provided several potential effects of 

capturing foreign public funds under 

the covered fund definition: U.S. 

banking entities would incur 

unnecessary and substantial costs to 

rebrand and restructure their non-U.S. 

regulated funds,1754 banking entities 

could be eliminated from the potential 

pool of counterparties, thereby affecting 

pricing and efficiency,1755 U.S. banking 

entities may exit the UCITS market and 

lose competitiveness,1756 the growth of 

mutual fund formation in foreign 

countries could be limited,1757 and 

market liquidity in foreign jurisdictions 

could be impaired.1758

Some commenters supported 

excluding any foreign public fund that 

is organized or formed under non-U.S. 

law, authorized for public sale in the 

jurisdiction in which it is organized or 

formed, and regulated as a public 

investment company in that 


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5950 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

1759See ICI Global; ICI (Feb. 2012); SSgA (Feb. 

2012); BNY Mellon et al. 

1760See UBS; ICI Global; ICI (Feb. 2012); Allen & 

Overy (on behalf of Foreign Bank Group); T. Rowe 

Price; HSBC Life; Union Asset; EFAMA; BVI; EBF; 

Hong Kong Inv. Funds Ass’n.; IMA; Ass’n. of 

Institutional Investors (Feb. 2012); Katten (on behalf 

of Int’l Clients); Credit Suisse (Williams). 

1761See T. Rowe Price; Credit Suisse (Williams); 

SSgA (Feb. 2012); BNY Mellon et al. 

1762See T. Rowe Price. 

1763See final rule § 75.10(c)(1). 

1764Although the discussion of this condition 

generally refers to U.S. banking entities for ease of 

reading, the condition also applies to foreign 

affiliates of a U.S. banking entity. See final rule 

§ 75.10(c)(1)(ii) (applying this limitation ‘‘[w]ith 

respect to a banking entity that is, or is controlled 

directly or indirectly by a banking entity that is, 

located in or organized under the laws of the United 

States or of any State and any issuer for which such 

banking entity acts as sponsor’’). 1765See final rule § 75.10(c)(1)(iii). 

jurisdiction.1759 In light of the 

proposal’s broad definition of covered 

fund, some commenters recommended 

explicitly excluding non-U.S. regulated 

funds based on characteristics to 

distinguish the foreign funds that 

should be treated as covered funds.1760

Several commenters recommended 

excluding non-U.S. funds based upon 

whether the funds are subject to a 

regulatory framework comparable to 

that which is imposed on SEC-registered 

funds; 1761 one commenter specifically 

identified European UCITS, Canadian 

mutual funds, Australian unit trusts, 

and Japanese investment trusts as 

examples of regulated funds to be 

excluded.1762

To address these concerns, the final 

rule generally excludes from the 

definition of covered fund any issuer 

that is organized or established outside 

of the United States and the ownership 

interests of which are authorized to be 

offered and sold to retail investors in the 

issuer’s home jurisdiction and are sold 

predominantly through one or more 

public offerings outside of the United 

States.1763 Foreign funds that meet these 

requirements will not be covered funds, 

except that an additional condition 

applies to U.S. banking entities 1764 with 

respect to the foreign public funds they 

sponsor. The foreign public fund 

exclusion is only available to a U.S. 

banking entity with respect to a foreign 

fund sponsored by the U.S. banking 

entity if, in addition to the requirements 

discussed above, the fund’s ownership 

interests are sold predominantly to 

persons other than the sponsoring 

banking entity, affiliates of the issuer 

and the sponsoring banking entity, and 

employees and directors of such 

entities. 

For purposes of this exclusion, the 

Agencies note that the reference to retail 

investors, while not defined, should be 

construed to refer to members of the 

general public who do not possess the 

level of sophistication and investment 

experience typically found among 

institutional investors, professional 

investors or high net worth investors 

who may be permitted to invest in 

complex investments or private 

placements in various jurisdictions. 

Retail investors would therefore be 

expected to be entitled to the full 

protection of securities laws in the 

home jurisdiction of the fund, and the 

Agencies would expect a fund 

authorized to sell ownership interests to 

such retail investors to be of a type that 

is more similar to a U.S. registered 

investment company rather than to a 

U.S. covered fund. 

In order to help maintain this 

distinction and to avoid circumstances 

that could result in an evasion of section 

13 and the final rule, the ownership 

interests of the fund must be sold 

predominantly in one or more public 

offerings outside of the United States to 

qualify for the exclusion. Given this 

restriction, a U.S. banking entity 

therefore could not rely on this 

exclusion to set up a foreign public fund 

for the purpose of selling a significant 

amount of ownership interests in the 

fund through one or more offerings 

conducted on an unregistered basis 

(whether in a foreign jurisdiction or in 

the United States). The Agencies 

generally expect that an offering is made 

predominantly outside of the United 

States if 85 percent or more of the fund’s 

interests are sold to investors that are 

not residents of the United States. 

The requirements that a foreign public 

fund both be authorized for sale to retail 

investors and sold predominantly in 

public offerings outside of the United 

States are based in part on the Agencies’ 

view that foreign funds that meet these 

requirements generally will be 

sufficiently similar to U.S. registered 

investment companies such that it is 

appropriate to exclude these foreign 

funds from the covered fund definition. 

A foreign fund authorized for sale to 

retail investors that is also publicly 

offered may, for example, provide 

greater information than funds that are 

sold through private offerings like funds 

that rely on section 3(c)(1) or 3(c)(7). 

Such foreign funds also may be subject 

to various restrictions, as deemed 

appropriate by foreign regulators in light 

of local conditions and practices, that 

exceed those applicable to privately 

offered funds. Foreign regulators may 

apply these or other enhanced 

restrictions or other requirements to 

funds that are offered on a broad basis 

to the general public for the protection 

of investors in those jurisdictions. 

A foreign fund that purports to 

publicly offer its shares but in fact offers 

them on a more limited basis, however, 

may be less likely to resemble a 

registered investment company in these 

and other respects. In order to limit the 

foreign public fund exclusion to funds 

that publicly offer their shares on a 

sufficiently broad basis, the final rule 

defines the term ‘‘public offering’’ for 

purposes of this exclusion to mean a 

‘‘distribution’’ (as defined in § 75.4(a)(3) 

of subpart B) of securities in any 

jurisdiction outside the United States to 

investors, including retail investors, 

provided that (i) the distribution 

complies with all applicable 

requirements in the jurisdiction in 

which such distribution is being made; 

(ii) the distribution does not restrict 

availability to investors having a 

minimum level of net worth or net 

investment assets; and (iii) the issuer 

has filed or submitted, with the 

appropriate regulatory authority in such 

jurisdiction, offering disclosure 

documents that are publicly 

available.1765

Under the final rule, therefore, a 

foreign fund’s distribution would not be 

a public offering for purposes of the 

foreign public fund exclusion if the 

distribution imposes investor 

restrictions based on a required 

minimum level of net worth or net 

investment assets. This would not be 

affected by any suitability requirements 

that may be imposed under applicable 

local law. In addition, the final rule 

requires that, in connection with a 

public offering by a foreign public fund, 

the offering disclosure documents must 

be ‘‘publicly available.’’ This 

requirement will provide assurance 

regarding the transparency for such an 

offering and will generally be satisfied 

where the documents are made 

accessible to all persons in such 

jurisdiction. Disclosure documents may 

be made publicly available in a variety 

of means, such as through a public filing 

with a regulatory agency or through a 

Web site that provides broad 

accessibility to persons in such 

jurisdiction. 

In addition and as discussed above, 

the final rule also places an additional 

condition on a U.S. banking entity’s 

ability to rely on the foreign public fund 

exclusion with respect to the foreign 

public funds it sponsors. For a U.S. 

banking entity to rely on the foreign 

public fund exclusion with respect to a 

foreign public fund it sponsors, the 

ownership interests in the fund must be 

sold predominantly to persons other 

than the sponsoring U.S. banking entity 


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1766See final rule § 75.20(e). 

1767See proposed rule § 75.14(a)(2)(iv); Joint 

Proposal, 76 FR at 68913. 

1768See, e.g., SIFMA et al. (Covered Funds) (Feb. 

2012), JPMC; Goldman (Covered Funds), NAIB et 

al.; GE (Feb. 2012); BoA; Chamber (Feb. 2012); 

Wells Fargo (Covered Funds); ABA (Keating); Ass’n. 

of Institutional Investors (Feb. 2012); Credit Suisse 

(Williams); Rep. Himes; BOK. 

1769See 15 U.S.C. 80a-3(a)(1)(A) & (C). 

and certain persons connected to that 

banking entity. Consistent with the 

Agencies’ view concerning whether a 

foreign public fund has been sold 

predominantly outside of the United 

States, the Agencies generally expect 

that a foreign public fund will satisfy 

this additional condition if 85 percent 

or more of the fund’s interests are sold 

to persons other than the sponsoring 

U.S. banking entity and certain persons 

connected to that banking entity. 

This additional condition reflects the 

Agencies’ view that the foreign public 

fund exclusion is designed to treat 

foreign public funds consistently with 

similar U.S. funds and to limit the 

extraterritorial application of section 13 

of the BHC Act, including by permitting 

U.S. banking entities and their foreign 

affiliates to carry on traditional asset 

management businesses outside of the 

United States. The exclusion is not 

intended to permit a U.S. banking entity 

to establish a foreign fund for the 

purpose of investing in the fund as a 

means of avoiding the restrictions 

imposed by section 13. Permitting a U.S. 

banking entity to invest in a foreign 

public fund under this exclusion only 

when that fund is sold predominantly to 

persons other than the sponsoring U.S. 

banking entity and certain persons 

connected to that banking entity permits 

U.S. banking entities to continue their 

asset management businesses outside of 

the United States while also limiting the 

opportunity for evasion of section 13 as 

discussed below. 

This additional condition only 

applies to U.S. banking entities with 

respect to the foreign public funds they 

sponsor because the Agencies believe 

that a foreign public fund sponsored by 

a U.S. banking entity may present 

heightened risks of evasion. Absent the 

additional condition, a U.S. banking 

entity could establish a foreign public 

fund for the purpose of itself investing 

substantially in that fund and, through 

the fund, making investments that the 

banking entity could not make directly 

under section 13. The Agencies believe 

it is less likely that a U.S. banking entity 

effectively could evade section 13 by 

investing in third-party foreign public 

funds that the banking entity does not 

sponsor. In those cases it is less likely 

that the U.S. banking entity would be 

able to control the investments of the 

fund, and the fund thus likely would be 

a less effective means for the banking 

entity to engage in proprietary trading 

through the fund. The Agencies 

therefore have declined to apply this 

additional condition with respect to any 

foreign public fund in which a U.S. 

banking entity invests but does not act 

as sponsor. 

The Agencies note that the foreign 

public fund exclusion is not intended to 

permit a banking entity to sponsor a 

foreign fund for the purpose of selling 

ownership interests to any banking 

entity (affiliated or unaffiliated) that is, 

or is controlled directly or indirectly by 

a banking entity that is, located in or 

organized under the laws of the United 

States or of any State (or to a limited 

group of such banking entities). The 

Agencies intend to monitor banking 

entities’ investments in foreign public 

funds to ensure that banking entities do 

not use the exclusion for foreign public 

funds in a manner that functions as an 

evasion of section 13 in this or any other 

way. The Agencies expect that one area 

of focus for such monitoring would be 

significant investments in a foreign 

public fund, including a fund that is 

unaffiliated with any banking entity 

located in or organized under the laws 

of the United States or of any State, 

where such investments represent a 

substantial percentage of the ownership 

interests in such fund. 

In order to conduct this monitoring 

more effectively, the Agencies also are 

adopting certain documentation 

requirements concerning U.S. banking 

entities’ investments in foreign public 

funds, as discussed in more detail below 

in Part VI.C.1 of this SUPPLEMENTARY

INFORMATION. Under the final rule, a U.S. 

banking entity with more than $10 

billion in total consolidated assets will 

be required to document its investments 

in foreign public funds, broken out by 

each foreign public fund and each 

foreign jurisdiction in which any foreign 

public fund is organized, if the U.S. 

banking entity and its affiliates’ 

ownership interests in foreign public 

funds exceed $50 million at the end of 

two or more consecutive calendar 

quarters. This requirement thus is 

tailored to apply only to U.S. banking 

entities above a certain size that also 

have substantial investments in foreign 

public funds.1766 The Agencies believe 

this approach appropriately balances 

the Agencies’ evasion concerns and the 

burdens that documentation 

requirements impose. 

For all of the reasons discussed above, 

the Agencies believe that the final rule’s 

approach to foreign public funds is 

consistent with the final rule’s 

exclusion of registered or otherwise 

exempt (without reliance on the 

exemptions in section 3(c)(1) or 3(c)(7)) 

funds in the United States. It also limits 

the extraterritorial application of section 

13 of the BHC Act and reduces the 

potential economic and other burdens 

commenters argued would result for 

banking entities. The Agencies believe 

that this exclusion represents an 

appropriate balancing of considerations 

that should not significantly increase 

the risks to the U.S. financial system 

that section 13 was designed to limit. 

2. Wholly-Owned Subsidiaries 

Under the proposed rule, a banking 

entity would have been permitted to 

invest in or sponsor a wholly-owned 

subsidiary that relies on the exclusion 

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

the Investment Company Act to avoid 

being an investment company under 

that Act if the subsidiary was carried on 

the balance sheet of its parent and was 

engaged principally in performing bona 

fide liquidity management activities.1767

Commenters argued that, instead of 

providing a permitted activity 

exemption for banking entities to invest 

in or sponsor certain wholly-owned 

subsidiaries as proposed, all whollyowned subsidiaries should be excluded 

from the definition of covered fund 

under the final rule because whollyowned subsidiaries are typically used 

for organizational convenience and 

generally do not have the 

characteristics, risks, or purpose of a 

hedge fund or private equity fund, 

which involves unaffiliated investors 

owning interests in the structure for the 

purpose of sharing in the profits and 

losses from investment activities.1768

Commenters explained that publicly 

traded companies often establish 

wholly-owned intermediate companies 

for the purpose of holding securities of 

operating entities or other corporate 

vehicles necessary to the business of the 

entity. Because these intermediate 

companies invest entirely (or 

substantially) in the securities of other 

entities, these intermediate companies 

may be investment companies for 

purposes of the Investment Company 

Act but for the exclusion provided by 

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

Investment Company Act.1769

Commenters contended that requiring 

banking entities to divest their interests 

in wholly-owned subsidiaries and cease 

certain intercompany transactions 

would have a material adverse effect on 

the safety, soundness, efficiency and 

stability of the U.S. and global financial 

systems, which could in turn have a 

material adverse effect on the wider 


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1770See, e.g., SIFMA et al. (Covered Funds) (Feb. 

2012). 

1771See SIFMA et al. (Covered Funds) (Feb. 

2012); BoA; Rep. Himes. 

1772See, e.g., Goldman (Covered Funds); BoA. 

1773See Rep. Himes; Fin. Services Roundtable 

(June 14, 2011); SIFMA et al. (Covered Funds) (Feb. 

2012); BOK; Chamber (Feb. 2012); ABA (Keating); 

GE (Feb. 2012); Wells Fargo (Covered Funds); 

Goldman (Covered Funds); Ass’n. of Institutional 

Investors (Feb. 2012); BoA; NAIB et al. 

1774See Wells Fargo (Covered Funds); Credit 

Suisse (Williams). 

1775See Credit Suisse (Williams). 

1776Although not a condition of the exclusion, 

banking entities may use wholly-owned 

subsidiaries to engage in bona fide liquidity 

management. As discussed below, however, a 

wholly-owned subsidiary is itself a banking entity, 

and thus is subject to all of the requirements that 

apply to banking entities, including the 

requirements applicable to a banking entity’s 

liquidity management activities under § 75.3(d)(3). 

1777See final rule § 75.10(c)(2). 

1778Cf. Section 2(a)(43) of the Investment 

Company Act (defining a ‘‘wholly-owned 

subsidiary’’ of a person to mean ‘‘a company 95 per 

centum or more of the outstanding voting securities 

of which are owned by such person, or by a 

company which, within the meaning of this 

paragraph, is a wholly-owned subsidiary of such 

person’’). 

1779The Agencies also note that depositors for 

asset-backed securities offerings are important to 

the process of securitization. See, e.g., ASF (July 

2012) (noting that a depositor, as used in a 

securitization structure, is an entity that generally 

acts only as a conduit to transfer the loans from the 

originating bank to the issuing entity for the 

purpose of facilitating a securitization transaction 

and engages in no discretionary investment or 

securities issuance activities). See also, Rule 191 

under the Securities Act of 1933 (17 CFR 230.191) 

(depositor as issuer for registered asset-backed 

securities offerings). Commenters raised a question 

about the treatment of depositors under the 

Investment Company Act, and therefore, whether 

they would technically fall within the definition of 

covered fund. See ASF (July 2012); GE (Aug. 2012). 

For purposes of the covered fund prohibitions, the 

Agencies note that depositors may fall within the 

wholly-owned subsidiary exclusion from the 

covered fund definition. 

1780See 12 U.S.C. 1851(h)(1) (defining banking 

entity to include any affiliate or subsidiary of a 

banking entity). 

economy in terms of reduced credit, 

increased unemployment and reduced 

output.1770 Commenters also argued that 

an exclusion for wholly-owned 

subsidiaries is necessary in order to 

avoid a conflict with other important 

requirements in the Dodd-Frank Act. 

For example, commenters alleged that 

including wholly-owned subsidiaries 

within the definition of covered fund for 

purposes of section 13 would create a 

conflict with the requirement that a 

banking entity that is a bank holding 

company serve as a source of strength to 

its subsidiaries because the prohibition 

in section 13(f) on transactions between 

a banking entity and covered funds 

owned or sponsored by the banking 

entity would effectively prohibit the 

banking entity from providing financial 

resources to wholly-owned intermediate 

holding companies and their 

subsidiaries.1771 Other commenters 

argued that banking entities would bear 

extensive compliance costs and 

operational burdens and likely would be 

restricted from structuring themselves 

effectively.1772

Commenters proposed several 

alternatives to address these concerns. 

For instance, commenters recommended 

that the final rule exclude all whollyowned subsidiaries from the definition 

of covered fund.1773 Commenters also 

urged that the final rule include 

ownership interests held by employees 

of a banking entity with any ownership 

interests held directly by the banking 

entity for purposes of qualifying for any 

exclusion granted by the rule for 

wholly-owned subsidiaries.1774 Another 

commenter recommended the exclusion 

of subsidiaries, wholly owned or not, 

that engage in bona fide liquidity 

management.1775

In light of these comments and 

consistent with the purposes of section 

13 and the terms of the Dodd-Frank Act 

as discussed in more detail above, the 

Agencies have revised the final rule to 

exclude wholly-owned subsidiaries 

from the definition of covered fund, 

including those not engaged in liquidity 

management.1776 A wholly-owned 

subsidiary, as defined in the final rule, 

is an entity, all of the outstanding 

ownership interests of which are owned 

directly or indirectly by the banking 

entity (or an affiliate thereof), except 

that (i) up to five percent of the entity’s 

ownership interests may be owned by 

directors, employees, and certain former 

directors and employees of the banking 

entity (or an affiliate thereof); and (ii) 

within the five percent ownership 

interests described in clause (i), up to 

0.5 percent of the entity’s outstanding 

ownership interests may be held by a 

third party if the ownership interest is 

held by the third party for the purpose 

of establishing corporate separateness or 

addressing bankruptcy, insolvency, or 

similar concerns.1777

Although the final rule includes 

ownership interests held by certain 

former directors and employees for 

purposes of qualifying for the exclusion, 

the exclusion requires that an interest 

held by a former (or current) director or 

employee must actually be held by that 

person (or by the banking entity) and 

must have been acquired while 

employed by or in the service of the 

banking entity. For example, if a former 

employee subsequently transfers his/her 

interest to a third party (other than to 

immediate family members of the 

employee or through intestacy of the 

employee), then the ownership interest 

would no longer be held by the banking 

entity or persons whose ownership 

interests may be aggregated with 

interests held by the banking entity for 

purposes of the exclusion for whollyowned subsidiaries under the final rule. 

The final rule also permits up to 0.5 

percent of the ownership interest of a 

wholly-owned subsidiary to be held by 

a third party if the interest is held by the 

third party for the purpose of 

establishing corporate separateness or 

addressing bankruptcy, insolvency, or 

similar concerns, and the ownership 

interest is included when calculating 

the five percent cap on employee and 

director ownership. The Agencies 

understand that it is often important, or 

in certain circumstances required, under 

the laws of various jurisdictions for a 

parent company to establish corporate 

separation of a subsidiary through the 

issuance of a small amount of 

ownership interest to a third party. 

The Agencies believe that permitting 

limited employee and director 

ownership of a vehicle and 

accommodating the foreign law 

requirements discussed above is 

consistent with a vehicle’s treatment as 

a wholly-owned subsidiary. Under the 

final rule, the banking entity (or an 

affiliate thereof) will control the vehicle 

because it must, as principal, own at 

least 95% of the vehicle.1778 These 

conditions are designed to exclude from 

the covered fund definition vehicles 

that are formed for corporate and 

organizational convenience, as 

discussed above, and that thus do not 

engage in the investment activities 

prohibited by section 13. The exclusion 

also should reduce the disruption to the 

operations of banking entities that 

commenters asserted would result from 

the proposed rule.1779

Importantly, the Agencies note that a 

wholly-owned subsidiary of a banking 

entity—although excluded from the 

definition of covered fund—still would 

itself be a banking entity, and therefore 

remain subject to the prohibitions and 

other provisions of section 13 of the 

BHC Act and the final rule.1780

Accordingly, a wholly-owned 

subsidiary of a banking entity would 

remain subject to the restrictions of 

section 13 and the final rule (including 

the ban on proprietary trading) and may 

not engage in activity in violation of the 

prohibitions of section 13 and the final 

rule. 

3. Joint Ventures 

The proposed rule would have 

permitted a banking entity to invest in 

or manage a joint venture between the 

banking entity and any other person, 


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1781See Joint Proposal, 76 FR at 68913. 

1782See,, e.g., ABA (Keating); Chamber (Feb. 

2012); SIFMA et al. (Covered Funds) (Feb. 2012); 

GE (Aug. 2012); Goldman (Covered Funds); NAIB 

et al.; Rep Himes; Sen. Bennet; see also 156 Cong 

Rec. H5226 (daily ed. June 30, 2010) (statement of 

Rep. Himes). 

1783See, e.g., ABA (Keating); NAIB et al.; GE 

(Aug. 2012); Chamber (Feb. 2012); SIFMA et al. 

(Covered Funds) (Feb. 2012); Wells Fargo (Covered 

Funds); Credit Suisse (Williams); Goldman 

(Covered Funds). 

1784See SIFMA et al. (Covered Funds) (Feb. 

2012). 

1785See Goldman (Covered Funds). 

1786See ABA (Keating); SIFMA et al. (Covered 

Funds) (Feb. 2012). 

1787See SIFMA et al. (Covered Funds) (Feb. 

2012); Goldman (Covered Funds); ABA (Keating); 

Chamber (Feb. 2012). 

1788See, e.g., SIFMA et al. (Covered Funds) (Feb. 

2012); Goldman (Covered Funds); ABA (Keating); 

GE (Feb. 2012); Chamber (Feb. 2012). 

1789See SIFMA et al. (Covered Funds) (Feb. 

2012); ABA (Keating); Credit Suisse (Williams). 

1790See SIFMA et al. (Covered Funds) (Feb. 

2012); Credit Suisse (Williams); GE (Feb. 2012). 

1791See Goldman (Covered Funds). 

1792See ABA (Keating); Credit Suisse (Williams); 

SIFMA et al. (Covered Funds) (Feb. 2012); SIFMA 

et al. (Mar. 2012); see also GE (Feb. 2012); NAIB 

et al. 

1793See Goldman (Covered Funds). 

1794See final rule § 75.10(c)(3). 

1795See 12 U.S.C. 1843(k)(4)(H). 

provided that the joint venture was an 

operating company and did not engage 

in any activity or any investment not 

permitted under the proposed rule. As 

noted in the proposal, many joint 

ventures rely on the exclusion 

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

the Investment Company Act.1781 Joint 

ventures are a common form of 

business, especially for firms seeking to 

enter new lines of business or new 

markets, or seeking to share 

complementary business expertise. 

Commenters supported this aspect of 

the proposal and argued that joint 

ventures do not share the same 

characteristics as a hedge fund or 

private equity fund. However, they 

expressed concern that joint ventures 

were defined too narrowly under the 

proposal because the exclusion was 

limited to joint ventures that were 

operating companies.1782 Some 

commenters criticized the lack of 

guidance regarding the meaning of 

operating company.1783 One commenter 

proposed defining operating company 

as any company engaged in activities 

that are permissible for a financial 

holding company under sections 3 or 4 

of the BHC Act, other than a company 

engaged exclusively in investing in 

securities of other companies for resale 

or other disposition.1784

Another commenter argued that joint 

ventures are often used to share risk 

from non-performing loans, credit card 

receivables, consumer loans, 

commercial real estate loans or 

automobile loans.1785 According to this 

commenter, these joint ventures, while 

not generally viewed as operating 

companies, promote safety and 

soundness by allowing a banking entity 

to limit the size of its exposure to 

permissible investments or to more 

efficiently transfer the risk of existing 

assets to a small number of partners. 

Commenters stated that banking entities 

often employ similar types of nonoperating company joint ventures to 

engage in merchant banking activities or 

other permissible banking activities, and 

that the final rule should not prevent a 

banking entity from sharing the risk of 

a portfolio company investment with 

third parties.1786 A number of 

commenters argued that treating joint 

ventures as covered funds would create 

the same inconsistencies with other 

provisions and principles embodied in 

the Dodd-Frank Act noted for whollyowned subsidiaries, were they to be 

treated as covered funds.1787 Several 

commenters argued that the proposed 

exemption, as drafted, was unworkable 

because it did not appear to provide an 

exception to the intercompany 

limitations on transactions under 

section 13(f), which prohibits 

transactions between a banking entity 

and a related covered fund.1788

Commenters proposed several 

alternatives to address these issues. 

Several commenters recommended that 

the final rule eliminate the operating 

company condition under the proposed 

exemption.1789 Other commenters 

recommended excluding joint ventures 

that have an unspecified but limited 

number of partners (such as five or 

fewer joint venture partners).1790 One 

commenter recommended excluding all 

‘‘controlled joint ventures’’ but did not 

provide an explanation of how to define 

that term.1791 Another commenter 

suggested defining a joint venture in one 

of the following ways: (1) Any company 

with a limited number of co-venturers 

that is managed pursuant to a 

shareholders’ agreement, as opposed to 

managed by a general partner; 1792 or (2) 

a joint venture in which: (a) There are 

a limited number of unaffiliated 

partners; (b) the parties operate the 

venture on a joint basis or in proportion 

to their relative ownership, including 

pursuant to a shareholders’ agreement; 

(c) material decisions are made by one 

party (for example, a general partner); 

and (d) the joint venture does not 

engage in any activity or investment not 

permitted under section 13, other than 

activities or investments incidental to 

its permissible business.1793

In response to commenter concerns, 

the final rule excludes joint ventures 

from the definition of covered fund with 

some modifications from the proposal to 

more clearly identify entities that are 

excluded. Under the final rule, a joint 

venture is excluded from the definition 

of covered fund if the joint venture is 

between the banking entity or any of its 

affiliates and no more than 10 

unaffiliated co-venturers, is in the 

business of engaging in activities that 

are permissible for the banking entity 

other than investing in securities for 

resale or other disposition, and is not, 

and does not hold itself out as being, an 

entity or arrangement that raises money 

from investors primarily for the purpose 

of investing in securities for resale or 

other disposition or otherwise trading in 

securities.1794 Banking entities, 

therefore, will continue to be able to 

share the risk and cost of financing their 

banking activities through these types of 

entities which, as noted by commenters 

as discussed above, may allow banking 

entities to more efficiently manage the 

risk of their operations. 

The Agencies have specified a limit 

on the number of joint venture partners 

at the request of many commenters that 

suggested such a limit be added (though 

typically without suggesting the specific 

number of partners). The Agencies 

believe that a limit of 10 partners allows 

flexibility in structuring larger business 

ventures without involving such a large 

number of partners as to suggest the 

venture is in reality a hedge fund or 

private equity fund established for 

investment purposes. The Agencies will 

monitor joint ventures—and other 

excluded entities—to ensure that they 

are not used by banking entities to 

evade the provisions of section 13. 

The final rule’s requirement that a 

joint venture not be an entity or 

arrangement that raises money from 

investors primarily for the purpose of 

investing in securities for resale or other 

disposition or otherwise trading in 

securities prevents a banking entity 

from relying on this exclusion to evade 

section 13 of the BHC Act by owning or 

sponsoring what is or will become a 

covered fund. Consistent with this 

restriction and to prevent evasion of 

section 13, a banking entity may not use 

a joint venture to engage in merchant 

banking activities because that involves 

acquiring or retaining shares, assets, or 

ownership interests for the purpose of 

ultimate resale or disposition of the 

investment.1795

As with wholly-owned subsidiaries, if 

a banking entity owns 25 percent or 

more of the voting securities of the joint 

venture or otherwise controls an entity 


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1796Cf. Joint Proposal, 76 FR at 68897. 

1797See Joint Proposal, 76 FR at 68913; SIFMA et 

al. (Covered Funds) (Feb. 2012). 

1798See, e.g., JPMC; SIFMA et al. (Covered Funds) 

(Feb. 2012); GE (Feb. 2012); Sen. Bennet; Sen. 

Carper et al. 

1799See, e.g., SIFMA et al. (Covered Funds) (Feb. 

2012); JPMC; GE (Feb. 2012). 

1800See final rule § 75.10(c)(4). 

1801The proposed rule contained an exemption 

for investments in acquisition vehicles, provided 

that the ‘‘the sole purpose and effect of such entity 

is to effectuate a transaction involving the 

acquisition or merger of one entity with or into the 

covered banking entity or one of its affiliates.’’ See 

proposed rule § 75.14(a)(2)(ii). The final rule 

excludes an acquisition vehicle, which is defined 

as an issuer that is ‘‘[f]ormed solely for the purpose 

of engaging in a bona fide merger or acquisition 

transaction’’ and that ‘‘exists only for such period 

as necessary to effectuate the transaction.’’ See final 

rule § 75.10(c)(4). 

1802As explained above, commenters also argued 

that a foreign pension plan should not be 

considered a banking entity if the plan is sponsored 

by a banking entity or is established for the benefit 

of employees of the banking entity. If deemed a 

banking entity, the pension plan could become 

subject to the limits on section 13 on investing in 

covered funds. See Allen & Overy (on behalf of 

Canadian Banks); Arnold & Porter; Credit Suisse 

(Williams). The final rule addresses these 

comments with the exclusions described above. 

1803See, e.g., Allen & Overy (on behalf of 

Canadian Banks). 

1804See Allen & Overy (on behalf of Canadian 

Banks); Arnold & Porter; UBS; Hong Kong Inv. 

Funds Ass’n. 

1805See Allen & Overy (on behalf of Canadian 

Banks); Arnold & Porter; UBS; Hong Kong Inv. 

Funds Ass’n.; Credit Suisse (Williams). 

1806See Arnold & Porter; UBS; Hong Kong Inv. 

Funds Ass’n.; Credit Suisse (Williams). 

that qualifies for the joint venture 

exclusion, the joint venture would then 

itself be a banking entity and would 

remain subject to the restrictions of 

section 13 and the final rule (including 

the ban on proprietary trading). 

The Agencies note that the statute 

defines banking entity to include not 

only insured depository institutions and 

bank holding companies, but also their 

affiliates. In the context of a company 

that owns an insured depository 

institution but is not a bank holding 

company or savings and loan holding 

company, the insured depository 

institution’s affiliates may engage in 

commercial activities impermissible for 

banks and bank holding companies. 

However, section 13 of the BHC Act and 

the final rule do not authorize a banking 

entity to engage in otherwise 

impermissible activities. Because of 

this, the scope of activities in which a 

joint venture may engage under the final 

rule will depend on the status and 

identity of its co-venturers. For instance, 

a joint venture between a bank holding 

company and unaffiliated companies 

may not engage in commercial activities 

impermissible for a bank holding 

company. 

4. Acquisition Vehicles 

Similar to wholly-owned subsidiaries 

and joint ventures, the proposed rule 

would have permitted a banking entity 

to invest in or sponsor an acquisition 

vehicle provided that the sole purpose 

and effect of the acquisition vehicle was 

to effectuate a transaction involving the 

acquisition or merger of an entity with 

or into the banking entity or one of its 

affiliates. As noted in the proposal, 

banking entities often form corporate 

vehicles for the purpose of 

accomplishing a corporate merger or 

asset acquisition.1796 Because of the way 

they are structured, acquisition vehicles 

may rely on section 3(c)(1) or 3(c)(7) of 

the Investment Company Act.1797

Commenters supported the exclusion 

of acquisition vehicles from the 

restrictions governing covered funds, 

and argued that acquisition vehicles do 

not share the same characteristics as a 

hedge fund or private equity fund.1798

However, similar to concerns articulated 

above with respect to wholly-owned 

subsidiaries and joint ventures, 

commenters argued that the proposed 

rule, as drafted, left uncertain how other 

provisions of section 13 would apply to 

these vehicles.1799

In light of the comments, the final 

rule has been modified to exclude 

acquisition vehicles from the definition 

of covered fund, rather than provide a 

permitted activity exemption for 

banking entities to invest in or sponsor 

the vehicles, so long as the vehicle is 

formed solely for the purpose of 

engaging in a bona fide merger or 

acquisition transaction and the vehicle 

exists only for such period as necessary 

to effectuate the transaction.1800 The 

final rule thus reflects modifications 

from the exemption for acquisition 

vehicles in the proposal, which was 

available for acquisition vehicles where 

the sole purpose and effect of the entity 

was to effectuate a transaction involving 

the acquisition or merger of one entity 

with or into the banking entity.1801 The 

Agencies modified the conditions in the 

final rule, as discussed above, to more 

clearly reflect the limited activities in 

which an excluded acquisition vehicle 

may engage and to exclude acquisition 

vehicles from the definition of covered 

fund, rather than only permit banking 

entities to invest in or sponsor them 

pursuant to an exemption. 

The Agencies also note that an 

acquisition vehicle that survives a 

transaction would likely be excluded 

from the definition of covered fund 

under the separate exclusion for either 

joint ventures or wholly-owned 

subsidiaries described above. An 

acquisition vehicle that is controlled by 

a banking entity would be a banking 

entity itself and would be subject to the 

restrictions of section 13 and the final 

rule that apply to a banking entity. 

5. Foreign Pension or Retirement Funds 

Under the proposed rule, a foreign 

pension plan that relied on section 

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

Company Act to avoid being an 

investment company (or that was a 

commodity pool), would have been a 

covered fund. Commenters argued that 

including pension funds within the 

definition of covered fund would 

produce many unexpected results for 

pension plans as well as plan 

participants.1802

Commenters generally argued that 

foreign pension or retirement funds are 

established by a foreign company or 

foreign sovereign for the purpose of 

providing a specific group of foreign 

persons with income during retirement 

or when they reach a certain age or meet 

certain predetermined criteria and are 

typically eligible for preferential tax 

treatment, and are not formed for the 

same purposes as hedge funds or private 

equity funds.1803 Commenters argued 

that the definition of covered fund 

should not include certain foreign 

pension or retirement funds, including 

managed investment arrangements and 

wrap platforms, such as so-called 

‘‘superannuation funds,’’ that are 

managed by foreign banks as part of 

providing retirement or pension 

schemes to foreign citizens pursuant to 

foreign law and are generally not 

available for sale to U.S. citizens. 

Commenters asserted that many foreign 

banking entities act as sponsor to and 

organize and offer foreign pension funds 

abroad as part of a foreign sovereign 

program to provide retirement, pension, 

or similar benefits to its citizens or 

workforce.1804 These commenters 

contended that a foreign pension plan 

might itself rely on the exclusion in 

section 3(c)(1) or 3(c)(7) in order to 

avoid being an investment company if it 

is offered to citizens of the foreign 

sovereign present in the United 

States.1805

Several commenters argued that 

foreign pension and retirement plans 

should be excluded from the definition 

of covered fund on the same basis as 

U.S. pension and retirement funds that 

are ERISA-qualified funds that rely on 

the exclusion from the definition of 

investment company provided under 

section 3(c)(11) of the Investment 

Company Act.1806 Commenters alleged 

that without an exclusion for foreign 


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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 5955 

1807See final rule § 75.10(c)(5). 

1808Additionally and as discussed above, the 

prohibitions of section 13 and the final rule do not 

apply to an ownership interest that is acquired or 

retained by a banking entity through a deferred 

compensation, stock-bonus, profit-sharing, or 

pension plan of the banking entity that is 

established and administered in accordance with 

the law of the United States or a foreign sovereign, 

if the ownership interest is held or controlled 

directly or indirectly by a banking entity as trustee 

for the benefit of persons who are or were 

employees of the banking entity. 

1809See proposed rule § 75.14(a)(1). 

1810See In re The Prudential Ins. Co. of Am., 41 

S.E.C. 335, 345 (1963), aff’d, The Prudential Ins. Co. 

of Am. v. SEC, 326 F.2d 383 (3d Cir.), cert. denied, 

377 U.S. 953 (1964). 

1811See ACLI (Jan. 2012); Nationwide; Sutherland 

(on behalf of Comm. of Annuity Insurers); see also 

STANY. 

1812See ACLI (Jan. 2012); Nationwide; Sutherland 

(on behalf of Comm. of Annuity Insurers); see also 

STANY. 

1813See final rule § 75.10(c)(6). 

pension or retirement funds, section 13 

of the BHC Act would have an extraterritorial effect on pension or 

retirement benefits abroad that would be 

severe and beyond what was 

contemplated by section 13 of the BHC 

Act. 

In light of comments received on the 

proposal, the final rule excludes from 

the definition of covered fund a plan, 

fund, or program providing pension, 

retirement, or similar benefits that is: (i) 

Organized and administered outside of 

the United States; (ii) a broad-based 

plan for employees or citizens that is 

subject to regulation as a pension, 

retirement, or similar plan under the 

laws of the jurisdiction in which the 

plan, fund, or program is organized and 

administered; and (iii) established for 

the benefit of citizens or residents of one 

or more foreign sovereign or any 

political subdivision thereof.1807 This is 

similar to the treatment provided to U.S. 

pension funds by virtue of the exclusion 

from the definition of investment 

company under the Investment 

Company Act for certain broad-based 

employee benefit plans provided by 

section 3(c)(11) of that Act. The 

exclusion from the covered fund 

definition for foreign plans would be 

available for bona fide plans established 

for the benefit of employees or citizens 

outside the U.S. even if some of the 

beneficiaries of the fund reside in the 

U.S. or subsequently become U.S. 

residents. 

The Agencies believe this exclusion is 

appropriate in order to facilitate parallel 

treatment of domestic and foreign 

pension and retirement funds to the 

extent possible and to assist in ensuring 

that section 13 of the BHC Act does not 

apply to foreign pension, retirement, or 

similar benefits programs.1808

6. Insurance Company Separate 

Accounts 

Under the proposed rule, insurance 

company separate accounts would have 

been covered funds to the extent that 

the separate accounts relied on section 

3(c)(1) or 3(c)(7). Such reliance would 

generally occur in circumstances where 

policies funded by the separate account 

are distributed in an unregistered 

securities offering solely to qualified 

purchasers or on a limited basis to 

accredited investors. While the 

proposed rule did not generally exclude 

insurance company separate accounts 

from the definition of covered fund, the 

proposed rule did provide a limited 

exemption for investing in or acting as 

sponsor to separate accounts that were 

used for the purpose of allowing a 

banking entity to purchase bank owned 

life insurance (‘‘BOLI’’), subject to 

certain restrictions.1809

Various state or foreign laws allow 

regulated insurance companies to create 

separate accounts that are generally not 

separate legal entities but represent a 

segregated pool of assets on the balance 

sheet of the insurance company that 

support a specific policy claim on the 

insurance company. These accounts 

have assets and obligations that are 

separate from the general account of the 

insurance company. Insurance 

companies often utilize these separate 

accounts to allow policyholders of 

variable annuity and variable life 

insurance to allocate premium amounts 

for the purpose of engaging in various 

investment strategies that are tailored to 

the requirements of the individual 

policyholder. The policyholder, and not 

the insurance company, primarily 

benefits from the results of investments 

in the separate account. These separate 

accounts are generally investment 

companies for purposes of the 

Investment Company Act, unless an 

exclusion from that definition is 

applicable,1810 and, as noted above, may 

rely on the exclusion contained in 

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

Investment Company Act. 

While most commenters supported 

the proposal’s recognition that interests 

in BOLI separate accounts should be 

permitted, commenters generally argued 

that the final rule should also provide 

a broader exclusion from the definition 

of covered fund for all insurance 

company separate accounts. 

Commenters argued that covering 

separate accounts could lead to 

unintended consequences and was 

inconsistent with the statutory 

recognition that the business of 

insurance should continue to be 

accommodated.1811 These commenters 

argued that covering separate accounts 

within the definition of covered fund 

would disrupt a substantial portion of 

customer-driven insurance or retirement 

planning activity and pose a burden on 

insurance companies and holders of 

insurance policies funded by separate 

accounts, a result commenters alleged 

Congress did not intend.1812

In response to commenter concerns 

and in order to more appropriately 

accommodate the business of insurance 

in a regulated insurance company, the 

final rule excludes an insurance 

company separate account from the 

definition of covered fund under certain 

circumstances. To prevent this 

exclusion from being used to evade the 

restrictions on investments and 

sponsorship of covered funds by a 

banking entity, the final rule provides 

that no banking entity other than the 

insurance company that establishes the 

separate account may participate in the 

account’s profits and losses.1813 In this 

manner, the final rule appropriately 

accommodates the business of insurance 

by permitting an insurance company 

that is a banking entity to continue to 

provide its customers with a variety of 

insurance products through separate 

account structures in accordance with 

applicable insurance laws while 

protecting against the use of separate 

accounts as a means by which banking 

entities might take a proprietary or 

beneficial interest in an account that 

engages in prohibited proprietary 

trading and thereby evade the 

requirements of section 13 of the BHC 

Act. The exclusion of insurance 

company separate accounts from the 

definition of covered fund therefore is 

designed to reduce the potential burden 

of the final rule on insurance companies 

and holders of insurance policies 

funded by separate accounts while also 

continuing to prohibit banking entities 

from taking ownership interests in, and 

sponsoring or having certain 

relationships with, entities that engage 

in investment and trading activities 

prohibited by section 13. 

7. Bank Owned Life Insurance Separate 

Accounts 

As explained above, bank owned life 

insurance (‘‘BOLI’’) is generally offered 

through a separate account held by an 

insurance company. In recognition of 

the fact that banking entities have for 

many years invested in life insurance 

policies that covered key employees, in 

accordance with supervisory policies 

established by the Federal banking 

agencies, the proposal contained a 

provision that would permit banking 


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5956 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

1814See proposed rule § 75.14(a)(1). 

1815See ACLI (Jan. 2012); Mass. Mutual; Jones of 

Northwestern; AALU; BBVA; BoA; Chris Barnard; 

Clark Consulting (Feb. 7, 2012); Clark Consulting 

(Feb. 13, 2012); Gagnon of GW Financial. 

1816See Occupy. 

1817See final rule § 75.10(c)(7). 

1818This requirement is not intended to preclude 

a banking entity from purchasing a life insurance 

policy from an affiliated insurance company. 

1819See, e.g., Bank Owned Life Insurance, 

Interagency Statement on the Purchase and Risk 

Management of Life Insurance (Dec. 7, 2004). 

1820See proposed rule § 75.2(q). 

1821See AFR et al. (Feb. 2012); Occupy; Public 

Citizen. 

1822See Public Citizen. This commenter argued 

that the loan definition should be limited to the 

plain meaning of the term ‘‘loan’’ and noted that a 

loan is not a security. Id. 

1823See Occupy (citing 156 Cong. Rec. S5895 

(daily ed. July 15, 2010)). 

1824See Allen & Overy (on behalf of Foreign Bank 

Group); ASF (Feb. 2012); Credit Suisse (Williams); 

GE (Feb. 2012); Goldman (Covered Funds); ICI (Feb. 

2012); Japanese Bankers Ass’n.; JPMC; LSTA (Feb. 

2012); RBC; SIFMA et al. (Covered Funds) (Feb. 

2012); SIFMA (Securitization) (Feb. 2012). One 

individual commenter supported the proposed 

definition of loan. See Alfred Brock. For example, 

one commenter requested that definition of ‘‘loan’’ 

be revised to include ‘‘(i) any loan, lease (including 

any lease residual), extension [of] credit, or secured 

or unsecured receivables, (ii) any note, bond or 

security collateralized and payable from pools of 

loans, leases (including Lease residuals), extensions 

of credit or secured or unsecured receivables, and 

(iii) any contractual rights arising from, or security 

interests or liens, assets, property guarantees, 

insurance policies, letters of credit, or supporting 

obligations underlying or relating to any of the 

foregoing.’’ See RBC. Another commenter requested 

that the definition of ‘‘loan’’ be revised to include 

‘‘any type of credit extension (including bonds, 

other [banking entity-eligible] debt securities, assetbacked securities [as defined in their letter], 

variable funding notes and securities lending 

agreements, repurchase agreements, reverse 

repurchase agreements and other similar extensions 

of credit) that a banking entity could hold or deal 

in.’’ See SIFMA (Securitization) (Feb. 2012). 

1825See JPMC. 1826See ASF (Feb. 2012); Credit Suisse 

(Williams); JPMC (arguing that such notes operate 

in economic substance as loans); SIFMA 

(Securitization) (Feb. 2012). 1827See ASF (Feb. 2012). This commenter 

asserted that a note purchase facility is negotiated 

by the asset-backed commercial paper conduit and 

allows the asset-backed commercial paper conduit 

to purchase asset-backed securities issued by an 

intermediate special purpose vehicle and backed by 

loans or asset-backed securities backed by loans. Id. 1828See ASF (Feb. 2012). 1829See Allen & Overy (on behalf of Foreign Bank 

Group); ASF (Feb. 2012); Credit Suisse (Williams); 

JPMC. 1830See ASF (Feb. 2012). This commenter argued 

that certain municipal securities may be ABS, 

including revenue bonds that involve the issuance 

of senior and subordinate bonds. Id. 

1831See Credit Suisse (Williams); SIFMA 

(Securitization) (Feb. 2012). 

1832See SIFMA (Securitization) (Feb. 2012). This 

commenter contended that because securitization 

transactions have been viewed by the Agencies and 

courts as ‘legally transparent’ (i.e., as simply 

another way for banking entities to buy and sell the 

loans or other assets underlying such securities), 

auto lease securitizations supported by a beneficial 

interest in a titling trust should be treated as 

securitizations of the underlying auto leases and 

should fall within the loan securitization 

exemption. This commenter also argued that if the 

definition of ‘‘loan’’ is not expanded to include 

securities, then banking entities could not act as 

sponsors for auto lease securitizations (including 

resecuritizations) supported by a beneficial interest 

in a titling trust. 

1833See Credit Suisse (Williams); Goldman 

(Covered Funds); SIFMA et al. (Covered Funds) 

(Feb. 2012); SIFMA (Securitization) (Feb. 2012). 

entities to invest in and sponsor BOLI 

separate accounts.1814

Many commenters supported the 

exemption in the proposal for BOLI 

separate accounts, arguing that 

permitting this kind of activity was 

appropriate and consistent with safety 

and soundness as well as financial 

stability.1815 Conversely, one 

commenter objected to the proposed 

rule’s exemption for investments in 

BOLI separate accounts, contending that 

such an exemption did not promote and 

protect the safety and soundness of 

banking entities or the financial stability 

of the United States.1816

After considering comments received 

on the proposal, the final rule excludes 

BOLI separate accounts from the 

definition of covered fund but maintains 

the substance of the conditions from the 

proposal designed to ensure that BOLI 

investments are not conducted in a 

manner that raises the concerns that 

section 13 of the BHC Act was designed 

to address. In particular, in order for a 

separate account to qualify for the BOLI 

exclusion from the definition of covered 

fund, the final rule requires that the 

separate account be used solely for the 

purpose of allowing one or more 

banking entities (which by definition 

includes their affiliates) to purchase a 

life insurance policy for which such 

banking entity(ies) is a beneficiary.1817

Additionally, if the banking entity is 

relying on this exclusion, the banking 

entity that purchases the insurance 

policy (i) must not control the 

investment decisions regarding the 

underlying assets or holdings of the 

separate account,1818 and (ii) must 

participate in the profits and losses of 

the separate account in compliance with 

applicable supervisory guidance 

regarding BOLI.1819

When made in the normal course, 

investments by banking entities in BOLI 

separate accounts do not involve the 

types of speculative risks section 13 of 

the BHC Act was designed to address. 

Rather, these accounts permit the 

banking entity to effectively hedge and 

cover costs of providing benefits to 

employees through insurance policies 

related to key employees. Moreover, 

applying the prohibitions of section 13 

to investments in these accounts would 

eliminate an investment that helps 

banking entities to efficiently reduce 

their costs of providing employee 

benefits, and therefore potentially 

introduce a burden to banking entities 

that would not further the statutory 

purpose of section 13. The Agencies 

expect this exclusion to be used by 

banking entities in a manner consistent 

with safety and soundness. 

8. Exclusion for Loan Securitizations 

and Definition of Loan 

a. Definition of Loan 

The proposal defined the term ‘‘loan’’ 

for purposes of the restrictions on 

proprietary trading and the covered 

funds provisions and, as discussed in 

more detail below, provided an 

exemption for loan securitizations in 

two separate sections of the proposed 

rule. As proposed, loan was defined as 

‘‘any loan, lease, extension of credit, or 

secured or unsecured receivable.’’ 1820

The definition of loan in the proposed 

rule was expansive, and included a 

broad array of loans and similar credit 

transactions, but did not include any 

asset-backed security issued in 

connection with a loan securitization or 

otherwise backed by loans. 

Some commenters requested that the 

Agencies narrow the proposed 

definition of ‘‘loan.’’ 1821 One of these 

commenters was concerned that the 

proposed definition could apply to any 

banking activity and argued that the 

definition of loan for purposes of the 

final rule should not include 

securities.1822 Another commenter, 

citing a statement made by Senator 

Merkley, asserted that Congress did not 

intend the rule of construction for the 

sale and securitization of loans in 

section 13(g)(2) to include ‘‘loans that 

become financial instruments traded to 

capture the change in their market 

value.’’ 1823

Other commenters requested that the 

Agencies expand the proposed 

definition of ‘‘loan’’ to capture many 

traditional extensions of credit that the 

proposal would otherwise exclude.1824

Examples of traditional credit 

extensions that commenters requested 

be specifically included within the 

definition of ‘‘loan’’ included loan 

participations,1825 variable funding 

notes or certificates,1826 note purchase 

facilities,1827 certain forms of revolving 

credit lines,1828 corporate bonds,1829

municipal securities,1830 securities 

lending agreements and reverse 

repurchase agreements,1831 auto lease 

securitizations,1832 and any other type 

of credit extension that banking entities 

traditionally have been permitted to 

issue under their lending authority.1833

The definition of ‘‘loan’’ in the final 

rule applies both in the context of the 


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1834See final rule § 75.2(s). 

1835 12 U.S.C. 1851(h)(4). 

1836See 15 U.S.C. 77b(a)(1) and 15 U.S.C. 

78c(a)(10); Reves v. Ernst & Young, 494 U.S. 56 

(1990) ; Trust Company of Louisiana v. N.N.P. Inc., 

104 F.3d 1478 (5th Cir. 1997); Pollack v. Laidlaw 

Holdings, 27 F.3d 808 (2d Cir. 1994); but see Marine 

Bank v. Weaver, 455 U.S. 551 (1982); Banco 

Espanol de Credito v. Security Pacific National 

Bank, 973 F.2d 51 (2d Cir. 1992); Bass v. Janney 

Montgomery Scott, Inc., 210 F.3d 577 (6th Cir. 

2000); Piaubert v. Sefrioui, 2000 WL 194140 (9th 

Cir. 2000). 

1837 Id. 

1838See 12 U.S.C. 1851(g)(2). 

1839See proposed rule § 75.13(d); Joint Proposal, 

76 FR at 68912. 

1840 Id. 

1841See Joint Proposal, 76 FR at 68931. 

1842See, e.g., Public Citizen. This commenter 

argued that any exemption should prevent evasion, 

should ensure that each exempted securitization 

reduces risk and should be designed to only serve 

client needs. A different commenter recommended 

a safe harbor available only to a particular prespecified, transparent and standardized 

securitization structure, where Agencies would 

need to justify why the specified structure protects 

Continued 

proprietary trading restrictions as well 

as in determining the scope of the 

exclusion of loan securitizations and 

asset-backed commercial paper conduits 

from the definition of covered fund. The 

final rule modifies the proposed 

definition and defines ‘‘loan’’ as ‘‘any 

loan, lease, extension of credit, or 

secured or unsecured receivable that is 

not a security or derivative.’’ 1834 The 

definition of loan in the final rule 

specifically excludes loans that are 

securities or derivatives because trading 

in these instruments is expressly 

included in the statute’s definition of 

proprietary trading.1835 In addition, the 

Agencies believe these instruments, if 

not excluded from the definition of 

loan, could be used to circumvent the 

restrictions on proprietary trading. 

The definition of loan in the final rule 

excludes loans that are securities or 

derivatives, including securities or 

derivatives of or based on such 

instruments. The definition of ‘‘loan’’ 

does not specify the type, nature or 

structure of loans included within the 

definition, other than by excluding 

securities and derivatives. In addition, 

the definition of loan does not limit the 

scope of parties that may be lenders or 

borrowers for purposes of the definition. 

The Agencies note that the parties’ 

characterization of an instrument as a 

loan is not dispositive of its treatment 

under the Federal securities laws or 

Federal laws applicable to derivatives. 

The determination of whether a loan is 

a security or a derivative for purposes of 

the loan definition is based on the 

Federal securities laws and the 

Commodity Exchange Act. Whether a 

loan is a ‘‘note’’ or ‘‘evidence of 

indebtedness’’ and therefore a security 

under the Federal securities laws will 

depend on the particular facts and 

circumstances, including the economic 

terms of the loan.1836 For example, 

loans that are structured to provide 

payments or returns based on, or tied to, 

the performance of an asset, index or 

commodity or provide synthetic 

exposure to the credit of an underlying 

borrower or an underlying security or 

index may be securities or derivatives 

depending on their terms and the 

circumstances of their creation, use, and 

distribution.1837 Regardless of whether a 

party characterizes the instrument as a 

loan, these kinds of instruments, which 

may be called ‘‘structured loans,’’ must 

be evaluated based on the standards 

associated with evaluating derivatives 

and securities in order to prevent 

evasion of the restrictions on 

proprietary trading and ownership 

interests in covered funds. 

b. Loan Securitizations 

An exemption for loan securitizations 

was contained in two separate sections 

of the proposed rule. The first, in 

section 75.13(a), was proposed as part of 

‘‘other permitted covered fund activities 

and investments.’’ The second, in 

§ 75.14(d), was proposed as part of 

‘‘covered fund activities determined to 

be permissible.’’ These proposed 

provisions would have acted in concert 

to permit a banking entity to acquire 

and retain an ownership interest in, or 

act as sponsor to, a loan securitization 

regardless of the relationship that the 

banking entity had with the 

securitization. The Agencies have 

evaluated all comments received on 

securitizations. These sections of the 

proposed rule were intended to 

implement the rule of construction 

contained in section 13(g)(2) of the BHC 

Act which provides that nothing in 

section 13 of the BHC Act shall be 

construed to limit or restrict the ability 

of a banking entity or nonbank financial 

company supervised by the Board to sell 

or securitize loans in a manner that is 

otherwise permitted by law.1838 The 

language of the proposed exemption for 

loan securitizations would have 

permitted a banking entity to acquire 

and retain an ownership interest in a 

covered fund that is an issuer of assetbacked securities, the assets or holdings 

of which were solely comprised of: (i) 

Loans (as defined); (ii) rights or assets 

directly arising from those loans 

supporting the asset-backed securities; 

and (iii) interest rate or foreign exchange 

derivatives that (A) materially relate to 

the terms of such loans or rights or 

assets and (B) are used for hedging 

purposes with respect to the 

securitization structure.1839 The 

proposed rule in § 75.13(d) was further 

augmented by the proposed rule in 

§ 75.14(a)(2) so that a banking entity 

would be permitted to purchase loan 

securitizations and engage in the sale 

and securitization of loans. This was 

accomplished through the authorization 

in proposed section 75.14(a)(2) of a 

banking entity’s acquisition or retention 

of an ownership interest in such 

securitization vehicles that the banking 

entity did not organize and offer, or for 

which it did not act as sponsor, 

provided that the assets or holdings of 

such vehicles were solely comprised of 

the instruments or obligations identified 

in the proposed exemption. 

The proposed rules would have 

allowed a banking entity to engage in 

the sale and securitization of loans by 

acquiring and retaining an ownership 

interest in certain securitization 

vehicles (which could be a covered fund 

for purposes of the proposed rules) that 

the banking entity organized and 

offered, or acted as sponsor to, without 

being subject to the ownership and 

sponsor limitations contained in the 

proposed rule.1840 As noted in the 

proposing release, the Agencies 

recognized that by defining ‘‘covered 

fund’’ broadly, and, in particular, by 

reference to sections 3(c)(1) and 3(c)(7) 

of the Investment Company Act, 

securitization vehicles may be affected 

by the restrictions and requirements of 

the proposed rule. The Agencies 

attempted to mitigate the potential 

adverse impact on the securitization 

market by excluding loan securitizations 

from the restrictions on sponsoring or 

acquiring and retaining ownership 

interests in covered funds, consistent 

with the rule of construction contained 

in section 13(g)(2) of the BHC Act.1841

As a result, under the proposal, loan 

securitizations would not be limited or 

restricted because banking entities 

would be able to find investors or 

buyers for their loans or loan 

securitizations. The proposing release 

included several requests for comment 

on the proposed loan securitization 

exemption and the application of the 

covered fund prohibitions to 

securitizations. 

Some commenters supported a 

narrow exemption for loan 

securitizations and in some cases 

suggested that the proposed exemption 

could be narrowed even further. For 

example, one commenter argued that 

the definition of ‘‘loan’’ for purposes of 

the exemption could include any 

extension of credit and any banking 

activity.1842 Also, in response to the 


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5958 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

against the systemic risks associated with 

securitization. See AFR (Nov. 2012). 

1843See Request for Comment No. 231 in the 

Proposing Release (noting that many issuers of 

asset-backed securities have features and structures 

that resemble some of the features of hedge funds 

and private equity funds (e.g., CDOs are managed 

by an investment adviser that has the discretion to 

choose investments, including investments in 

securities) and requesting comment on how to 

prevent hedge funds or private equity funds from 

structuring around an exemption for asset-backed 

securities from the covered fund prohibitions). 

1844See, e.g., AFR et al. (Feb. 2012); Occupy; 

Public Citizen. But see Credit Suisse (Williams) 

(arguing it would be difficult to use the typical 

structure and operation of securitizations to avoid 

the prohibition on proprietary trading because the 

structures are not set up to engage in the kind of 

proprietary trading about which Congress was 

concerned). 

1845See AFME et al.; Ass’n. of German Banks; 

Cleary Glottlieb; Credit Suisse (Williams); GE (Feb. 

2012); IIB/EBF; RBC; SIFMA (Securitization) (Feb. 

2012). 

1846See, e.g., Credit Suisse (Williams). 

1847See Credit Suisse (Williams); JPMC. These 

commenters cited the sponsoring of asset-backed 

commercial paper conduits as an example of 

permissible bank securitization activity. 

1848See Allen & Overy (on behalf of Foreign Bank 

Group); Credit Suisse (Williams); JPMC. 

1849See GE (Feb. 2012); GE (Aug. 2012); ICI (Feb. 

2012). 

1850See Allen & Overy (on behalf of Foreign Bank 

Group); ASF (Feb. 2012); Cleary Gottlieb; Credit 

Suisse (Williams) (including cash that did not arise 

directly from the underlying loans); JPMC; LSTA 

(Feb. 2012); LSTA (July 2012); RBC; SIFMA 

(Securitization) (Feb. 2012). 

1851See Cleary Gottlieb; Credit Suisse (Williams). 

1852See JPMC (requesting high quality, highly 

liquid investments, including Treasury securities 

and highly rated commercial paper); LSTA (Feb. 

2012); LSTA (July 2012) (requesting short-term 

highly liquid investments such as obligations 

backed by the full faith and credit of the United 

States, deposits insured by the Federal Deposit 

Insurance Corporation, various obligations of U.S. 

financial institutions and investments in money 

market funds); ASF (Feb. 2012); Commercial Real 

Estate Fin. Council; RBC (requesting short-term, 

high quality investments); Allen & Overy (on behalf 

of Foreign Bank Group) (requesting short-term 

eligible investments); Credit Suisse (Williams) 

(requesting government guaranteed securities, 

money market funds and other highly credit-worthy 

and liquid investments); Cleary Gottlieb (requesting 

money-market interests; SIFMA (Securitization) 

(Feb. 2012) (requesting associated investments 

which are customarily employed in securitization 

transactions). One commenter further noted that 

such investments are required by securitization 

documents. See Commercial Real Estate Fin. 

Council. 

1853RBC. This commenter argued that the loan 

securitization exemptions as proposed would not 

permit ‘‘traditional securitizations and 

securitizations with the characteristics of traditional 

securitizations’’ and ‘‘would effectively eliminate a 

substantial portion of the very securitization 

activities carried on by banks that the [loan 

securitization exemptions] are designed to 

preserve.’’ 

1854See Allen & Overy (on behalf of Foreign Bank 

Group); ASF (Feb. 2012); Credit Suisse (Williams); 

GE (Feb. 2012); JPMC; RBC; SIFMA et al. (Covered 

Funds) (Feb. 2012); SIFMA (Securitization) (Feb. 

2012). 

1855See, e.g., ASF (Feb. 2012); Cleary Gottlieb; 

LSTA (Feb. 2012). LSTA (Feb. 2012) specifically 

requested that entities issuing collateralized loan 

obligations that are primarily backed by loans or 

loan participations also be permitted to hold a 

limited amount of corporate credit obligations. This 

commenter provided recommendations about such 

limitations—if the amount of such corporate credit 

obligations exceeded 10 percent, a CLO would not 

be able to purchase any assets other than senior, 

secured syndicated loans and temporary 

investments (as defined in the letter). If the amount 

of such assets exceeded 30 percent, the entity 

should not be able to purchase any assets other than 

loans. 

1856See AFME et al.; Allen & Overy (on behalf of 

Foreign Bank Group); Credit Suisse (Williams); 

Japanese Bankers Ass’n.; LSTA (Feb. 2012); SIFMA 

(Securitization) (Feb. 2012). 

1857See ASF (Feb. 2012). Permissible synthetic 

exposure would include ‘‘credit default swaps, total 

return swaps or other agreements referencing 

corporate loans or corporate bonds pursuant to 

which the issuer is the seller of credit protection or 

otherwise ‘long’ the credit exposure of the reference 

corporate loan or bond, and receives a yield derived 

from the yield on the reference corporate loan or 

bond.’’ 

1858See AFME et al.; ASF (July 2012); GE (Aug. 

2012); Capital Group; Goldman (Covered Funds); 

LSTA (Feb. 2012); SIFMA et al. (Covered Funds) 

(Feb. 2012). 

proposing release,1843 some commenters 

suggested that any exemption for 

securitizations should seek to prevent 

evasion of the covered fund prohibitions 

by issuers with ‘‘hedge-fund or private 

equity fund-like characteristics’’ or 

issuers with ‘‘hidden proprietary trading 

operations.’’ 1844

On the other hand, many commenters 

believed that the proposed exemption 

from the covered fund prohibitions for 

loan securitizations should be expanded 

to cover securitizations generally and 

not just loan securitizations. These 

commenters provided various 

arguments for their request to exempt all 

securitizations from the covered fund 

prohibitions, including that the 

regulation of securitizations was 

addressed in other areas of the DoddFrank Act,1845 that securitization is 

essentially a lending activity,1846 and 

that securitizations have ‘‘long been 

recognized as permissible activities for 

banking entities.’’ 1847

Commenters recommending a broader 

exclusion for securitizations also 

provided a wide variety of specific 

suggestions or concerns. Some 

commenters suggested that permissible 

assets for a loan securitization include 

assets other than loans acquired in the 

course of collecting a debt previously 

contracted, restructuring a loan, during 

a loan work out or during the 

disposition of a loan or other similar 

situation.1848 Commenters noted that, 

for example, rules 2a–7 and 3a–7 under 

the Investment Company Act define 

eligible assets for a securitization as not 

only including financial assets but also 

‘‘any rights or other assets designed to 

assure the servicing or timely 

distribution of proceeds to security 

holders.’’ 1849 Commenters requested 

that various additional rights or assets 

be added to the list of permissible assets 

held by a loan securitization such as 

cash and cash accounts,1850 cash 

equivalents,1851 and various other high 

quality short term investments, liquidity 

agreements or credit enhancements, 

certain beneficial interests in titling 

trusts used in lease securitizations or 

lease residuals.1852 One commenter 

suggested that a loan securitization be 

permitted to include ‘‘any contractual 

rights arising from or supporting 

obligations underlying or relating to the 

loans.’’ 1853

Others requested that loan 

securitizations also be permitted to hold 

repurchase agreements or unlimited 

amounts of various forms of securities, 

including municipal securities, assetbacked securities, credit-linked notes, 

trust certificates and ‘‘equity likerights.’’ 1854 Some commenters 

requested that loan securitizations be 

permitted to hold a limited amount of 

certain rights such as securities.1855

Commenters also had suggestions about 

the types of derivatives that an 

exempted securitization vehicle be 

permitted to hold.1856 For example, one 

industry association requested that the 

loan securitization exemption include 

securitizations where up to 10 percent 

of the assets are held in the form of 

synthetic risk exposure that references 

‘‘loans that could otherwise be held 

directly’’ under the proposal in order to 

achieve risk diversification.1857 This 

commenter stated its belief that the rule 

of construction requires that synthetic 

exposures be permitted because they are 

used in certain types of loan 

securitizations. 

In addition to requests that specific 

types of underlying assets be permitted 

under the loan securitization 

exemption, the Agencies also received 

comments about specific types of asset 

classes or structures. Some commenters 

suggested certain asset classes or 

structures should be an excluded 

securitization from the covered fund 

prohibitions including insurance-linked 

securities, collateralized loan 

obligations, tender option bonds, assetbacked commercial paper conduits 

(ABCP conduits), resecuritizations of 

asset-backed securities, and corporate 

debt re-packagings.1858 In some cases, 

commenters believed that the Agencies 

should use their authority under section 

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

these types of vehicles. Some 

commenters identified other vehicles 

such as credit funds and issuers of 

covered bonds that they believed should 

be excluded from the covered fund 


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1859See Goldman (Covered Funds) (requesting 

exclusion for credit funds). AFME et al. (requesting 

exclusion for covered bonds); FSA (Apr. 2012) 

(requesting exclusion for covered bonds); UKRCBC 

(requesting exclusion for covered bonds). 

1860See Sens. Merkley & Levin (Feb. 2012). These 

commenters argued that there should be increased 

capital charges in line with the complexity of a 

securitization and using the ‘‘high risk asset 

limitations on permitted activities to bar any 

securitization by a bank from using complex 

structures, re-securitization techniques, synthetic 

features, or other elements that may increase risk or 

make a risk analysis less reliable.’’ 

1861See AFME et al.; SIFMA (May 2012) (arguing 

that because of the narrowness of the proposed 

exemption and because it would not exempt 

securitizations from prohibitions on covered 

transactions imposed by section 13(f), the rule as 

proposed ‘‘will effectively prevent banking entities 

from sponsoring and owning a large variety of assetbacked securities, in contravention of the rule of 

construction.’’) 

1862See AFME et al.; ASF (Feb. 2012); SIFMA 

(Securitization) (Feb. 2012). 

1863See Occupy; Public Citizen. Occupy 

contended that the structured security issued in a 

multi-step securitization can hide underlying risks 

under layers of structured complexity. See Occupy. 

Public Citizen argued that prohibiting such activity 

would ensure that securitizations do not become 

proprietary trading vehicles for banking entities that 

are effectively off-balance sheet. See Public Citizen. 

See infra Part VI.B.1.c.8.b.iv. of this SUPPLEMENTARY

INFORMATION. 

1864A depositor, as used in a securitization 

structure, is an entity that generally acts only as a 

conduit to transfer the loans from the originating 

bank to the issuing entity for the purpose of 

facilitating a securitization transaction and engages 

in no discretionary investment or securities 

issuance activities. See ASF (July 2012); GE (Aug. 

2012). For purposes of this rule, the Agencies 

believe the wholly owned subsidiary exclusion is 

available for depositors. See supra note 1779. 

1865 15 U.S.C. 78c(a)(79). This definition was 

added by Section 941 of the Dodd-Frank Act. 

1866See final rule § 75.10(c)(8). Consistent with 

the proposal, certain securitizations, regardless of 

asset composition, would not be considered 

covered funds because the securitization issuer is 

deemed not to be an investment company under 

Investment Company Act exclusions other than 

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

Act. For example, this would include issuers that 

meet the requirements of section 3(c)(5) or rule 3a– 

7 of the Investment Company Act, and the assetbacked securities of such issuers may be offered in 

transactions registered under the Securities Act. 

1867As discussed below, the Agencies are 

adopting an exclusion from the definition of 

covered funds for the pools of assets that are 

involved in the covered bond financings. Although 

the cover pools must satisfy the same criteria as the 

excluded loan securitizations, a separate exclusion 

is needed because the securities involved in the 

covered bond issuance are not asset-backed 

securities. 

1868See, e.g., Credit Suisse (Williams). 

prohibitions.1859 On the other hand, the 

Agencies also received comment letters 

that argued that certain securitizations 

should not be exempted from the 

covered fund prohibitions, including 

resecuritizations, CDO-squared, and 

CDO-cubed securitizations because of 

concern about their complexity and lack 

of reliable performance data or ability to 

value those securities.1860

Because a loan securitization could 

still be a covered fund, several 

commenters expressed concern that the 

proposed loan securitization exemption, 

as drafted, did not exempt loan 

securitizations from the prohibitions of 

section 13(f) of the BHC Act. As a result, 

one commenter noted that the proposed 

loan securitization exemptions would 

not have their intended result of 

excluding loan securitizations from the 

BHC Act restrictions applicable to 

covered funds.1861

Certain securitization transactions 

may involve the issuance of an 

intermediate asset-backed security that 

supports the asset-backed securities that 

are issued to investors, such as in auto 

lease securitizations and ABCP 

conduits. Commenters suggested that 

the Agencies should look through 

intermediate securitizations to the assets 

that support the intermediate assetbacked security to determine if those 

assets would satisfy the definition of 

‘‘loan’’ for purposes of the loan 

securitization exemption. If those assets 

are loans, these commenters suggested 

that the entire securitization transaction 

should be deemed a loan securitization, 

even if the assets supporting the assetbacked securities issued to investors are 

not loans.1862 However, some 

commenters argued that each step in a 

multi-step securitization should be 

viewed separately to ensure compliance 

with the specific restrictions in the 

proposal because otherwise a multi-step 

securitization could include 

impermissible assets.1863 Some 

commenters also raised question about 

whether depositors would fall within 

the definition of ‘‘investment company’’ 

under the Investment Company Act and, 

therefore, may fall within the proposed 

definition of covered fund.1864

After considering carefully the 

comments received on sections of the 

proposed rule, the Agencies have 

determined to adopt a single section in 

the final provision relating to loan 

securitizations that would exclude loan 

securitizations that meet certain criteria 

contained in the rule from the definition 

of covered fund. The rule, as adopted, 

takes into account comments received 

on each of the conditions specified in 

the two loan securitization sections of 

the proposed provisions and has 

adopted those conditions with some 

clarifying changes from the proposed 

language. In addition, in response to 

comments, as discussed more fully 

below, the Agencies are adopting 

additional exclusions from the 

definition of covered fund for certain 

types of vehicles if they are backed by 

the same types of assets as the assets 

that are permitted to be held in the loan 

securitization exclusion. These 

additional exclusions are tailored to 

vehicles that are very similar to loan 

securitizations but have particular 

structural issues, which are described in 

more detail below. 

In light of the comments received on 

the proposal, the final rule was revised 

to exclude from the definition of 

covered fund an issuing entity of assetbacked securities, as defined in Section 

3(a)(79) of the Exchange Act,1865 if the 

underlying assets or holdings are 

comprised solely of: (A) loans, (B) any 

rights or other assets (i) designed to 

assure the servicing or timely 

distribution of proceeds to security 

holders or (ii) related or incidental to 

purchasing or otherwise acquiring, and 

holding the loans, (C) certain interest 

rate or foreign exchange derivatives, and 

(D) certain special units of beneficial 

interests and collateral certificates 

(together, ‘‘loan securitizations’’).1866 In 

addition, as discussed below, the 

Agencies are adopting specific 

exclusions for certain vehicles that issue 

short term asset-backed securities and 

for pools of assets that are part of 

covered bond transactions which pools 

also meet the conditions delineated 

above.1867

Although commenters argued that 

various types of assets should be 

included within the definition of loan or 

otherwise permitted to be held under 

the loan securitization exclusion, the 

loan securitization exclusion in the final 

rule has not been expanded to be a 

broad exclusion for all securitization 

vehicles. Although one commenter 

suggested that any securitization is 

essentially a lending activity,1868 the 

Agencies believe such an expansion of 

the exclusion would not be consistent 

with the rule of construction in section 

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

specifically refers to the ‘‘sale and 

securitization of loans.’’ The Agencies 

believe that a broad definition of loan 

and therefore a broad exemption for 

transactions that are structured as 

securitizations of pooled financial assets 

could undermine the restrictions 

Congress intended to impose on banking 

entities’ covered fund activities, which 

could enable market participants to use 

securitization structures to engage in 

activities that otherwise are constrained 

for covered funds. The Agencies believe 

the purpose underlying section 13 is not 

to expand the scope of assets in an 

excluded loan securitization beyond 

loans as defined in the final rule and the 

other assets that the Agencies are 

specifically permitting in a loan 

securitization. 


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5960 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

1869Commenters’ concerns regarding credit funds 

are discussed below in Part VI.B.1.d.6. of this 

SUPPLEMENTARY INFORMATION. 

1870As discussed below, the Agencies are 

excluding those loan securitizations that hold only 

loans (and certain other assets identified in the final 

rule), consistent with the rule of construction in 

section 13(g)(2) of the BHC Act. 

1871The Agencies note that the loan securitization 

and other securitization exclusions apply only to 

the definition of covered fund, and therefore the 

covered fund-related provisions of the rule, and not 

to its prohibition on proprietary trading. The 

Agencies recognize that trading in loans is not 

subject to the proprietary trading restrictions. 

1872See proposed rule § 75.2(q). 

1873See Occupy (citing 156 Cong. Rec. S5895 

(daily ed. July 15, 2010)). 

1874See § 75.2(r). 

1875 12 U.S.C. 1851(h)(4). 

1876Under the final provision, the issuing entity 

for the SUBIs and collateral certificate may rely on 

the loan securitization exclusion because of the 

separate provisions allowing such a holding. 

While not expanding the permitted 

assets under the loan securitization 

exclusion, the Agencies have made 

modifications in response to 

commenters to ensure that the 

provisions of the final rule 

appropriately accommodate the need, in 

administering a loan securitization 

transaction on an ongoing basis, to hold 

various assets other than the loans that 

support the asset-backed securities. 

Moreover, the Agencies do not believe 

that the assets permitted under the loan 

securitization need to be narrowed 

further to prevent evasion and hidden 

proprietary trading as requested by 

certain commenters because the 

Agencies believe that the potential for 

evasion has been adequately addressed 

through modifications to the definition 

of loan and more specific limitations on 

the types of securities and derivatives 

permitted in an excluded loan 

securitization. The Agencies have 

revised the scope of the loan 

securitization exclusion to 

accommodate existing market practice 

for securitizations as discussed by 

commenters while limiting the 

availability of the exclusion for these 

particular types of securitization 

transactions to issuers of asset-backed 

securities supported by loans. 

The Agencies are not adopting 

specific exclusions for other 

securitization vehicles identified by 

commenters, including insurance-linked 

securities, collateralized loan 

obligations, and corporate debt repackagings.1869 The Agencies believe 

that providing such exclusions would 

not be consistent with the rule of 

construction in section 13(g)(2) of the 

BHC Act, which specifically refers to 

the ‘‘sale and securitization of loans.’’ 

These other types of securitization 

vehicles referenced by commenters are 

used to securitize exposures to 

instruments which are not included in 

the definition of loan as adopted by the 

final rule. Moreover, the Agencies note 

in response to commenters that 

resecuritizations of asset-backed 

securities and CDO-squared and CDOcubed securitizations could be used as 

a means of evading the prohibition on 

the investment in the ownership 

interests of covered funds. 

As with the proposed rules, the 

Agencies are excluding certain loan 

securitizations from the definition of 

covered fund and therefore the 

prohibitions applicable to banking 

entities’ involvement in covered funds 

in order to implement Congressional 

intent expressed in the rule of 

construction in section 13(g)(2) of the 

BHC Act.1870 The Agencies believe that, 

as reflected in the rule of construction, 

the continued ability of banking entities 

to participate in loan securitizations is 

important to enable banks of all sizes to 

be able to continue to provide financing 

to loan borrowers at competitive prices. 

Loan securitizations provide an 

important avenue for banking entities to 

obtain investor financing for existing 

loans, which allows such banks greater 

capacity to continuously provide 

financing and lending to their 

customers. The Agencies also believe 

that loan securitizations that meet the 

conditions of the rule as adopted do not 

raise the same types of concerns as other 

types of securitization vehicles that 

could be used to circumvent the 

restrictions on proprietary trading and 

prohibitions in section 13(f) of the BHC 

Act. 

Under the rule as adopted, loan 

securitizations that meet the conditions 

of the rule as adopted are excluded from 

the definition of covered fund and, 

consequently, banking entities are not 

restricted as to their ownership of such 

entities or their ongoing relationships 

with such entities by the final rule. As 

the Agencies stated in the proposal, 

permitting banking entities to acquire or 

retain an ownership interest in these 

loan securitizations will allow for a 

deeper and richer pool of potential 

participants and a more liquid market 

for the sale of such securitizations, 

which in turn should result in the 

continued availability of funding to 

individuals and small businesses, as 

well as provide an efficient allocation of 

capital and sharing of risk. The 

Agencies believe that excluding these 

loan securitizations from the definition 

of covered fund is consistent with the 

terms and the purpose of section 13 of 

the BHC Act, including the rule of 

construction regarding loan 

securitizations.1871

i. Loans 

The first condition of the loan 

securitization exclusion from the 

definition of covered fund is that the 

underlying assets or holdings are 

comprised of loans. In the proposal, 

‘‘loan’’ was a defined term for purposes 

of the restrictions on proprietary trading 

and the covered funds provisions. As 

proposed, a loan was defined as a loan, 

lease, extension of credit, or secured or 

unsecured receivable.1872 The definition 

of loan in the proposed rule was 

expansive, and included a broad array 

of loans and similar credit transactions, 

but did not include any asset-backed 

security that is issued in connection 

with a loan securitization or otherwise 

backed by loans. 

As discussed above under ‘‘Definition 

of Loan,’’ the Agencies received 

comments regarding the loan definition 

in the securitization context. In 

particular, one commenter, citing a 

statement made by Senator Merkley, 

argued that Congress did not intend the 

loan securitization exemption to include 

‘‘loans that become financial 

instruments traded to capture the 

change in their market value.’’ 1873

The Agencies, after considering 

carefully the comments received, have 

adopted a definition of loan that is 

revised from the proposed definition. 

The final rule defines ‘‘loan’’ as ‘‘any 

loan, lease, extension of credit, or 

secured or unsecured receivable that is 

not a security or derivative.’’ 1874 The 

definition of loan in the final rule 

specifically excludes loans that are 

securities or derivatives because trading 

in these instruments is expressly 

included in the statute’s definition of 

proprietary trading.1875 In addition, the 

Agencies believe these instruments, if 

not excluded from the definition of 

loan, could be used to circumvent the 

restrictions on proprietary trading. 

Further, for purposes of the loan 

securitization exclusion, the loan 

securitization must own the loan 

directly; a synthetic exposure to a loan, 

such as through holding a derivative, 

such as a credit default swap, will not 

satisfy the conditions for the loan 

securitization exclusion.1876 As such, a 

securitization that owns a tranche of 

another loan securitization is not itself 

a loan securitization, even if the 

ownership of such tranche by a banking 

entity would otherwise be permissible 

under the final rule. 

As discussed above under ‘‘Definition 

of Loan,’’ the definition of loan in the 

final rule has not been expanded as 

requested by some commenters but has 


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1877The determination of whether an instrument 

falls outside the definition of loan because it is a 

security or a derivative is based on the Federal 

securities laws and the Commodity Exchange Act. 

Whether a loan, lease, extension of credit, or 

secured or unsecured receivable is a note or 

evidence of indebtedness that is defined as a 

security under the Federal securities laws will 

depend on the particular facts and circumstances, 

including the economic terms of the transaction. 

See supra note 1836 and accompanying text. 

1878See proposed rule § 75.13(d). 

1879See Allen & Overy (on behalf of Foreign Bank 

Group); AFME et al.; ASF (Feb. 2012); Cleary 

Gottlieb; Credit Suisse (Williams); Commercial Real 

Estate Fin. Council; GE (Feb. 2012); GE (Aug. 2012); 

ICI (Feb. 2012); Japanese Bankers Ass’n.; JPMC; 

LSTA (Feb. 2012); LSTA (July 2012); RBC; SIFMA 

et al. (Covered Funds) (Feb. 2012); SIFMA 

(Securitization) (Feb. 2012); Vanguard. 

1880See Allen & Overy (on behalf of Foreign Bank 

Group); ASF (Feb. 2012); Cleary Gottlieb; Credit 

Suisse (Williams). 

1881See Allen & Overy (on behalf of Foreign Bank 

Group); ASF (Feb. 2012); Cleary Gottlieb; Credit 

Suisse (Williams); Commercial Real Estate Fin. 

Council; JPMC; LSTA (Feb. 2012); LSTA (July 

2012); RBC; SIFMA (Securitization) (Feb. 2012). 

Commenters requested inclusion of the following 

examples of cash equivalents: government 

guaranteed securities, money market funds, and 

‘‘other highly credit-worthy and liquid 

investments’’ (Credit Suisse (Williams)); and high 

quality, highly liquid investments, including 

Treasury securities and highly rated commercial 

paper (JPMC). In addition, LSTA (Feb. 2012) 

requested inclusion of the following: (i) short-term 

highly liquid investments; (ii) direct obligations of, 

and obligations fully guaranteed as to full and 

timely payment by, the United States (or by any 

agency thereof to the extent such obligations are 

backed by the full faith and credit of the United 

States); (iii) demand deposits, time deposits or 

certificates of deposit that are fully insured by the 

Federal Deposit Insurance Corporation; (iv) 

corporate, non-extendable commercial paper; (v) 

notes that are payable on demand or bankers’ 

acceptances issued by regulated U.S. financial 

institutions; (vi) investments in money market 

funds or other regulated investment companies; 

time deposits having maturities of not more than 90 

days; (vii) repurchase obligations with respect to 

direct obligations and guaranteed obligations of the 

U.S. entered into with a regulated U.S. financial 

institution; and (viii) other investments with a 

maturity one year or less, with the requirement that 

each of the investments listed have, at the time of 

the securitization’s investment or contractual 

commitment to invest therein, a rating of the 

highest required investment category. 

1882See Allen & Overy (on behalf of Foreign Bank 

Group); ASF (Feb. 2012); GE (Feb. 2012); JPMC; 

RBC; SIFMA (Securitization) (Feb. 2012). 

1883See Allen & Overy (on behalf of Foreign Bank 

Group); ASF (Feb. 2012); GE (Feb. 2012); JPMC; 

RBC; SIFMA (Securitization) (Feb. 2012). For 

example, SIFMA (Securitization) (Feb. 2012) 

requested inclusion of third party credit 

enhancements such as guarantees and letters of 

credit. Commenters requested inclusion of the 

following examples of credit enhancements: (i) 

external credit support of borrower obligations 

under such loans, including a credit support 

facilities, third party or parent guarantee, insurance 

policy, letter of credit or other contractual 

commitment to make payments or perform other 

obligations of the borrower under the loans (ASF 

(Feb. 2012)); and (ii) property guarantees, insurance 

policies, letters of credit, or supporting obligations 

underlying or relating to any of the loans (RBC). 

1884See Allen & Overy (on behalf of Foreign Bank 

Group); AFME et al.; ASF (Feb. 2012); Credit Suisse 

(Williams); GE (Feb. 2012); GE (Aug. 2012); ICI 

(Feb. 2012); JPMC; RBC; SIFMA et al. (Covered 

Funds) (Feb. 2012); SIFMA (Securitization) (Feb. 

2012). Commenters requested inclusion of the 

following examples of asset-backed securities: (i) 

SUBI certificates (beneficial interests in titling 

trusts typically used in lease securitizations) (AFME 

et al.; ASF (Feb. 2012); GE (Aug. 2012); SIFMA 

(Securitization) (Feb. 2012)); (ii) ownership 

interests and bonds issued by CLOs (JPMC); a broad 

array of receivables that support asset-backed 

commercial paper (ICI (Feb. 2012)); certain notes, 

certificates or other instruments backed by loans or 

financial assets that are negotiated by the 

purchasing asset-backed commercial paper conduit 

(ASF (Feb. 2012); GE (Feb. 2012)); municipal 

securities that are technically ABS, including 

revenue bonds that involve the issuance of senior 

and subordinate bonds (ASF (Feb. 2012)); 

ownership interests in credit funds (as defined in 

their letter) (SIFMA et al. (Covered Funds) (Feb. 

2012)); any note, bond or security collateralized and 

payable from pools of loans, leases (including lease 

residuals), extensions of credit or secured or 

unsecured receivables (RBC); asset-backed 

securities issued by intermediate vehicles in a 

securitization collateralized predominantly by loans 

and financial assets, and other similar instruments 

(Credit Suisse (Williams)); and asset-backed 

securities backed by loans or receivables that are 

originated by or owned by the sponsor of such 

securitization or which are issued by an entity that 

is organized under the direction of the same 

sponsor as the issuer of the covered fund (ASF (Feb. 

2012)). 1885See ICI (Feb. 2012); Vanguard. 

1886See Credit Suisse (Williams); SIFMA 

(Securitization) (Feb. 2012). 

1887See Allen & Overy (on behalf of Foreign Bank 

Group). 

1888See Credit Suisse (Williams). 

1889See ASF (Feb. 2012); GE (Feb. 2012); GE 

(Aug. 2012); RBC. 

1890See GE (Aug. 2012). 

1891See Allen & Overy (on behalf of Foreign Bank 

Group); Credit Suisse (Williams); Japanese Bankers 

Ass’n.; LSTA (Feb. 2012); SIFMA (Securitization) 

(Feb. 2012). Commenters requested inclusion of the 

following examples of derivatives: (i) credit 

derivatives (without explanation) as a means of 

diversifying the portfolio (Japanese Bankers 

Association); (ii) synthetic securities that reference 

corporate credits or other debt (Credit Suisse 

(Covered Fund)); (iii) credit instruments or other 

obligations that the banking entity could originate 

or invest or deal in directly, including tranched or 

untranched credit linked notes exposed to the 

credit risk of such reference assets through a credit 

default swap or other credit derivative entered into 

by the related ABS Issuer (SIFMA (Securitization) 

(Feb. 2012)); (iv) any derivatives structured as part 

of the securitization of loans (without explanation) 

(Allen & Overy (on behalf of Foreign Bank Group)); 

(v) hedge agreements (Credit Suisse (Williams)); 

and (vi) any derivative, including a credit default 

swap, as and to the extent a banking entity could 

use such derivative in managing its own investment 

portfolio (SIFMA (Securitization) (Feb. 2012)). 

been clarified in some respects in 

response to comments. The final rule 

explicitly excludes securities or 

derivatives.1877 In addition, the 

definition of loan has not been modified 

to include repurchase agreements or 

reverse repurchase agreements 

regardless of the character of the 

underlying asset. The Agencies are 

concerned that parties, under the guise 

of a ‘‘loan’’ might instead create 

instruments that provide the same 

exposures to securities and derivatives 

that otherwise are prohibited by section 

13 and might attempt to use the loan 

securitization exclusion to acquire 

ownership interests in covered funds 

holding those types of instruments, 

counter to the terms and the purpose of 

section 13 of the BHC Act. As the 

Agencies have noted previously, the 

rules relating to covered funds and to 

proprietary trading are not intended to 

interfere with traditional lending 

practices or with securitizations of loans 

generated as a result of such activities. 

Although the Agencies have revised the 

definition of loan in response to 

commenters’ concerns as discussed 

above, the Agencies are not adopting a 

separate definition of loan for 

securitization transactions as requested 

by commenters. The Agencies believe 

that the definition of loan adopted in 

the final rule appropriately 

encompasses the financial instruments 

that result from lending money to 

customers. 

ii. Contractual Rights or Assets 

Under the proposed loan 

securitization definition, a covered fund 

that is an issuer of asset-backed 

securities would have been permitted to 

hold contractual rights or assets directly 

arising from those loans supporting the 

asset-backed securities.1878 The 

proposal did not identify or describe 

such contractual rights or assets. 

Commenters requested that the 

Agencies expand the list of contractual 

rights and assets that an issuer of assetbacked securities would be permitted to 

hold under the proposed loan 

securitization exemption.1879 Examples 

of the additional rights and assets 

requested by commenters include cash 

and cash accounts; 1880 cash 

equivalents;1881 liquidity agreements, 

including asset purchase agreements, 

program support facilities and support 

commitments; 1882 credit 

enhancements: 1883 asset-backed 

securities; 1884 municipal securities; 1885

repurchase agreements; 1886 creditlinked notes; 1887 trust certificates; 1888

lease residuals; 1889 debt securities; 1890

and derivatives.1891 As an alternative, 

commenters requested that an issuer of 

asset-backed securities be permitted to 

hold under the proposed loan 

securitization exemption certain of such 

additional rights and/or assets up to a 

threshold, such as a specified 


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1892See ASF (Feb. 2012); Cleary Gottlieb; Credit 

Suisse (Williams); GE (Feb. 2012); GE (Aug. 2012); 

LSTA (Feb. 2012); LSTA (July 2012). 1893See final rule § 75.10(c)(8)(i)(B). The use of 

the term ‘‘servicing assets’’ is not meant to imply 

that servicing assets are limited to those contractual 

rights or assets related to the servicer and the 

performance of the servicer’s obligations. 1894For example, under the final rule, mortgage 

insurance policies supporting the mortgages in a 

loan securitization are servicing assets permissible 

for purposes of § 75.10(c)(8)(i)(B). However, a 

separate securitization of the payments on those 

mortgage insurance policies would not qualify for 

the loan securitization exclusion. 

1895The Agencies believe that for purposes of the 

final rule, in the context of securitization, such 

related or incidental assets in a loan securitization 

should support or further, and therefore, be 

secondary to the loans held by the securitization 

vehicle. 

1896See final rule § 75.10(c)(8)(iii). 

1897 If either the loans supporting the loan 

securitization or the asset-backed securities issued 

by the loan securitization are denominated in a 

foreign currency, for purposes of the exclusion a 

loan securitization would be permitted to hold 

foreign currency, cash equivalents denominated in 

foreign currency and foreign exchange derivatives 

that comply with § 75.10(c)(8)(iv). 

1898Servicing assets should not introduce 

significant additional risks to the transaction, 

including foreign currency risk or maturity risk. For 

instance, funds on deposit in an account that is 

swept on a monthly basis should not be invested 

in securities that mature in 90 days. 

1899Commenters expressed concerns about the 

use of securitization vehicles for evasion. See, e.g., 

AFR et al. (Feb. 2012); Occupy; Public Citizen. 

1900See Joint Proposal, 76 FR at 68912. 

1901 Id. 

1902See AFME et al.; Allen & Overy (on behalf of 

Foreign Bank Group); ASF (Feb. 2012) (requesting 

that an excluded loan securitization be permitted to 

hold up to 10% of its assets in the form of synthetic 

risk exposure to loans); Credit Suisse (Williams); 

Japanese Bankers Ass’n.; LSTA (Feb. 2012) (for 

CLOs); SIFMA (Securitization) (Feb. 2012). 

percentage of the assets of such covered 

fund.1892

In response to comments, the final 

rule modifies the loan securitization 

exclusion from the proposal to identify 

the types of contractual rights or assets 

directly arising from those loans 

supporting the asset-backed securities 

that a loan securitization relying on 

such exclusion may hold. Under the 

final rule, a loan securitization which is 

eligible for the loan securitization 

exclusion may hold contractual rights or 

assets (i) designed to assure the 

servicing or timely distribution of 

proceeds to security holders or (ii) 

related or incidental to purchasing or 

otherwise acquiring, and holding the 

loans (‘‘servicing assets’’).1893 The 

servicing assets are permissible in an 

excluded loan securitization transaction 

only to the extent that they arise from 

the structure of the loan securitization 

or from the loans supporting a loan 

securitization. If such servicing assets 

are sold and securitized in a separate 

transaction, they will not qualify as 

permissible holdings for the loan 

securitization exclusion.1894

In adopting this approach, the 

Agencies considered commenters’ 

concerns and determined to revise the 

condition to be more consistent with the 

definition and treatment of servicing 

assets in other asset-backed 

securitization regulations, such as the 

exemption from the definition of 

‘‘investment company’’ under rule 3a–7 

promulgated under the Investment 

Company Act.1895

Although the Agencies have revised 

the proposal in response to commenters’ 

concerns, the final rule does not permit 

a loan securitization to hold as servicing 

assets a number of instruments 

specifically requested by commenters 

whether in their entirety or as a 

percentage of the pool. Under the final 

rule, servicing assets do not include 

securities or derivatives other than as 

specified in the rule. 

Under the final rule, a loan 

securitization which is eligible for the 

loan securitization exclusion may hold 

securities if those securities fall into one 

of three categories.1896 First, such loan 

securitizations may hold securities that 

are cash equivalents. For purposes of 

the exclusion for loan securitizations, 

the Agencies interpret ‘‘cash 

equivalents’’ to mean high quality, 

highly liquid short term investments 

whose maturity corresponds to the 

securitization’s expected or potential 

need for funds and whose currency 

corresponds to either the underlying 

loans or the asset-backed securities.1897

Depending on the specific funding 

needs of a particular securitization, 

‘‘cash equivalents’’ might include 

deposits insured by the Federal Deposit 

Insurance Corporation, certificates of 

deposit issued by a regulated U.S. 

financial institution, obligations backed 

by the full faith and credit of the United 

States, investments in registered money 

market funds, and commercial 

paper.1898 Second, such loan 

securitizations may hold securities 

received in lieu of debts previously 

contracted with respect to the loans 

supporting the asset-backed securities. 

Finally, such loan securitizations may 

hold securities that qualify as SUBIs or 

collateral certificates subject to the 

provisions set forth in the rule for such 

intermediate asset-backed securities. 

The Agencies have specifically 

limited the types of securities held as 

eligible assets in a loan securitization 

that may be excluded from the 

definition of covered fund under the 

final rule, even in limited amounts, in 

order to assure that the types of 

securities are cash equivalents or 

otherwise related to the loan 

securitization and to prevent the 

possible misuse of the loan 

securitization exclusion to circumvent 

the restrictions on proprietary trading, 

investments in covered funds and 

prohibitions in section 13(f) of the BHC 

Act.1899 The Agencies believe that types 

of securities other than those 

specifically included in the final rule 

could be misused in such manner, 

because without limitations on the types 

of securities in which an excluded loan 

securitization may invest, a banking 

entity could structure an excluded loan 

securitization with provisions to engage 

in activities that are outside the scope 

of the definition of loan as adopted and 

also to engage in impermissible 

proprietary trading. Further, the 

Agencies do not believe that the use of 

thresholds with respect to such other 

types of securities as an alternative is 

appropriate because similarly, such a 

securitization would then involve a 

securitization of non-loan assets, 

outside the scope of what the Agencies 

believe the rule of construction was 

intended to cover. By placing 

restrictions on the securities permitted 

to be held by an excluded loan 

securitization, the potential for evasion 

is reduced. Loan securitizations are 

intended, as contemplated by the rule of 

construction, to permit banks to 

continue to engage in securitizations of 

loans. Including all types of securities 

within the scope of permitted assets in 

an excluded loan securitization would 

expand the exclusion beyond the scope 

of the definition of loan in the final rule 

that is intended to implement the rule 

of construction. 

iii. Derivatives 

Under the proposed loan 

securitization definition, an exempted 

loan securitization would be permitted 

to hold interest rate or foreign exchange 

derivatives that materially relate to the 

terms of any loans supporting the assetbacked securities and any contractual 

rights or assets directly arising from 

such loans so long as such derivatives 

are used for hedging purposes with 

respect to the securitization 

structure.1900 The Agencies indicated in 

the proposing release that the proposed 

loan securitization definition would not 

allow an exempted loan securitization 

to use credit default swaps.1901

Commenters criticized the proposed 

limitations on the use of derivatives 

included in the proposed loan 

securitization definition.1902 In 

particular, one commenter indicated 

that the use of credit derivatives such as 

credit default swaps is important in loan 

securitizations to provide diversification 


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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 5963 

1903See Japanese Bankers Ass’n. This commenter 

indicated that credit derivatives are important in 

securitizations to provide diversification when the 

desired mix of assets cannot be achieved. 1904See ASF (Feb. 2012). This commenter argued 

that for some loan securitizations, investors may 

seek a broader pool of credit exposures than the 

bank has available or can obtain to securitize in 

order to achieve risk diversification. 1905See AFR et al. (Feb. 2012); Public Citizen. 

One of these commenters stated that the credit 

default exclusion was appropriate because 

‘‘synthetic securitizations and resecuritizations 

were a key contributor to financial contagion during 

the crisis.’’ See AFR et al. (Feb. 2012). Another 

commenter argued that the loan securitization 

definition should not permit the use of derivatives. 

See Occupy. This commenter argued that covered 

funds should only be permitted to engage in 

hedging activity in accordance with the proposed 

exemption for hedging activity. This commenter 

also argued that the inclusion of derivatives in the 

loan securitization definition exceeded the 

Agencies’ statutory authority. Id. Two senators 

indicated that ‘‘complex securitizations’’ including 

those with ‘‘synthetic features’’ and ‘‘embedded 

derivatives’’ should not be allowed to rely on the 

exclusion for loan securitizations. See Sens. 

Merkley & Levin (Feb. 2012). 

1906See final rule § 75.10(c)(8)(iv). 

1907Under the final rule, the Agencies expect that 

a loan securitization relying on the loan 

securitization exclusion would not have a 

significant amount of interest rate and foreign 

exchange derivatives with respect to risks arising 

from contractual rights or other assets. 

1908For example, a $100 million securitization 

cannot be hedged using an interest rate hedge with 

a notional amount of $200 million. 

1909The derivatives permitted in a securitization 

that may rely on the loan securitization exclusion 

would permit a securitization to hedge the risk 

resulting from differences between the income 

received by the issuing entity and the amounts due 

under the terms of the asset-backed securities. For 

example, fixed rate loans could support floating rate 

asset-backed securities; loans with an interest rate 

determined by reference to the Prime Rate could 

support asset-backed securities with an interest rate 

determined by reference to LIBOR; or Eurodenominated loans could support U.S. Dollardenominated asset-backed securities. 

1910Loan securitizations excluded from the 

covered fund definition may only hold certain 

directly related derivatives as specified in 

§ 75.11(c)(8)(iv) and as discussed in this Part. 

of assets.1903 Another commenter noted 

the use of such instruments to manage 

risks with respect to corporate loan and 

debt books by accessing capital from a 

broad group of capital markets investors 

and facilitates making markets.1904 In 

contrast, two commenters generally 

supported the limitations on the use of 

derivatives under the proposed loan 

securitization definition and indicated 

that excluding credit default swaps from 

the loan securitization definition was 

appropriate.1905

With respect to the use of derivatives, 

the Agencies are adopting the loan 

securitization exclusion substantially as 

proposed with certain modifications to 

reflect a restructuring of this provision 

in order to more closely align the 

permissible uses of derivatives under 

the loan securitization exclusion with 

the loans, the asset-backed securities, or 

the contractual rights and other assets 

that a loan securitization relying on the 

loan securitization exclusion may hold. 

As adopted, for a loan securitization to 

be eligible for the loan securitization 

exclusion, the loan securitization may 

hold only interest rate or foreign 

exchange derivatives that meet the 

following requirements: (i) the written 

terms of the derivatives directly relate to 

either the loans or the asset-backed 

securities that such loan securitization 

may hold under the other provisions of 

the loan securitization exclusion; and 

(ii) the derivatives reduce interest rate 

and/or foreign exchange risk with 

respect to risks related to either such 

loans, the asset-backed securities or the 

contractual rights or other assets that a 

loan securitization may hold.1906

The first requirement that the written 

terms of the derivatives ‘‘directly relate’’ 

to either the loans or the asset-based 

securities themselves is intended to 

quantitatively and qualitatively limit the 

use of derivatives permitted under the 

loan securitization exclusion.1907 The 

Agencies would expect that neither the 

total notional amount of directly related 

interest rate derivatives nor the total 

notional amount of directly related 

foreign exchange derivatives would 

exceed the greater of either the 

outstanding principal balance of the 

loans supporting the asset-backed 

securities or the outstanding principal 

balance of the asset-backed 

securities.1908 Moreover, under the loan 

securitization exclusion, the type of 

derivatives must be related to the types 

of risks associated with the underlying 

assets and may not be derivatives 

designed to supplement income based 

on general economic scenarios, income 

management or unrelated risks. 

The second requirement that 

derivatives reduce the interest rate and/ 

or foreign exchange risks related to 

either such loans, contractual rights or 

other assets, or such asset-backed 

securities is intended to permit the use 

of derivatives to hedge interest rate and/ 

or foreign exchange risks that result 

from a mismatch between the loans and 

the asset-backed securities.1909

The Agencies believe that the 

statutory rule of construction should be 

implemented in a manner that does not 

limit or restrict the sale and 

securitization of loans. The Agencies 

further believe that the sale and 

securitization of credit exposures other 

than ‘‘loans’’ as defined in the rule, such 

as through securities or derivatives, 

could be abused. The derivatives that 

may be held in a loan securitization for 

purposes of the exclusion may not be 

used for speculative purposes. 

Consistent with the proposal, the loan 

securitization exclusion does not permit 

a loan securitization relying on such 

exclusion to hold credit default swaps 

or other types of derivatives whether or 

not they are related either to the 

underlying loans or the asset-backed 

securities.1910 Under the final rule, a 

synthetic securitization in which the 

asset-backed securities are supported by 

cash flow from derivatives, such as 

credit default swaps and total return 

swaps, would not be permitted to rely 

on the loan securitization exclusion 

because such derivatives are excluded 

from the final rule’s definition of loan 

specifically, as a derivative. Similarly, a 

loan securitization that relies on the 

loan securitization exclusion would not 

be permitted to hold a credit default 

swap or total return swap that 

references a loan that is held by the loan 

securitization. Under the final rule as 

adopted, an excluded loan 

securitization would not be able to hold 

derivatives that would relate to risks to 

counterparties or issuers of the 

underlying assets referenced by these 

derivatives because the operation of 

derivatives, such as these, that expand 

potential exposures beyond the loans 

and other assets, would not in the 

Agencies’ view be consistent with the 

limited exclusion contained in the rule 

of construction under section 13(g)(2) of 

the BHC Act, and could be used to 

circumvent the restrictions on 

proprietary trading and prohibitions in 

section 13(f) of the BHC Act. The 

Agencies believe that the use of 

derivatives by an issuing entity for 

asset-backed securities that is excluded 

from the definition of covered fund 

under the loan securitization exclusion 

should be narrowly tailored to hedging 

activities that reduce the interest rate 

and/or foreign exchange risks directly 

related to the asset-backed securities or 

the loans supporting the asset-backed 

securities because the use of derivatives 

for purposes other than reducing 

interest rate risk and foreign exchange 

risks would introduce credit risk 

without necessarily relating to or 

involving a reduction of interest rate 

risk or foreign exchange risk. 

On the other hand, while the 

Agencies are not expanding the types of 

permitted derivatives to be held in a 

loan securitization, the Agencies in the 

final rule are not restricting the use of 

all derivatives under the loan 

securitization exclusion as requested by 

certain commenters. The Agencies 

believe that a loan securitization that is 

excluded from the definition of covered 

fund should be allowed to engage in 

activities that reduce interest rate and 


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1911See AFR et al. (Feb. 2012); Occupy; Public 

Citizen. 

1912See Occupy. This commenter argued that 

covered funds should only be permitted to engage 

in hedging activity in accordance with the proposed 

exemption for hedging activity. 

1913For example, a banking entity may hold an 

ownership interest in a covered fund in order to 

hedge employee compensation risks. Because 

securitizations do not have employees, such a 

hedging exemption would not be applicable to a 

securitization structure. 

1914See Occupy. 

1915See AFME et al.; Allen & Overy (on behalf of 

Foreign Bank Group); ASF (Feb. 2012); Credit 

Suisse (Williams); GE (Aug. 2012); PNC; RBC; 

SIFMA (Securitization) (Feb. 2012). 

1916See SIFMA (Securitization) (Feb. 2012). 

1917See, e.g., ASF (Feb. 2012). UK RMBS master 

trusts also use a master trust structure. See AFME 

et al.; ASF (Feb. 2012); SIFMA (Securitization) (Feb. 

2012). 

1918See Occupy. 

1919The use of SUBIs, for example, allows the 

sponsor to avoid administrative expenses in 

retitling the physical property underlying the 

leases. 

1920See final rule § 75.10(c)(8)(v). 1921The provision will allow for the existing 

practice of a master trust to hold a collateral 

certificate issued by a legacy master trust. 

1922This would include a collateral certificate 

issued by a legacy master trust that meets the 

requirements of the loan securitization exclusion. 

foreign exchange risk because the 

hedging of such risks is consistent with 

the prudent risk management of interest 

rate and currency risk in a loan portfolio 

while at the same time avoiding the 

potential for additional risk arising from 

other types of derivatives.1911 The 

Agencies do not believe that the 

exemption for hedging activity 

applicable to market making and 

underwriting under the final rule is the 

appropriate measure for permitted 

derivatives in a loan securitization that 

would be excluded from definition of 

covered fund 1912 because the hedging 

exemptions for market making and 

underwriting are not tailored to the 

hedging requirements of a securitization 

transaction.1913 The Agencies also do 

not believe that they lack the statutory 

authority to permit a loan securitization 

relying on the loan securitization 

exclusion to use derivatives, as 

suggested by one commenter,1914

because the Agencies believe that the 

permitted derivatives relate directly to 

loans that are permitted and have 

limited the quality and quantity of 

derivatives that an excluded loan 

securitization is permitted to hold 

directly to the reduction of risks that 

result from the loans and the loan 

securitization. 

While loan securitizations that 

include non-loan assets are not 

excluded from the definition of covered 

fund, banking entities are not prohibited 

from owning interests or sponsoring 

these covered funds under the final rule. 

Under the final rule, these 

securitizations would be covered funds, 

and banking entities engaged with these 

covered funds would be subject to the 

limitations on ownership interests and 

relationships with these covered funds 

imposed by section 13 of the BHC Act. 

iv. SUBIs and Collateral Certificates 

Commenters also argued that, under 

the proposed exemption for loan 

securitizations, securitizations that are 

backed by certain intermediate assetbacked securities would not satisfy the 

conditions for the exemption and 

therefore would be subject to the 

covered fund prohibitions.1915 For 

example, commenters noted that, in a 

securitization of leases with respect to 

equipment where a titling trust is used 

to hold ownership of the equipment, a 

titling trust will typically own the 

equipment and the right to payment on 

the leases, and then will issue a security 

or other instrument, often referred to as 

a special unit of beneficial interest 

(SUBI), that represents an ownership 

interest in the titling trust to the 

securitization issuer.1916 As another 

example, certain securitizations 

frequently use a master trust structure 

allowing the trust to issue more than 

one series of asset-backed security 

collectively backed by a common 

revolving pool of assets. In such a 

structure, a master trust may hold assets 

(such as loans) and issue a collateral 

certificate supported by those assets to 

an issuing trust that issues asset-backed 

securities to investors. The assets held 

by the master trust are typically a pool 

of revolving accounts that may be paid 

in full each month (e.g., credit card 

receivables) or a revolving pool of shortterm loans that are replaced with new 

loans as they mature (e.g., floor plan 

loans).1917 One commenter opposed the 

inclusion of securitizations backed by 

intermediate asset-backed securities, 

arguing that each step should be viewed 

separately to ensure compliance to 

prevent the inclusion of impermissible 

assets such as prohibited 

derivatives.1918

In response to comments, the 

Agencies are modifying the proposal to 

provide that a securitization backed by 

certain intermediate asset-backed 

securities will qualify for the loan 

securitization exclusion. The Agencies 

recognize that securitization structures 

that use these types of intermediate 

asset-backed securities are essentially 

loan securitization transactions, because 

the intermediate asset-backed securities 

in the asset pool are created solely for 

the purpose of facilitating a 

securitization 1919 and once created, are 

issued directly into a securitization 

vehicle rather than to any third party 

investor. 

Under the final rule, a loan 

securitization that is excluded from the 

definition of covered fund may include 

SUBIs or collateral certificates, provided 

that four conditions are met.1920 First, 

the special purpose vehicle issuing the 

SUBI or collateral certificate itself must 

meet the conditions of the loan 

securitization exclusion, as adopted in 

the final rule.1921 Under this provision, 

for example, the special purpose 

vehicle, in addition to the issuing entity, 

may hold an interest rate or foreign 

exchange derivative or other assets only 

if the derivative or asset is permitted to 

be held in accordance with the 

requirements for derivatives in respect 

of the loan securitization exclusion. 

Second, the SUBI or collateral certificate 

must be used for the sole purpose of 

transferring economic risks and benefits 

of the loans (and other permissible 

assets) 1922 to the issuing entity for the 

securitization and may not directly or 

indirectly transfer any interest in any 

other economic or financial exposures. 

Third, the SUBI or collateral certificate 

must be created solely to satisfy legal 

requirements or otherwise facilitate the 

structuring of the loan securitization. 

Fourth, the special purpose vehicle 

issuing the SUBI or collateral certificate 

and the issuing entity for the excluded 

loan securitization transaction must be 

established under the direction of the 

same entity that initiated the loan 

securitization transaction. The Agencies 

believe that the fourth condition will 

ensure that the resecuritizations of 

asset-backed securities purchased in the 

secondary market, which the Agencies 

do not believe would constitute a loan 

securitization, will not be able to use 

these special provisions tailored only 

for transactions utilizing SUBIs and 

collateral certificates in order to fall 

within the loan securitization exclusion. 

The Agencies believe that these 

conditions provide that only 

securitizations backed by SUBIs and 

collateral certificates involving loans— 

and not other types of securities or other 

types of assets—will be able to use the 

loan securitization exclusion. These 

conditions are intended to assure that 

for purposes of the loan securitization 

exclusion that only SUBI and collateral 

certificates that essentially represent the 

underlying loans are included 

consistent with the terms and the 

purpose of section 13 of the BHC Act, 

while also not adversely affecting 


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1923See, e.g., rule 190 under the Securities Act. 

See also, e.g., ASF (Feb. 2012) (noting that certain 

rules under the Securities Act and staff 

interpretations have carved out SUBIs and collateral 

certificates from certain disclosure and other 

requirements). 

1924See final rule § 75.10(c)(8)(ii). 

1925The Agencies discuss earlier in this Part the 

permissible assets an excluded loan securitization 

may hold and the Agencies’ belief that excluding 

loan securitizations as defined in the final rule is 

consistent with the terms and the purpose of 

section 13 of the BHC Act, including the rule of 

construction in section 13(g)(2). See, e.g., supra 

note 1871 and accompanying and following text. 

1926See final rule § 75.10(c)(8)(iv); see also 7 

U.S.C. 27(a)–(b). 

1927See the discussion above in Part VI.B.1.c.8 of 

this SUPPLEMENTARY INFORMATION. 

1928For a discussion of commodity forward 

contracts, see Further Definition of ‘‘Swap,’’ 

‘‘Security-Based Swap,’’ and ‘‘Security-Based Swap 

Agreement’’; Mixed Swaps; Security-Based Swap 

Agreement Recordkeeping, 77 FR 48208 (Aug. 13, 

2012) (Release Nos. 33–9338 and 34–67453, July 18, 

2012). 

1929See proposed rule § 75.13(d). 

1930Structured investment vehicles (‘‘SIVs’’) and 

securities arbitrage ABCP programs both purchase 

securities (rather than receivables and loans). SIVs 

typically lack liquidity facilities covering all of 

these liabilities issued by the SIV, while securities 

arbitrage ABCP programs typically have such 

liquidity coverage, though the terms are more 

limited than those of the ABCP conduits eligible for 

the exclusion pursuant to the final rule. 

1931See Joint Proposal, 76 FR at 68899. 

1932See, e.g., ASF (Feb. 2012); BoA; Capital 

Group; Eaton Vance; Fidelity; ICI (Feb. 2012); 

Japanese Bankers Ass’n.; PNC; RBC. 

1933See, e.g., ICI (Feb. 2012); PNC et al.; SIFMA 

(May 2012). 

1934See 12 U.S.C. 1851(d)(1)(J). 

1935See ICI (Feb. 2012). 

1936See PNC. 

1937See Barclays. 

1938See 12 U.S.C. 1851(g)(2). 

1939See ICI (Feb. 2012). 

1940See Credit Suisse (Williams). 

securitization of ‘‘loans’’ as defined in 

the final rule.1923 The Agencies believe 

that the limitation of the types of assetbacked securities permitted in an 

excluded loan securitization (only 

SUBIs and collateral certificates) and 

the restrictions placed on those SUBIs 

and collateral certificates that are 

permitted in an excluded loan 

securitization will avoid loan 

securitizations that contain other types 

of assets from being excluded from the 

definition of covered fund. 

v. Impermissible Assets 

As discussed above, commenters on 

the loan securitization proposals argued 

that various types of assets should be 

included within the definition of loan or 

otherwise permitted to be held by the 

loan securitization that would be 

entitled to rely on the proposed 

exemptions. 

After considering comments, the 

Agencies have determined to retain the 

narrower scope of the permitted assets 

in a loan securitization that is eligible 

for the loan securitization exclusion. 

The Agencies have revised the language 

regarding loan securitizations from the 

proposal to specify certain types of 

assets or holdings that a loan 

securitization would not be able to hold 

if it were eligible to rely on the 

exclusion from the definition of covered 

fund for loan securitizations.1924 The 

Agencies recognize that securitization 

structures vary significantly and, 

accordingly, the loan securitization 

exclusion as adopted in the final rule 

accommodates a wider range of 

securitization practices. The Agencies 

believe that these limitations provide 

that only securitizations backed by 

loans—and not securities, derivatives or 

other types of assets—will be able to use 

the loan securitization exclusion 

consistent with the terms and the 

purpose of section 13 of the BHC 

Act.1925 The Agencies believe that the 

limitation of the types of assets 

permitted in an excluded loan 

securitization will avoid loan 

securitizations that contain other types 

of assets from being excluded from the 

definition of covered fund. 

Under the final rule, in order to be 

excluded from the definition of covered 

fund, a loan securitization may not hold 

(i) a security, including an asset-backed 

security, or an interest in an equity or 

debt security (unless specifically 

permitted, such as with respect to a 

SUBI or collateral certificate as 

described above), (ii) a derivative other 

than an interest rate or foreign exchange 

derivative that meets the requirements 

described above,1926 or (iii) a 

commodity forward contract.1927 The 

Agencies have determined that a loan 

securitization relying on the loan 

securitization exclusion may not 

include a commodity forward contract 

because a commodity forward contract 

is not a loan.1928

9. Asset-Backed Commercial Paper 

Conduits 

Under the proposed rule, certain 

securitization vehicles, including ABCP 

conduits, would not have been covered 

by the loan securitization exclusion and, 

therefore, would have been deemed to 

be a covered fund.1929 ABCP is a type 

of liability that is typically issued by a 

special purpose vehicle (commonly 

referred to as a ‘‘conduit’’) sponsored by 

a financial institution or other entity. 

The short term asset-backed securities 

issued by the conduit are supported by 

a managed pool of assets, which may 

change over the life of the entity. 

Depending on the type of ABCP 

conduit, the securitized assets 

ultimately supporting the short term 

asset-backed securities may consist of a 

wide range of assets including 

automobile loans, commercial loans, 

trade receivables, credit card 

receivables, student loans, and other 

loans in addition to asset-backed 

securities supported by such assets. The 

term of ABCP typically is short, and the 

liabilities are ‘‘rolled’’ (i.e., replaced or 

refinanced) at regular intervals. Thus, 

ABCP conduits generally fund longerterm assets with shorter-term 

liabilities.1930 In this regard, in the 

proposing release, the Agencies 

requested comment on the proposed 

rule’s definition of ‘‘covered fund’’ with 

respect to asset-backed securities and/or 

securitization vehicles 1931 and received 

numerous comments requesting a 

variety of exemptions for ABCP 

conduits.1932

A number of commenters requested 

that the final rule exclude ABCP 

conduits from the definition of covered 

fund 1933 or that the Agencies use their 

authority under section 13(d)(1)(J) of the 

BHC Act 1934 to similar effect.1935 One 

commenter argued that ABCP conduits 

do not have the characteristics of a 

private equity fund or hedge fund,1936

even though they typically rely on the 

exemptions set forth in section 3(c)(1) or 

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

Another commenter argued that the 

proposed rule’s definition of covered 

fund would negatively impact assetbacked securitizations (including ABCP 

conduits), and suggested that the 

Agencies define covered funds, in part, 

as those that both (i) rely on section 

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

Company Act and (ii) have the 

traditional characteristics of private 

equity funds or hedge funds.1937

Another commenter stated that the rule 

of construction set forth in section 

13(g)(2) of the BHC Act 1938 is a clear 

indication that section 13 of the BHC 

Act was not intended to apply to 

securitization vehicles such as ABCP 

conduits.1939 Another commenter stated 

that the lending that occurs through 

ABCP conduits is the type of activity 

that Congress and the Executive Branch 

have urged banks to expand in order to 

support economic growth and job 

creation,1940 while another commenter 

stated that ABCP conduits provide low 

cost, reliable financing for registered 

investment companies, which poses 

little risk to the safety and soundness of 

banks because Federal law requires 

registered investment companies to 


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1941See Eaton Vance. 

1942See RBC; ASF (Feb. 2012). 

1943See Credit Suisse (Williams). 

1944 Id. 

1945See ICI (Feb. 2012). This commenter 

emphasized the importance of the ABCP conduit 

market to money market funds, noting that as of 

November 2011, taxable money market funds held 

$126 billion of the $348.1 billion of securities 

issued by ABCP conduits outstanding, which 

represented approximately 5.4% of taxable money 

market funds’ total assets. Another commenter 

noted that approximately $66.7 billion of 

automobile loans and leases, $52.1 billion of 

student loans, $22.3 billion of credit card charges, 

$49.4 billion of loans to commercial borrowers and 

$50.7 billion of trade receivables were financed by 

the U.S. ABCP conduit market as of October 31, 

2011, and that the total outstanding amount of 

securities sold by ABCP conduits in the U.S. market 

was $344.5 billion as of January 18, 2012. See ASF 

(Feb. 2012). 

1946See AFME et al.; Allen & Overy (on behalf of 

Foreign Bank Group); ASF (Feb. 2012); PNC; SIFMA 

(Securitization) (Feb. 2012). 

1947See ASF (Feb. 2012); Capital Group (alleging 

that ABCP does not pose the risks that the rule is 

meant to combat); GE (Feb. 2012). One commenter 

proposed an exemption for ABCP conduits that 

included a requirement of 100% liquidity support 

from a regulated, affiliated entity, and such 

liquidity support may be conditional or 

unconditional. See RBC. 

1948See Credit Suisse (Williams) (alleging that 

ABCP conduits acquire ownership of loans 

indirectly through the purchase of variable funding 

notes, trust certificates, asset-backed securities, 

repurchase agreements and other instruments that 

may be considered securities, all of which 

economically are consistent with providing funding 

or extensions of credit to customers); ICI (Feb. 2012) 

(requesting that the definition of loan include the 

broad array of receivables that back ABCP). 

1949See AFME et al.; SIFMA (Securitization) 

(Feb. 2012). 

1950See ASF (Feb. 2012) (requesting that ABCP 

conduits be permitted to own asset-backed 

securities purchased on the secondary market only 

if the aggregate principal amount of such securities 

does not exceed 5% of the aggregate principal or 

face amount of all assets held by the ABCP conduit 

in order to diversify their asset base and avoid the 

negative consequences of divestiture of such assets); 

RBC (requesting that loan securitizations be 

permitted to hold cash equivalents and assets, other 

than loans, which, by their terms, convert to cash 

within a finite period of time so long as such assets 

comprise no more than 10% of their total assets 

based on book value). 

1951See ASF (Feb. 2012) (arguing that the loans, 

receivables, leases, or other assets purchased by the 

ABCP conduit might have fit the definition of loan 

in the proposed rules but for the proposal’s express 

assertion that the definition of loan does not 

include any asset-backed security that is issued in 

connection with a loan securitization or otherwise 

backed by loans). See Joint Proposal, 76 FR at 

68865; GE (Feb. 2012); RBC. 

1952See PNC. 

1953See Public Citizen. 

1954See 12 U.S.C. 1851(f); see also § 75.16 of the 

proposed rule. 

1955See, e.g., Allen & Overy (on behalf of Foreign 

Bank Group); Credit Suisse (Williams); Fidelity; IIB/ 

EBF; JPMC; PNC; RBC; SIFMA (Securitization) (Feb. 

2012). 

1956See ICI (Feb. 2012); Fidelity. 

1957See JPMC. 

1958See ASF (Mar. 2012). 

1959See Allen & Overy (on behalf of Foreign Bank 

Group). 

1960See ASF (Feb. 2012); Fidelity. 

1961See ASF (Mar. 2012). 

1962See final rule § 75.10(c)(9)(i). The rule of 

construction contained in section 13(g)(2) of the 

BHC Act provides that nothing in section 13 of the 

BHC Act shall be construed to limit or restrict the 

ability of a banking entity or nonbank financial 

company supervised by the Board to sell or 

securitize loans in a manner that is otherwise 

maintain prescribed asset coverage in 

connection with borrowings.1941

Two commenters contended that, 

while certain issuers of asset-backed 

securities may rely on section 3(c)(5) of 

the Investment Company Act or rule 3a– 

7 thereunder, and, therefore, not be 

brought under the proposed rule’s 

definition of covered fund, ABCP 

conduits typically cannot rely on this 

section or rule either because to do so 

would be too restrictive (in the case of 

section 3(c)(5)) or because they cannot 

meet the rule’s requirements.1942

One commenter, employing ABCP 

conduits as an example, stated that 

failing to exempt securitization vehicles 

from the covered fund prohibitions 

would preclude banking entities from 

engaging in activities that have long 

been recognized as permissible 

activities for banking entities and that 

are vital to the normal functioning of the 

securitization markets, and will have a 

significant and negative impact on the 

securitization markets and on the ability 

of banking entities and other companies 

to provide credit to their customers.1943

This commenter further stated that 

ABCP conduits are an efficient and 

attractive way for banking entities to 

lend their own credit-worthiness to 

expand the pool of possible lenders 

willing to finance key economic activity 

while maintaining a low cost of funding 

for consumers, and because of the 

liquidity support provided by the 

sponsoring banking entity, the 

sponsoring banking entity to the ABCP 

conduit has full exposure to the assets 

acquired by or securing the amounts 

lent by the ABCP conduit and the 

banking entity subjects those assets and 

the obligors to the same analysis as it 

would engage in if the bank were 

lending directly against those assets.1944

Another commenter stated that the 

provision of credit to companies to 

finance receivables through ABCP 

conduits is an area of traditional 

banking activity that should be 

distinguished from the type of high-risk, 

conflict-ridden financial activities that 

Congress sought to restrict under section 

13 of the BHC Act.1945

To this end, commenters proposed 

several means to exclude ABCP 

conduits from the proposed rule’s 

restrictions and requirements, including 

an expansion of the loan securitization 

exemption to treat two-step 

securitization transactions as a single 

loan securitization,1946 a separate 

exclusion for ABCP conduits,1947 an 

expansion of the definition of loan,1948

or as part of a broad exclusion for all 

issuers of asset-backed securities.1949 In 

order to allow ABCP conduits to qualify 

as loan securitizations, commenters 

suggested that the loan securitization 

exclusion should permit a limited 

amount of securities purchased in the 

secondary market.1950 Commenters also 

proposed changes to the permissible 

assets such as allowing a loan 

securitization to hold liquidity and 

support commitments, asset-backed 

securities and certain financial assets in 

addition to loans that by their terms 

convert to cash within a finite period of 

time.1951 Another commenter argued 

that the loan securitization exemption 

should allow banking entities to 

sponsor, control, and invest in ABCP 

conduits that facilitate the securitization 

of customer loans and receivables.1952

In contrast, one commenter supported 

the restriction of the loan securitization 

exemption to the plain meaning of what 

constitutes a loan and advocated that 

the Agencies not include ABCP 

conduits under the exemption.1953

In addition to the effect the proposed 

rule’s definition of covered fund would 

have on ABCP conduits, commenters 

also noted that section 13(f) of the BHC 

Act 1954 would prohibit certain 

transactions between a banking entity 

sponsor and a covered fund 

securitization.1955 Two commenters 

requested a specific exemption from 

§ 75.16 of the proposed rule for ABCP 

conduits based on the interpretation 

that the proposed rule subjects covered 

funds exempted under the loan 

securitization exemption or other 

exemptions to § 75.16.1956 Commenters 

argued that without liquidity and credit 

support, ABCP conduits are not 

viable,1957 cannot effectively 

operate,1958 could not function,1959 or 

would not be marketable.1960 One 

commenter argued that prohibiting a 

banking entity from providing liquidity 

facilities to ABCP conduits is 

tantamount to requiring the banking 

entity to wind down the operation of 

such ABCP conduits.1961

In response to the comments received 

and in light of the rule of construction 

contained in section 13(g)(2) of the BHC 

Act, the Agencies have determined in 

the final rule to exclude from the 

definition of covered fund an ABCP 

conduit that is a ‘‘qualifying assetbacked commercial paper conduit’’ as 

defined in the final rule is excluded 

from the definition of covered fund.1962


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permitted by law. As noted above and explained 

below, a qualifying asset-backed commercial paper 

conduit under the final rule is an ABCP conduit 

that holds only (i) loans or other assets that would 

be permissible in a loan securitization and (ii) assetbacked securities that are supported solely by assets 

permissible for a loan securitization and are 

acquired by the conduit as part of an initial 

issuance directly from the issuer or directly from an 

underwriter engaged in the distribution of the 

securities. 

1963See final rule § 75.10(c)(8). 

1964See final rule § 75.10(c)(9)(i)(B). 

1965See final rule § 75.10(c)(9)(ii) and (iii). 

1966See 12 U.S.C. 1813. 

1967See 12 U.S.C. 1841. 

1968See 12 U.S.C. 1467a. 

1969See 12 U.S.C. 1843(k). 

1970See 12 CFR 211.21. 

1971See final rule § 75.10(c)(9)(iii). 

Under the final rule, a qualifying 

asset-backed commercial paper conduit 

is an ABCP conduit that holds only (i) 

loans or other assets that would be 

permissible in a loan securitization 1963

and (ii) asset-backed securities that are 

supported solely by assets permissible 

for a loan securitization and are 

acquired by the conduit as part of an 

initial issuance directly from the issuer 

or directly from an underwriter engaged 

in the distribution of the securities.1964

In addition, a qualifying asset-backed 

commercial paper conduit must issue 

only asset-backed securities, comprising 

of a residual and securities with a term 

of 397 days or less and in addition, a 

‘‘regulated liquidity provider,’’ as 

defined in the final rule, must provide 

a legally binding commitment to 

provide full and unconditional liquidity 

coverage with respect to all the 

outstanding short term asset-backed 

securities issued by the qualifying assetbacked commercial paper conduit in the 

event that funds are required to redeem 

the maturing securities.1965

Under the final rule, a regulated 

liquidity provider is (i) a depository 

institution as defined in section 3 of the 

Federal Deposit Insurance Act; 1966 (ii) a 

bank holding company or a subsidiary 

thereof; 1967 (iii) a savings and loan 

holding company,1968 provided all or 

substantially all of the holding 

company’s activities are permissible for 

a financial holding company,1969 or a 

subsidiary thereof; (iv) a foreign bank 

whose home country supervisor as 

defined in section 211.21 of the Federal 

Reserve Board’s Regulation K 1970 has 

adopted capital standards consistent 

with the Capital Accord of the Basel 

Committee on Banking Supervision, as 

amended, and that is subject to such 

standards, or a subsidiary thereof; or (v) 

a sovereign nation.1971 In order for a 

sovereign nation to qualify as a 

regulated liquidity provider, the 

liquidity provided must be 

unconditionally guaranteed by the 

sovereign, which would include its 

departments and ministries, including 

the central bank. 

In this regard, under the final rule, the 

exclusion from the definition of covered 

fund in respect of ABCP conduits is 

only available to an issuer of short-term 

asset-backed securities supported by 

loans and certain asset-backed securities 

supported by loans that were issued or 

initially sold to the ABCP conduit, and 

the short term asset-backed securities 

issued by the ABCP conduit are 

supported by a liquidity facility that 

provides 100 percent liquidity coverage 

from a regulated liquidity provider. The 

exclusion, therefore, is not available to 

ABCP conduits that lack 100 percent 

liquidity coverage. The liquidity 

coverage may be provided in the form 

of a lending facility, an asset purchase 

agreement, a repurchase agreement, or 

similar arrangement and 100 percent 

liquidity coverage means that, in the 

event the qualifying asset-backed 

commercial paper conduit is unable for 

any reason to repay maturing assetbacked securities issued by the issuing 

entity, the total amount for which the 

regulated liquidity provider may be 

obligated is equal to 100 percent of the 

amount of asset-backed securities 

outstanding plus accrued and unpaid 

interest. In addition, amounts due 

pursuant to the required liquidity 

coverage may not be subject to the credit 

performance of the asset-backed 

securities held by the qualifying assetbacked commercial paper conduit or 

reduced by the amount of credit support 

provided to the qualifying asset-backed 

commercial paper conduit. Under the 

final rule, liquidity coverage that only 

funds an amount determined by 

reference to the amount of performing 

loans, receivables, or asset-backed 

securities will not be permitted to 

satisfy the liquidity requirement for a 

qualifying asset-backed commercial 

paper conduit. 

As discussed above, the final rule 

defines a qualifying asset-backed 

commercial paper conduit as having 

certain elements. First, a qualifying 

asset-backed commercial paper conduit 

must issue only a residual interest and 

short-term asset-backed securities. This 

requirement distinguishes ABCP 

conduits from covered funds that issue 

partnership interests and mitigates the 

potential that a qualifying ABCP 

conduit would be used for evasion of 

the covered fund prohibitions. The 

Agencies chose a maximum term of 397 

days for these securities because this 

time frame corresponds to the maximum 

maturity of securities allowed to be 

purchased by money market funds 

under Rule 2a-7 of the Investment 

Company Act. 

Second, the asset-backed securities 

issued by the ABCP conduit must be 

supported only by loans and certain 

asset-backed securities that meet the 

requirements of the loan securitization 

exclusion. By placing restrictions on the 

assets permitted to be held by an 

excluded loan securitization, the 

potential for evasion of the covered fund 

prohibitions is reduced. The exclusion 

for qualifying ABCP conduits is 

intended, as contemplated by the rule of 

construction in section 13(g)(2) of the 

BHC Act, to permit banks to continue to 

engage in securitizations of loans. 

Including all types of securities and 

other assets within the scope of 

permitted assets in a qualifying ABCP 

conduit, as with loan securitizations, 

would expand the exclusion beyond the 

scope of the definition of loan in the 

final rule that is intended to implement 

the rule of construction. 

Third, the asset-backed securities 

supporting a qualifying asset-backed 

commercial paper conduit must be 

purchased as part of the initial issuance 

of such asset-backed securities. Assetbacked securities purchased by an 

ABCP conduit in the secondary market 

will not be permitted because such a 

purchase would not be part of an initial 

issuance and the banking entity that 

established and manages the ABCP 

conduit would not have participated in 

the negotiation of the terms of such 

asset-backed securities. Without a more 

direct connection between the banking 

entity and the ABCP conduit, the 

purchase of such asset-backed securities 

in the secondary market would resemble 

investments in securities. 

Fourth, under the final rule, the ABCP 

conduit exclusion will not be available 

to ABCP conduits that lack 100 percent 

liquidity coverage. The Agencies believe 

that the 100 percent liquidity coverage 

requirement distinguishes the conduits 

eligible for the exemption, which 

sometimes hold and securitize a 

customer’s loans through an intervening 

special-purpose vehicle instead of 

holding the loans directly, and are 

supported by a 100 percent liquidity 

guarantee, from other types of conduits 

with partial liquidity guarantees (such 

as structured investment vehicles) that 

have sometimes been operated by 

banking entities for the purpose of 

financing portfolios of securities 

acquired or retained as part of their 

activities in the securities markets. 

The Agencies recognize that ABCP 

conduits that do not satisfy the elements 

of the ABCP conduit exclusion may be 

covered funds and therefore would be 

subject to section 13(f) of the BHC 


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1972See 12 U.S.C. 1851(f); see also § 75.16 of the 

proposed rule. 

1973See, e.g., ASF (Feb. 2012). 

1974See Credit Suisse (Williams) (employing 

ABCP conduits as an example); ASF (Feb. 2012) 

(describing the constriction of the market for assetbacked securities if banking entities are restricted 

from owning debt classes of new asset backed 

securities). 

1975See RBC; ASF (Feb. 2012). 

1976See Allen & Overy (on behalf of Foreign Bank 

Group); UKRCBC; FSA (Apr. 2012); ASF (Feb. 

2012). 

1977See AFME et al.; Allen & Overy (on behalf of 

Foreign Bank Group); ASF (Feb. 2012); FSA (Apr. 

2012); UKRCBC. 

1978See UKRCBC. For example, a commenter 

indicated that in the European Union, Article 52(4) 

of the EU UCITS Directive sets out the defining 

characteristics of covered bonds, and this directive 

is implemented by specific legislative frameworks. 

1979See UKRCBC; FSA (Apr. 2012). One 

commenter argued that there are two main models 

used for covered bond structures in Europe—the 

integrated model (where the collateral pool 

continues to be owned directly by the bank issuer 

and is segregated by special legislation) and the 

structured model (where the pool is transferred to 

a special purpose vehicle and is segregated by 

operation of legal principles). See UKRCBC. 

1980See Allen & Overy (on behalf of Foreign Bank 

Group). 

1981See FSA (Apr. 2012). 

1982See UKRCBC. 

1983See Allen & Overy (on behalf of Foreign Bank 

Group). 

Act.1972 As a result of section 13(f) of 

the BHC Act, which prohibits certain 

transactions between banking entities 

and a covered fund securitization that 

the banking entity sponsors or for which 

it provides investment management 

services, the banking entity would be 

prohibited from providing liquidity 

support for the ABCP conduit. 

Similarly, while some commenters 

requested that the loan securitization 

exclusion permit the holding of a 

limited amount of securities purchased 

in the secondary market, the final rule 

does not provide for this in the context 

of ABCP conduits. The Agencies believe 

that the limitations on the types of 

securities that a qualifying asset-backed 

commercial paper conduit may invest in 

are needed to avoid the possibility that 

a banking entity could use a qualifying 

asset-backed commercial paper conduit 

to securitize non-loan assets or to 

engage in proprietary trading of such 

securities prohibited under the final 

rule. Thus this limitation reduces the 

potential for evasion of the covered fund 

provisions of section 13 of the BHC Act. 

In developing the exclusion from the 

definition of covered fund for qualifying 

asset-backed commercial paper conduits 

in the final rule, the Agencies 

considered the factors set forth in 

sections 13(g)(2) and 13(h)(2) of the BHC 

Act. The final rule includes conditions 

designed to ensure that an ABCP 

conduit established and managed by a 

banking entity serves as a means of 

facilitating that banking entity’s loan 

securitization activity rather than 

financing that banking entity’s capital 

market investments. The final rule 

distinguishes between qualifying assetbacked commercial paper conduits and 

other ABCP conduits in order to adhere 

to the tenets of section 13 of the BHC 

Act while accommodating the market 

practices discussed by the commenters 

by facilitating reasonable access to 

credit by consumers and businesses 

through the issuance of ABCP backed by 

consumer and business receivables. As 

discussed above, the Agencies 

understand that some existing ABCP 

conduits may need to be restructured to 

conform to the requirements of the 

ABCP conduit exclusion. 

To the extent that the definition of 

covered fund, the loan securitization 

exclusion and the ABCP conduit 

exclusion do not eliminate the 

applicability of the final rule provisions 

to certain covered funds, there may be 

adverse effects on the provision of 

capital to customers,1973 to 

securitization markets,1974 and to the 

creation of new securitization products 

to meet investor demands that Congress 

may not have contemplated. 1975

However, financial institutions that are 

not banking entities and therefore are 

not subject to the restrictions on 

ownership can continue to engage in 

activities relating to securitization, 

including those securitizations that fall 

under the definition of covered fund. 

Furthermore, new securitizations may 

be structured so as to qualify for the 

loan securitization exclusion or other 

exclusions under the final rule. For 

these reasons, the impact on 

securitizations that are not excluded 

under the final rule may be mitigated. 

The Agencies believe that the final 

rule excludes from the definition of 

covered fund typical structures used in 

the most common loan securitizations 

representing a significant majority of the 

current securitization market, such as 

residential mortgages, commercial 

mortgages, student loans, credit card 

receivables, auto loans, auto leases and 

equipment leases. Additionally, the 

Agencies believe that esoteric asset 

classes supported by loans may also be 

able to rely on the loan securitization 

exclusion, such as time share loans, 

container leases and servicer advances. 

10. Covered Bonds 

Several commenters called for 

covered bond structures to be excluded 

from the definition of covered fund.1976

They indicated that the proposed rule 

may interfere with and restrict non-U.S. 

banks’ ability to establish or issue 

covered bonds. As described by several 

commenters, covered bonds are full 

recourse debt instruments typically 

issued by a non-U.S. entity that are fully 

secured or ‘‘covered’’ by a pool of highquality collateral (e.g., residential or 

commercial mortgage loans or public 

sector loans).1977 Certain of these 

covered bond structures utilize a special 

purpose vehicle (‘‘SPV’’) that holds a 

collateral pool. As such, under the 

proposed rule, an SPV could be a 

covered fund that relies on the 

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

the Investment Company Act. 

According to one commenter, the 

majority of covered bonds are issued 

under specific legislative frameworks 

which define permitted characteristics 

for covered bond issuances, including 

the kinds and quality of collateral that 

may be included in cover pools, the 

specific legal framework for issuance of 

covered bonds, and the procedures for 

resolution in the event that the issuer 

becomes insolvent.1978 Some 

commenters expressed concern about 

the possibility that certain covered bond 

structures could fall within the 

definition of covered fund, as proposed. 

In particular, commenters expressed 

concern about covered bond structures 

in the United Kingdom that also would 

be relevant in principle with respect to 

covered bond structures used in other 

European Union (‘‘EU’’) jurisdictions 

(e.g., the Netherlands and Italy) and 

certain non-EU jurisdictions (e.g., 

Canada, Australia, and New 

Zealand).1979 Another commenter 

indicated that covered bonds issued by 

certain French entities that hold a 

revolving pool of loans may be impacted 

by the proposed rule.1980

Certain commenters argued that in 

order to achieve the intended economic 

effect of providing recourse to both the 

bank issuing covered bonds and to the 

collateral pool, the issuing bank may 

enter into a number of agreements with 

the SPV that holds the collateral. This 

includes transactions where the bank 

takes on credit exposure to the SPV 

(e.g., through derivatives and securities 

lending, provision of loans, and/or 

investments in securities of the 

SPV).1981 The issuing bank typically 

also provides asset and liability 

management services to the SPV and 

may also repurchase certain assets from 

the SPV.1982 Commenters also 

contended that under certain legislative 

frameworks, the SPV issues the covered 

bonds and holds the collateral, and a 

sponsoring bank lends money to the 

SPV.1983 According to commenters, the 


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1984See Allen & Overy (on behalf of Foreign Bank 

Group); UKRCBC; FSA (Apr. 2012). 

1985See Allen & Overy (on behalf of Foreign Bank 

Group); UKRCBC; FSA (Apr. 2012); ASF (Feb. 

2012); AFME et al. For a discussion of possible 

economic effects, see FSA (Feb. 2012); UKRCBC; 

Allen & Overy (on behalf of Foreign Bank Group). 

1986See ASF (Feb. 2012); AFME et al.; UKRCBC. 

1987See UKRCBC. 

1988See, e.g., AFME et al. 

1989See final rule § 75.10(c)(10). 

1990See final rule § 75.10(c)(10)(ii)(A). 

1991See final rule § 75.10(c)(10)(ii)(B). As 

discussed above in the section describing the 

wholly-owned subsidiary exclusion from the 

definition of covered fund, the Agencies are 

permitting 0.5 of a wholly-owned subsidiary to be 

owned by an unaffiliated party for the purpose of 

establishing corporate separateness or addressing 

bankruptcy, insolvency, or similar concerns. 

1992See supra note 1985 and accompanying text. 

1993 Id. 

1994The Agencies note that section 13(d)(1)(E) of 

the BHC Act incorrectly provides that the term 

‘‘small business investment company’’ is defined in 

section 102 of the SBA, while the definition is in 

fact contained in section 103(3) of the SBA as 

codified at 15 U.S.C. 662. The statute includes the 

correct citation to 15 U.S.C. 662. The Agencies are 

correcting this technical error in the final rule by 

updating the reference to section 102 to section 

103(3). 

broad definition of covered fund in the 

proposed rule could capture an SPV that 

holds the collateral, so transactions 

between an SPV and the issuing bank or 

sponsor bank may be prohibited.1984

These commenters argued that 

including covered bond structures in 

the definition of covered fund is 

inconsistent with the legislative intent 

of the rule, would have a negative and 

disproportionate effect on foreign banks, 

markets and economies and would give 

rise to potential conflicts with such 

foreign legislative frameworks.1985

According to certain commenters, 

SPVs whose sole function is as part of 

an offering of covered bonds should be 

excluded from the definition of covered 

fund in the final rule. These 

commenters provided that the proposed 

rule was not clear on whether these 

SPVs, which effectively function as 

collateral devices for the covered bond, 

would be excluded from the definition 

of covered fund.1986 One commenter 

indicated that the key concern was 

primarily due to the wide definition of 

covered fund in the proposed rule.1987

Other commenters indicated that the 

final rule should not apply to covered 

bond transactions because they are not 

traditionally recognized or regulated as 

asset-backed securities transactions, and 

they are not the type of transactions that 

the rule was intended to address.1988

As a result of comments received on 

covered bond vehicles, the final rule 

specifically excludes from the definition 

of covered fund certain entities that own 

or hold a dynamic or fixed pool of assets 

that covers the payment obligations of 

covered bonds. In order to qualify for 

the exclusion, the assets or holdings in 

the cover pool must satisfy the 

conditions in the loan securitization 

exclusion, except for the requirement 

that the securities they issue are assetbacked securities (the ‘‘permitted cover 

pool’’).1989 The Agencies believe this 

approach is consistent with the rule of 

construction contained in section 

13(g)(2) of the BHC Act. The rule of 

construction in section 13(g)(2) of the 

BHC Act specifically refers to the ‘‘sale 

and securitization of loans’’ and the 

Agencies would not want a banking 

entity to use an excluded cover pool to 

engage in proprietary trading of such 

securities prohibited under the final 

rule. The Agencies believe this 

restriction reduces the potential for 

evasion of the final rule. 

By placing restrictions on the assets 

permitted to be held by a cover pool, the 

potential for evasion of the covered fund 

prohibitions is reduced. The exclusion 

for cover pools is intended, as 

contemplated by the rule of 

construction in section 13(g)(2) of the 

BHC Act, to permit banking entities to 

continue to engage in lending activities 

and the financing those lending 

activities. Including all types of 

securities and other assets within the 

scope of permitted assets in a cover 

pools would expand the exclusion 

beyond the scope of the definition of 

loan in the final rule that is intended to 

implement the rule of construction. 

Additionally, because the exclusion for 

cover pools is only available to foreign 

banking organizations, allowing such 

cover pools to hold securities would 

provide unequal treatment of covered 

bonds as compared to a loan 

securitization sponsored by a U.S. 

banking entity. 

Under the definition of covered bond 

in the final rule, the debt obligation may 

be issued directly by a foreign banking 

organization or by an entity that owns 

a permitted cover pool. In both cases, 

the payment obligations of the debt 

obligation must be fully and 

unconditionally guaranteed. If the debt 

obligation is issued by a foreign banking 

organization, such debt obligation will 

be a ‘‘covered bond’’ under the final rule 

if the payment obligations are fully and 

unconditionally guaranteed by an entity 

that owns a permitted cover pool.1990 If 

the debt obligation is issued by an entity 

that owns a permitted cover pool, such 

debt obligation will be a ‘‘covered 

bond’’ under the final rule if (i) the 

payment obligations are fully and 

unconditionally guaranteed by a foreign 

banking organization and (ii) the issuer 

of the debt obligation is a wholly-owned 

subsidiary (as defined) by such foreign 

banking organization.1991 Thus, under 

the final rule, a covered bond structure 

in which an entity holds the cover pool 

and issues securities that are fully and 

unconditionally guaranteed by a foreign 

banking organization may also be able to 

rely on the loan securitization exclusion 

if it meets all of the requirements of that 

exclusion. 

The Agencies recognize that many 

covered bond programs may involve 

foreign covered bond programs (and 

their related cover pools) that are 

permitted by their respective laws to 

own residential mortgage-backed 

securities and other non-loan assets. As 

a result, the exclusion for covered bonds 

in the final rule may not be available to 

many of the existing cover pools that 

support outstanding covered bonds. The 

Agencies recognize that this approach 

may not exclude all foreign covered 

bond programs. Although certain 

commenters argued that including 

covered bond structures in the 

definition of covered fund is 

inconsistent with the legislative intent 

of the rule,1992 the Agencies believe that 

the exclusion for qualifying covered 

bonds, including the limitations on the 

types of securities that a loan 

securitization can hold, is consistent 

with the rule of construction contained 

in section 13(g)(2) of the BHC Act and 

appropriate for the reasons discussed 

directly above and under ‘‘Definition of 

Loan.’’ The Agencies also recognize that 

commenters argued that including 

covered bonds as covered funds could 

have a negative and disproportionate 

effect on foreign banks, markets and 

economies and would give rise to 

potential conflicts with such foreign 

legislative frameworks.1993 The 

Agencies note that, although they do not 

know the composition of the cover 

pools, the Agencies believe that foreign 

banking organizations should be able to 

look at the composition of their cover 

pools to evaluate how to meet the 

requirements of the exclusion — and 

thus to avoid or mitigate the adverse 

effects commenters asserted would 

occur—as they determine appropriate. 

11. Certain Permissible Public Welfare 

and Similar Funds 

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

permits a banking entity to make and 

retain: (i) Investments in one or more 

small business investment companies 

(‘‘SBICs’’), as defined in section 103(3) 

of the Small Business Investment Act of 

1958 (SBA) (15 U.S.C. 662) 1994; (ii) 


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1995See 12 U.S.C. 1851(d)(1)(E). 

1996The proposal implemented a proposed 

determination by the Agencies under 13(d)(1)(J) 

‘‘that a banking entity may not only invest in such 

entities as provided under section 13(d)(1)(E) of the 

BHC Act, but also may sponsor an entity described 

in that paragraph and that such activity, since it 

generally would facilitate investment in small 

businesses and support the public welfare, would 

promote and protect the safety and soundness of 

banking entities and the financial stability of the 

United States.’’ Joint Proposal, 76 FR at 68908 

n.292. 

1997See proposed rule § 75.13(a). 

1998See Novogradac (LIHTC); Novogradac 

(NMTC); Novogradac (RETC); PNC; Raymond 

James; SIFMA et al. (Covered Funds) (Feb. 2012); 

SBIA. 

1999See AHIC; Novogradac (LIHTC); Novogradac 

(NMTC); Novogradac (RETC); SBIA; Union Bank; 

U.S. Bancorp. 

2000See ABA (Keating); Lone Star; Novogradac 

(LIHTC); Novogradac (NMTC); Novogradac (RETC); 

SVB; U.S. Bancorp. 

2001See NCHSA; SBIA; Novogradac (LIHTC); 

Novogradac (NMTC); Novogradac (RETC). 

2002See SBIA; see also SEC Rule 3c-2. 

2003See ABA (Keating); PNC. 

2004See USAA. 

2005See JPMC; SIFMA et al. (Covered Funds) 

(Feb. 2012). 

2006See final rule § 75.10(c)(11). This provision 

would cover any issuer that engages in the business 

of making tax credit investments (e.g., Low Income 

Housing Tax Credit, New Markets Tax Credit, 

Renewable Energy Tax Credit, Rural Business 

Investment Company) that are either designed to 

promote the public welfare of the type permitted 

under 12 U.S.C. 24 (Eleventh) or are qualified 

rehabilitation expenditures with respect to a 

qualified rehabilitated building or certified historic 

structure, as provided for under § 75.10(c)(11). 

2007See proposed rule § 75.10(b)(1). 

2008See, e.g., Arnold & Porter; BoA; Goldman 

(Covered Funds); ICI (Feb. 2012); Putnam; TCW; 

Vanguard. According to these commenters, a 

registered investment company may use security or 

commodity futures, swaps, or other commodity 

interests in various ways to manage its investment 

portfolio and be swept into the broad definition of 

‘‘commodity pool’’ contained in the Commodity 

Exchange Act. 

investments that are designed primarily 

to promote the public welfare, of the 

type permitted under paragraph (11) of 

section 5136 of the Revised Statutes of 

the United States (12 U.S.C. 24); and 

(iii) investments that are qualified 

rehabilitation expenditures with respect 

to a qualified rehabilitated building or 

certified historic structure, as such 

terms are defined in section 47 of the 

Internal Revenue Code of 1986 or a 

similar State historic tax credit 

program.1995 The proposed rule 

permitted banking entities to invest in 

and act as sponsor 1996 to these entities, 

but did not explicitly exclude them 

from the definition of covered fund.1997

Commenters generally supported the 

proposed exemption for investments in 

and sponsorship of funds designed to 

promote the public welfare, SBICs, and 

other tax credit funds given the valuable 

funding and assistance these 

investments provide in facilitating 

community and economic priorities and 

the role these investments play in the 

ability of banking entities, especially 

community and regional banks, to 

achieve their financial and Community 

Reinvestment Act (‘‘CRA’’) goals. 

However, commenters raised some 

issues with respect to the proposed 

exemption and sought clarification on 

its application to specific 

investments.1998 Of primary concern to 

commenters was the impact of the 

prohibition in section 13(f) of the BHC 

Act on the ability of a banking entity 

sponsoring a tax credit fund or its 

affiliate to guarantee certain obligations 

of the fund in order to provide 

assurance to investors that the 

investment has been properly structured 

to enable the investor to receive the tax 

benefits on which the investment are 

sold.1999 Some commenters noted that 

failure to address this issue in the final 

rule would damage a large segment of 

this market and therefore urged the 

Agencies to exempt these investments 

from the application of section 13(f) or, 

in the alternative, from the definition of 

covered fund.2000

In addition, commenters requested 

clarification that specific types of public 

welfare, SBIC, and other tax credit 

investments would be eligible for the 

exemption, including Low Income 

Housing Tax Credits, Renewable Energy 

Tax Credits, New Markets Tax Credits, 

and Rural Business Investment 

Companies.2001 One commenter 

requested that applicants for an SBIC 

license that have received permission 

from the Small Business Administration 

to file a formal SBIC license application 

be viewed the same as an SBIC.2002

Other commenters sought coverage of 

investments in non-SBIC funds that 

provide capital to small and middlemarket companies,2003 investments in 

any state administered tax credit 

program,2004 and investments outside 

the United States that are of the type 

permitted under paragraph (11) of 

section 5136 of the Revised Statutes of 

the United States (12 U.S.C. 24).2005

In light of the comments received, the 

final rule excludes from the definition 

of covered fund an issuer that is an SBIC 

(or that has received from the Small 

Business Administration notice to 

proceed to qualify for a license as an 

SBIC, which notice or license has not 

been revoked) or the business of which 

is to make investments that are: (i) 

Designed primarily to promote the 

public welfare, of the type permitted 

under paragraph (11) of section 5136 of 

the Revised Statutes of the United States 

(12 U.S.C. 24), including the welfare of 

low- and moderate-income communities 

or families (such as providing housing, 

services, or jobs); or (ii) qualified 

rehabilitation expenditures with respect 

to a qualified rehabilitated building or 

certified historic structure, as such 

terms are defined in section 47 of the 

Internal Revenue Code of 1986 or a 

similar State historic tax credit 

program.2006

By excluding SBICs and other public 

interest funds from the definition of 

covered fund—rather than provide a 

permitted activity exemption as 

proposed—the Agencies addressed 

commenters’ concerns regarding the 

burdens imposed by section 13(f). The 

Agencies believe that excluding these 

investments from the definition of 

covered fund addresses the issues many 

commenters raised with respect to the 

application of section 13(f) of the BHC 

Act, and gives effect to the statutory 

exemption of these investments in a 

way that appropriately facilitates 

national community and economic 

development objectives. The Agencies 

believe that permitting a banking entity 

to sponsor and invest in these types of 

public interest entities will result in 

banking entities being able to provide 

valuable expertise and services to these 

entities and to provide funding and 

assistance to small businesses and lowand moderate-income communities. The 

Agencies believe that providing the 

exclusion will also allow banking 

entities to continue to provide capital to 

community-improving projects and in 

some instances promote capital 

formation. 

12. Registered Investment Companies 

and Excluded Entities 

The proposed rule did not specifically 

include registered investment 

companies (including mutual funds) or 

business development companies 

within the definition of covered 

fund.2007 As explained above, the 

statute references funds that rely on 

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

Investment Company Act. Registered 

investment companies and business 

development companies do not rely on 

either section 3(c)(1) or 3(c)(7) of the 

Investment Company Act and are 

instead registered or regulated in 

accordance with the Investment 

Company Act. 

Many commenters argued that 

registered investment companies and 

business development companies would 

be treated as covered funds under the 

proposed definition if commodity pools 

are treated as covered funds.2008 A few 

commenters argued that the final rule 

should specifically provide that all SECVerDate Mar<15>2010 23:00 Jan 30, 2014 Jkt 232001 PO 00000 Frm 00164 Fmt 4701 Sfmt 4700 E:\FR\FM\31JAR3.SGM 31JAR3

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2009See Arnold & Porter; Goldman (Covered 

Funds); see also SIFMA et al. (Covered Funds) (Feb. 

2012); SIFMA et al. (Mar. 2012); ABA (Keating); 

BoA; ICI (Feb. 2012); JPMC (requesting clarification 

that registered investment companies are not 

banking entities); TCW. 

2010See ICI (Feb. 2012); TCW. 

2011See final rule § 75.10(c)(12). 

2012See final rule §§ 75.10(c)(12)(i); 10(c)(12)(iii); 

75.20(e). 2013The Agencies also note that banking entities 

with more than $10 billion in total consolidated 

assets as reported on December 31 of the previous 

two calendar years must maintain records that 

include, among other things, documentation of the 

exclusions or exemptions other than sections 3(c)(1) 

and 3(c)(7) of the Investment Company Act of 1940 

relied on by each fund sponsored by the banking 

entity in determining that such fund is not a 

covered fund. See final rule § 75.20(e). 

2014See also FSOC study. 

2015See SIFMA et al. (Covered Funds) (Feb. 

2012); Credit Suisse (Williams); GE (Feb. 2012). 

2016See final rule § 75.10(c)(14). 

2017As discussed above, the Agencies also may 

determine jointly that an entity excluded from the 

definition of covered fund under § 75.10(c) is in fact 

a covered fund, and consequently banking entities’ 

investments in and transactions with such fund 

would be subject to limitations and/or divestiture. 

The Agencies intend to utilize this authority to 

monitor for and address, as appropriate, instances 

of evasion. See, e.g., 12 U.S.C. 1851(e)(2). 

2018A joint determination specified under 

§ 75.10(c)(14) may take a variety of forms. 

registered funds are excluded from the 

definition of covered fund (and the 

definition of banking entity) to avoid 

any uncertainty about whether section 

13 applies to these types of funds.2009

Commenters also requested that the 

final rule exclude from the definition of 

covered fund entities formed to 

establish registered investment 

companies during the seeding period. 

These commenters contended that, 

during the early stages of forming and 

seeding a registered investment 

company, an entity relying on section 

3(c)(1) or (3)(c)(7) may be created to 

facilitate the development of a track 

record for the registered investment 

company so that it may be marketed to 

unaffiliated investors.2010

Section 13’s definition of private 

equity fund and hedge fund by reference 

to section 3(c)(1) and 3(c)(7) of the 

Investment Company Act appears to 

reflect Congress’ concerns about 

banking entities’ exposure to and 

relationships with investment funds 

that explicitly are excluded from SEC 

regulation as investment companies. 

The Agencies do not believe it would be 

appropriate to treat as a covered fund 

registered investment companies and 

business development companies, 

which are regulated by the SEC as 

investment companies. The Agencies 

believe that the proposed rule’s 

inclusion of commodity pools would 

have resulted in some registered 

investment companies and business 

development companies being covered 

funds, a result the Agencies did not 

intend. The Agencies, in addition to 

narrowing the commodity pools that 

will be included as covered funds as 

discussed above, have also modified the 

final rule to exclude SEC-registered 

investment companies and business 

development companies from the 

definition of covered fund.2011

The Agencies also recognize that an 

entity that becomes a registered 

investment company or business 

development company might, during its 

seeding period, rely on section 3(c)(1) or 

3(c)(7). The Agencies have determined 

to exclude these seeding vehicles from 

the covered fund definition for the same 

reasons the Agencies determined to 

exclude entities that are operating as 

registered investment companies or 

business development companies as 

discussed above. 

In order to prevent banking entities 

from purporting to use this exclusion for 

vehicles that the banking entity does not 

reasonably expect to become a 

registered investment company or 

business development company, the 

exclusion is available only with respect 

to a vehicle that the banking entity 

operates (i) pursuant to a written plan, 

developed in accordance with the 

banking entity’s compliance program, 

that reflects the banking entity’s 

determination that the vehicle will 

become a registered investment 

company or business development 

company within the time period 

provided by the final rule for seeding a 

covered fund; (ii) consistently with the 

leverage requirements under the 

Investment Company Act of 1940 that 

are applicable to registered investment 

companies and SEC-regulated business 

development companies.2012 A banking 

entity that seeds a covered fund for any 

purpose other than to register it as an 

investment company or establish a 

business development company must 

comply with the requirements of section 

13(d)(1)(G) of the BHC Act and § 75.11 

of the final rule as described above. The 

Agencies will monitor this seeding 

activity for attempts to use this 

exclusion to evade the requirements 

governing the ownership of and 

relationships with covered funds under 

section 13 of the BHC Act and the final 

rule.2013

13. Other Excluded Entities 

Section 13(h)(2) permits the Agencies 

to include similar funds within the 

definition of covered fund, but the 

proposal did not contain a process for 

excluding from the definition of covered 

fund other entities that do not engage in 

the investment activities contemplated 

by section 13. Many commenters argued 

that the breadth of entities that may be 

required to rely on the exclusions in 

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

Investment Company Act could result in 

additional unidentified entities 

becoming subject to the definition of 

covered fund.2014 In order to ensure that 

the final rule effectively addresses the 

full scope of entities that may 

inadvertently be included within the 

definition of covered fund, a number of 

commenters urged that the final rule 

include a mechanism to exclude other 

entities from the term ‘‘covered fund’’ 

by rule or order if the Agencies 

determine such an exclusion is 

appropriate.2015

As evidenced by the extensive 

comments discussed above identifying 

the many types of corporate structures 

and other vehicles (not just investment 

funds) that rely on sections 3(c)(1) and 

3(c)(7) but do not engage in investment 

activities of the type contemplated by 

section 13, the scope of an overly broad 

definition of covered fund may impose 

significant burdens on banking entities 

that are in conflict with the purposes of 

section 13 of the BHC Act. In response 

to commenters’ concerns and to address 

the potential that the final rule’s 

definition of covered fund might 

encompass entities that do not engage in 

the investment activities contemplated 

by section 13, the final rule includes a 

provision that provides that the 

Agencies may jointly determine to 

exclude an issuer from the definition of 

covered fund if the exclusion is 

consistent with the purposes of section 

13 of the BHC Act.2016

As noted above, the statute permits 

the Agencies to act by rule to modify the 

definition of covered fund. After issuing 

the proposed rule and receiving 

comment on it, the final rule provides 

that the Agencies may act jointly to 

provide an exclusion.2017 The Agencies 

are working to establish a process 

within which to evaluate requests for 

exclusions and expect to provide 

additional guidance on this matter as 

the Agencies gain experience with the 

final rule.2018 As a result, the definition 

of covered fund would remain unified 

and consistent. The final rule also 

provides that a determination by the 

Agencies to exclude an entity from the 

definition of covered fund will be 

promptly made public in order to 

ensure that both banking entities and 

the public may understand what entities 

are and are not included within the 

definition of covered fund. 


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2019See, e.g., PNC; SVB; SIFMA (Securitization) 

(Feb. 2012); AFME et al.; BoA. See also, e.g., Credit 

Suisse (Williams). 

2020See SIFMA et al. (Covered Funds) (Feb. 

2012); Credit Suisse (Williams). 

2021 12 USC 5461 et seq. 

2022See id. 

2023Section 3(b)(1) of the Investment Company 

Act excludes from the definition of investment 

company ‘‘[a]ny issuer primarily engaged, directly 

or through a wholly-owned subsidiary or 

subsidiaries, in a business or businesses other than 

that of investing, reinvesting, owning, holding, or 

trading in securities.’’ 

2024See 12 U.S.C. 1562(6); 12 CFR Part 234. 

2025See RMA; State Street (Feb. 2012); see also 

BNY Mellon et al. 

2026See RMA; State Street (Feb. 2012). 

2027See RMA; BNY Mellon et al. (citing 

Comptroller’s Handbook: Custody Services (Jan. 

2002)). 

2028See RMA. 

d. Entities Not Specifically Excluded 

From the Definition of Covered Fund 

In addition to the entities identified 

above which are excluded from the 

definition of covered fund under the 

final rule, commenters argued that a 

number of other entities such as 

financial market utilities, venture 

capital funds, credit funds, cash 

management vehicles or cash collateral 

pools may also be an investment 

company but for the exclusion 

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

the Investment Company Act and 

requested that these entities expressly 

be excluded from the final rule’s 

definition of covered fund. The 

Agencies have considered carefully the 

comments received on each of these 

entities but, for the reasons explained 

below, have declined to provide a 

separate exclusion for them from the 

definition of covered fund at this time. 

As discussed below, some of these 

entities are not covered funds for 

various reasons or may, with relatively 

little cost, conform to the terms of an 

exclusion or exemption from the 

definition of covered fund. As noted 

above, to the extent that one of these 

entities qualifies for one or more of the 

other exclusions from the definition of 

covered fund, that entity would not be 

a covered fund under the final rule. Any 

entity that would be a covered fund 

would still be able to rely on the 

conformance period in order to come 

into compliance with the requirements 

of section 13 and the final rule. 

A number of commenters requested 

that certain existing covered funds be 

either excluded from the definition of 

covered fund or grandfathered and not 

be subject to the limitations of section 

13 of the BHC Act.2019 The Agencies 

note, however, that section 13 

specifically addresses a banking entity’s 

preexisting investments in covered 

funds by providing a conformance 

period, which banking entities may use 

to bring their activities and investments 

into compliance with the requirements 

of section 13 and the final rule. To the 

extent that section 13 could be 

interpreted to permit the Agencies to 

take a different approach, despite 

addressing banking entities’ preexisting 

covered fund investments directly, the 

Agencies believe it would be 

inconsistent with the purposes of 

section 13 to permit banking entities to 

continue to hold ownership interests in 

covered funds beyond the conformance 

period provided by the statute. Section 

13’s prohibition on banking entities’ 

investments in and relationships with 

covered funds and the requirement that 

banking entities divest or conform these 

investments appear to reflect the 

statutory purpose that banking entities 

be limited in their ability to continue to 

be exposed to these investments outside 

of the statutorily-provided conformance 

period. The Agencies believe that 

permitting banking entities to hold 

ownership interests indefinitely beyond 

the conformance period provided by the 

statute appears inconsistent with this 

purpose. 

1. Financial Market Utilities 

Several commenters contended that 

financial market utilities (‘‘FMUs’’) 

could be covered funds because they 

might rely on section 3(c)(1) or 3(c)(7) 

for an exclusion from the definition of 

investment company under the 

Investment Company Act and may not 

qualify for an alternative exemption.2020

These commenters argued that banking 

entities have long been investors in 

domestic and foreign FMUs, such as 

securities clearing agencies, derivatives 

clearing organizations, securities 

exchanges, derivatives boards of trade 

and alternative trading systems. These 

commenters expressed concern that, 

unless FMUs are expressly excluded 

from the definition of covered fund, 

banking entities could be prohibited 

from entering into any new covered 

transactions with related FMUs and 

would be required to divest their 

investments in FMUs, thereby 

disrupting the operations of those FMUs 

and financial markets generally. 

After carefully considering 

commenters’ concerns, the Agencies 

believe that FMUs are not investment 

vehicles of the type section 13 of the 

BHC Act was designed to address, but 

rather entities that generally engage in 

other activities, including acting as 

central counterparties that reduce 

counterparty risk in clearing and 

settlement activities. Congress 

recognized, in the Payment, Clearing, 

and Settlement Supervision Act of 2010 

(title VIII of the Dodd-Frank Act),2021

that properly designed, operated, and 

supervised financial market utilities as 

defined in that Act mitigate systemic 

risk and promote financial stability.2022

However, the Agencies have not 

provided an exclusion from the covered 

fund definition for FMUs because these 

kinds of entities do not generally appear 

to rely on section 3(c)(1) or 3(c)(7) of the 

Investment Company Act, and therefore 

do not appear to need an exclusion. For 

example, section 3(b)(1) of the 

Investment Company Act excludes from 

the definition of investment company— 

and thus from the definition of a 

covered fund—entities primarily 

engaged in a business other than that of 

an investment company.2023 If an FMU 

is primarily engaged in a business other 

than those that would make it an 

investment company, for example, if the 

FMU is primarily engaged in 

transferring, clearing, or settling 

payments, securities, or other financial 

transactions among or between financial 

institutions,2024 the FMU could rely on 

the exclusion to the definition of 

investment company provided by 

section 3(b)(1) and would not need to 

rely on section 3(c)(1) or 3(c)(7) and, as 

such, would not be a covered fund. 

2. Cash Collateral Pools 

Some commenters expressed concern 

that cash collateral pools, which are part 

of securities lending programs, could be 

included in the definition of covered 

fund.2025 According to these 

commenters, banking entities, including 

bank custodians acting as lending agent 

for customer’s securities lending 

activities, typically manage these pools 

as fiduciaries for their customers.2026

These commenters argued that collateral 

pools are part of a banks’ traditional 

custody and advisory services and have 

been an integral part of any lending 

agent’s role (whether custodial or noncustodial) for years.2027

Cash collateral pools are typically 

formed when, as part of a securities 

lending program, a customer of a bank 

authorizes the bank to take securities 

from the customer’s account and lend 

them in the open market. The agent 

bank then lends those securities and 

receives collateral in return from the 

borrower; a securities lending customer 

of a bank typically elects to have cash 

collateral provided by a borrower 

pooled by the agent bank with other 

cash collateral provided to other 

clients.2028 These investment pools may 

exist in the form of trusts, partnerships, 

limited liability companies, or separate 


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2029See RMA. 2030See RMA. 2031See State Street; RMA. Commenters also 

argued that as part of offering pooled cash collateral 

management, agent banks have traditionally 

provided short-term extensions of credit and 

contractual income and settlement services to 

lending clients and cash collateral pools to facilitate 

trade settlement and related cash collateral 

investment activities. See RMA. One commenter 

further argued that if banks are required to 

‘‘outsource’’ cash collateral pools and/or the related 

short-term credit services provided to the pools, 

‘‘participation in securities lending programs would 

only be cost effective for the largest lending clients’’ 

and, as a result, ‘‘many small and intermediate 

securities lending clients would be denied the 

incremental revenue securities lending can 

provide’’; ‘‘securities lending programs could lose 

significant diversification in lending clients, 

lendable assets, borrowers and agent banks’’; and, 

as a result of lost revenues, ‘‘the actual costs of [ 

] custodial or other services provided to clients that 

no longer participate in lending would increase.’’ 

Id. 

2032See RMA. 

2033See RMA. 

2034See RMA. 

2035For instance, the Agencies understand that a 

banking entity may set up a cash collateral pool in 

reliance on the exclusion contained in section 

3(c)(3) of the Investment Company Act, or may be 

able to structure these pools as SEC-registered 

money market funds operated in accordance with 

rule 2a–7 under the Investment Company Act. 

2036See PNC. 

2037See PNC. 

2038See ABA (Keating); PNC. 

2039See ABA (Keating); PNC. 

2040See PNC; ABA (Keating). These commenters 

argued that most REIT preferred securities contain 

a conditional exchange provision that allows the 

primary regulator to direct that the preferred 

securities be automatically exchanged for preferred 

shares of the bank or parent BHC upon occurrence 

of a conditional exchange event. Because this 

arrangement involves the purchase of securities 

issued by an affiliate or the purchase of assets, it 

would be prohibited under section 13(f) of the BHC 

Act if the pass-through REIT were a covered fund. 

accounts maintained by more than one 

party and these structures may rely on 

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

Investment Company Act to avoid being 

an investment company.2029 While their 

ownership interest may be nominal in 

amount, the agent banks may hold a 

general partnership, limited liability 

company membership or trustee interest 

in the cash collateral pool.2030 As part 

of these arrangements, custodian banks 

routinely offer borrower default 

indemnifications to the securities lender 

in a securities lending transactions. 

Commenters raised concerns that 

these indemnification agreements could 

be considered a covered transaction 

prohibited by section 13(f) of the BHC 

Act.2031 Since some cash collateral 

pools are established outside of the 

United States, commenters requested 

that the final rule permit banking 

entities to have interests in and 

relationships with both U.S. and nonU.S. cash collateral pools.2032 These 

commenters suggested that cash 

collateral pools be excluded from the 

definition of covered fund or, in the 

alternative, that the Agencies make clear 

that cash collateral pools managed by 

agent banks qualify for the exemption in 

§ 75.11 of the proposed rule for 

organizing and offering a covered fund 

and that the prime brokerage exemption 

from the restrictions of section 13(f) 

would permit the indemnification and 

income or settlement services agent 

banks typically provide to the pools.2033

These commenters also suggested that 

the Agencies use their authority under 

section 13(d)(1)(J) to provide an 

exemption for banking entities to 

continue to have interests in and 

provide services to these types of 

pools.2034

After carefully considering comments 

received, the final rule does not provide 

a specific exclusion from the definition 

of covered fund for cash collateral 

pools. The Agencies have determined to 

provide specific exclusions for entities 

that do not function as investment 

funds, consistent with the intent of 

section 13’s restrictions, or in response 

to other unique considerations (e.g., to 

provide consistent treatment for certain 

foreign and domestic pension plans). 

These considerations do not support a 

separate exclusion for cash collateral 

pools. 

The Agencies note, however, that 

some cash collateral pools may not be 

covered funds because they rely on an 

exclusion from the definition of 

investment company other than those 

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

the Investment Company Act.2035

Banking entities may determine to 

register cash collateral pools with the 

SEC as investment companies or to 

operate them as separate accounts to 

exclude the pools from the covered fund 

definition or, if the pools remain 

covered funds, to organize and offer 

them in compliance with the 

requirements of § 75.11 of the final rule. 

In response to comments received on 

the proposal, the Agencies note that the 

provision of a borrower default 

indemnification by a banking entity to 

a lending client in connection with 

securities lending transactions involving 

a covered fund is not a covered 

transaction subject to 13(f) or a 

guarantee of the performance or 

obligations of a covered fund prohibited 

under § 75.11 of the final rule. Those 

restrictions apply to transactions with 

the covered fund or guarantees of the 

covered fund’s performance. Borrower 

default indemnifications are provided to 

the bank’s securities lending customer, 

not to the cash collateral pool. 

3. Pass-Through REITS 

Some banking entities may issue real 

estate investment trust (‘‘REIT’’) 

preferred securities to the public 

directly from a subsidiary that qualifies 

for the exclusion in section 3(c)(5) or 

section 3(c)(6) of the Investment 

Company Act. These entities would not 

be considered a ‘‘covered fund’’ because 

they may rely on an exclusion from the 

definition of an investment company 

other than the exclusion in section 

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

Company Act.2036 However, in order to 

meet the demands of customers and 

avoid undesirable tax consequences, 

some banking entities structure their 

REIT offerings by using a passive, passthrough statutory trust between the 

banking entity and the REIT to issue 

REIT preferred securities to the 

public.2037 Because the pass-through 

trust holds the preferred securities of 

the underlying REIT (which would itself 

not be a covered fund), as well as 

provides administrative and ministerial 

functions for the REIT (including 

passing through dividends from the 

underlying REIT), the pass-through trust 

may not itself rely on the exclusion 

contained in section 3(c)(5) or 3(c)(6) 

and, thus, typically relies on section 

3(c)(1) or 3(c)(7).2038

Some commenters urged the Agencies 

to provide an exclusion for pass-through 

REITS from the definition of covered 

fund.2039 These commenters argued that 

because the pass-through trust exists as 

a corporate convenience as part of 

issuing REIT preferred securities to the 

banking entity and its customers, it is 

not the type of entity that the covered 

fund prohibition in section 13 of the 

BHC Act was intended to address. These 

commenters also argued that passthrough REITs enable banking entities to 

offer preferable tax treatment to holders 

of the REIT preferred securities and that 

if pass-through REITs were included as 

covered funds, because of the 

limitations on covered transactions 

contained in section 13(f), the minority 

interests in the preferred securities 

issued by the REIT would no longer be 

able to be included in a banking entity’s 

tier 1 capital, thereby negatively 

impacting the safety and soundness of 

the banking entity.2040

The Agencies are not providing a 

specific exclusion from the definition of 

covered fund for pass-through REITs 

because the Agencies are concerned that 

such an exclusion could enable banking 

entities to structure non-loan 

securitization transactions using a passthrough entity in a manner inconsistent 

with the final rule’s treatment of similar 

vehicles that invest in securities. 


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5974 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

2041The Agencies recognize that banking entities 

may have relied on pass-through REIT structures to 

issue preferred securities in the past and 

prohibiting such transactions may pose 

inefficiencies. Furthermore, it may not be possible 

to unwind or conform past issuances without 

significant effort by the banking entity and 

negotiation with the holders of the preferred 

securities. As noted above, in these circumstances, 

section 13 provides a conformance period which 

banking entities may take advantage of in order to 

bring their activities and investments into 

compliance with the requirements of section 13 and 

the final rule. 

2042See, e.g., Ashurst; SIFMA (Municipal 

Securities) (Feb. 2012); Citigroup (Jan. 2012); 

Cadwalader (Municipal Securities); Vanguard; ICI 

(Feb. 2012); ASF (Feb. 2012); Fidelity; Wells Fargo 

(Covered Funds). Commenters also noted that 

tender option bond programs as currently 

structured may not meet the requirements of section 

3(a)(5) of the Investment Company Act or rule 3a– 

7 thereunder, or any other exclusion or exemption 

under the Investment Company Act. See Ashurst; 

RBC; ASF (Feb. 2012). 

2043See, e.g., ASF (Feb. 2012); BDA (Feb. 2012); 

Eaton Vance; Fidelity; ICI (Feb. 2012); RBC; SIFMA 

(Municipal Securities) (Feb. 2012); SIFMA (May 

2012); State Street (Feb. 2012); Vanguard. 

2044See Ashurst; ASF (Feb. 2012). 

2045See ASF (Feb. 2012); SIFMA (Municipal 

Securities) (Feb. 13, 2012); Citigroup (Jan. 2012). 

See also Cadwalader (Municipal Securities) 

(alleging that the legislative history of section 13 of 

the BHC Act suggests that the exemption relating 

to municipal securities should not be construed to 

apply only to the section of the rule pertaining to 

the proprietary trading prohibitions); BDA (Feb. 

2012) (arguing that any fund or trust the assets of 

which are entirely invested in any of the obligations 

that are excluded from the proprietary trading 

prohibitions should also be excluded from the 

definition of covered fund). 

2046See, e.g., Ashurst; Cadwalader (Municipal 

Securities); Eaton Vance; Nuveen Asset Mgmt.; 

SIFMA (Municipal Securities) (Feb. 13, 2012); State 

Street (Feb. 2012); Vanguard; Wells Fargo (Covered 

Funds); Citigroup (Jan. 2012). 

2047See, e.g., ASF (Feb. 2012); State Street (Feb. 

2012); Citigroup (Jan. 2012); Vanguard; Wells Fargo 

(Covered Funds); Cadwalader (Municipal 

Securities); Ashurst. 

2048See Cadwalader (Municipal Securities); ICI 

(Feb. 2012); Ashurst; ASF (Feb. 2012). 2049See Cadwalader (Municipal Securities). 2050See RBC. 2051See ICI (Feb. 2012). 2052See ASF (Feb. 2012). 2053See RBC. 2054See Ashurst. 2055See, e.g., RBC; ASF (Mar. 2012); ASF (Feb. 

2012). 

2056The Agencies received a variety of requests 

requesting specific treatment of tender option bond 

transactions. See, e.g., supra notes 2050–2055. As 

discussed above, the Agencies believe that, in light 

of the comments received, tender option bond 

vehicles do not fall within the rule of construction 

contained in section 13(g)(2) of the BHC Act and, 

as a result, the final rule does not provide such 

treatment. 

2057See 12 U.S.C. 1851(g)(2). 

Furthermore, banking entities have 

alternative manners in which they may 

issue or hold REIT preferred securities, 

including through REITs directly, which 

do not raise the same concerns about 

evasion.2041

4. Municipal Securities Tender Option 

Bond Transactions 

The Agencies received a number of 

comments addressing how the final rule 

should treat municipal securities tender 

option bond vehicles. A number of 

commenters argued that issuers of 

municipal securities tender option 

bonds would fall under the definition of 

covered fund in the proposed rule 

because these issuers typically rely on 

the exclusion contained in section 

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

Company Act.2042 According to 

commenters, a typical tender option 

bond transaction consists of the deposit 

of a single issue of highly-rated, longterm municipal bonds in a trust and the 

issuance by the trust of two classes of 

securities: a floating rate, puttable 

security (the ‘‘floaters’’), and an inverse 

floating rate security (the ‘‘residual’’) 

with no tranching involved. According 

to commenters, the holders of the 

floaters have the right, generally on a 

daily or weekly basis, to put the floaters 

for purchase at par. The put right is 

supported by a liquidity facility 

delivered by a highly-rated provider (in 

many cases, the banking entity 

sponsoring the trust) and allows the 

floaters to be treated as a short-term 

security. The floaters are in large part 

purchased and held by money market 

mutual funds. The residual is held by a 

longer-term investor (in many cases the 

banking entity sponsoring the trust, or 

an insurance company, mutual fund, or 

hedge fund). According to commenters, 

the residual investors take all of the 

market and structural risk related to the 

tender option bonds structure, with the 

investors in floaters taking only limited, 

well-defined insolvency and default 

risks associated with the underlying 

municipal bonds generally equivalent to 

the risks associated with investing in 

the municipal bonds directly. According 

to commenters, the structure of tender 

option bond transactions is governed by 

certain provisions of the Internal 

Revenue Code in order to preserve the 

tax-exempt treatment of the underlying 

municipal securities. 

Many commenters requested a 

specific exclusion for municipal tender 

option bond vehicles from the definition 

of a covered fund.2043 These 

commenters argued that, without an 

exclusion from the definition of covered 

fund, banking entities would be 

prohibited from owning or sponsoring 

tender option bonds and from providing 

credit enhancement, liquidity support, 

remarketing, and other services required 

in connection with a tender option bond 

program.2044 Commenters argued that 

tender option bond vehicles should be 

excluded because section 13(d)(1)(A) of 

the BHC Act already allows banking 

entities to own and dispose of 

municipal securities directly,2045 tender 

option bonds are economically similar 

to repurchase agreements, which are 

expressly excluded from the proprietary 

trading restrictions of the proposed rule, 

and, because they are safe and low risk 

are similar to the types of transactions 

that the proposed rule would have 

exempted.2046 Commenters also argued 

that tender option bonds are different 

from other covered funds that rely on 

the exclusion contained in section 

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

Company Act 2047 and play an important 

role in the municipal bond markets.2048

Commenters requested that the 

Agencies use their authority under 

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

exclude tender option bonds because 

they argued that tender option bonds 

promote the safety and soundness of 

banking entities and the financial 

stability of the United States by 

providing for a deeper, richer pool of 

potential investors, a larger and more 

liquid market for municipal securities 

that results in lower borrowing costs for 

municipalities and other issuers of 

municipal securities, and greater 

efficiency and risk diversification.2049

Commenters also suggested a number of 

other ways to exclude tender option 

bonds, including defining ownership 

interest to exclude any interest in a 

tender option bond transaction; 2050

defining banking entity to exclude 

tender option bond issuers; 2051

expanding the loan securitization 

exclusion to include tender option bond 

issuers; 2052 and revising the definition 

of sponsor to exclude sponsors of tender 

option bond vehicles.2053 One 

commenter urged the Commission to 

consider amending the exemption under 

rule 3a–7 under the Investment 

Company Act or providing formal 

guidance regarding the status of tender 

option bond programs.2054 In addition, 

some commenters requested an 

exclusion for tender option bond 

transactions from the provisions of 

section 13(f) of the BHC Act.2055

After carefully considering the 

comments received, the final rule does 

not provide a specific exclusion from 

the definition of covered fund or from 

the prohibitions and requirements of the 

final rule for tender option bond 

vehicles.2056 The Agencies have 

determined to provide specific 

exclusions for entities that they believe 

fall within the rule of construction 

contained in section 13(g)(2) of the BHC 

Act, which expressly relates to the sale 

and securitization of loans,2057 do not 


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2058For these same reasons, and based on the 

definitions of sponsor and banking entity in section 

13, the Agencies have not modified those 

definitions in the final rule to exclude sponsors of 

tender options bonds and tender bond issuers, 

respectively, as some commenters requested. See 

supra notes 2051 and 2053 and accompanying text. 

2059Commenters also argued that to the extent 

tender option bond programs are not excluded from 

the definition of covered fund, the definition of 

ownership interest should exclude any interest in 

a tender option bond program (see RBC) or that 

where a third party owns the residual, the banking 

entity should not be treated as having an ownership 

interest, even when it owns a small interest for tax 

purposes or becomes the owner through liquidity or 

remarketing agreements (see Cadwalader 

(Municipal Securities)). The definition of 

ownership interest in the final rule focuses on the 

attributes of the interest, as discussed below, and 

not the particular type of covered fund involved. 

The Agencies are not providing separate definitions 

of or exclusions from the ownership interest 

definition based on the type of vehicle or financing 

involved. See infra note 2103 and preceding and 

following text. Banking entities will need to 

evaluate whether the interests they may acquire are 

ownership interests as defined under the final rule. 

2060See 12 U.S.C. 1851(f). 

2061As discussed above, while commenters 

requested treatment of municipal tender option 

bond vehicles that would cause section 13(f) of the 

BHC Act not to apply to them, the final rule does 

not exclude these vehicles from the definition of 

covered fund or the prohibitions relating to covered 

funds. As a result, section 13(f) of the BHC Act will 

apply to a banking entity that is sponsoring a tender 

option bond vehicle. 

2062See ASF (Feb. 2012); Nuveen Asset Mgmt. 

2063See Ashurst. 

2064See Eaton Vance. 

2065See SVB; NVCA; Rep. Eshoo; Sen. Boxer; 

Rep. Goodlatte; Rep. Schweikert; Rep. Speier; Rep. 

Honda; Rep. Lofgren; Rep. Peters et al. 2066See, e.g., NVCA; SVB; Scale. 2067See, e.g., SVB; Scale; Sen. Boxer; SIFMA et 

al. (Covered Funds) (Feb. 2012) (citing a colloquy 

between Sen. Dodd and Sen. Boxer supporting an 

exemption for venture capital funds (156 Cong. Rec. 

H5226 (daily ed., June 30, 2010)). 2068See River Cities; Scale. See also Sofinnova; 

Canaan (Young); Canaan (Ahrens); Canaan (Kamra); 

Mohr Davidow; ATV; BlueRun; Westly; Charles 

River; Flybridge; SVB. 2069See, e.g., SVB. 

function as investment funds, consistent 

with the intent of section 13’s 

restrictions, or in response to other 

unique considerations. The Agencies do 

not believe that these considerations 

support a separate exclusion for tender 

option bond vehicles, which have 

municipal securities as underlying 

assets and not loans. 

The Agencies recognize commenters’ 

concerns about the treatment of tender 

option bonds under the final rule, as 

discussed above. However, as there is 

no corresponding rule of construction in 

section 13 of the BHC Act for financial 

instruments other than loans, the 

Agencies do not believe that the 

resecuritization of municipal debt 

instruments should be treated 

differently than the resecuritization of 

other debt instruments.2058

Notwithstanding the statutory treatment 

of municipal securities for purposes of 

the proprietary trading restrictions, the 

Agencies also do not believe that tender 

option bond vehicles fall within the rule 

of construction contained in section 

13(g)(2) of the BHC Act, because, in 

light of commenters’ descriptions of 

these vehicles, tender option bond 

vehicles are more in the nature of other 

types of bond repackaging 

securitizations and other non-excluded 

securitization vehicles.2059 The final 

rule, however, does not prevent a 

banking entity from owning or 

otherwise participating in a tender 

option bond vehicle; it requires that 

these activities be conducted in the 

same manner as with other covered 

funds. 

In this regard, under the final rule, a 

banking entity would need to evaluate 

whether a tender option bond vehicle is 

a covered fund as defined in the final 

rule. If a tender option bond vehicle is 

a covered fund and an exclusion from 

that definition is not available, then 

banking entities sponsoring such a 

vehicle will be subject to the 

prohibitions in § 75.14 of the final rule 

and the provisions of section 13(f) of the 

BHC Act.2060

As tender option bond vehicles are 

considered issuers of asset-backed 

securities subject to the risk retention 

requirements of section 15G of the 

Exchange Act, banking entities may look 

to the provisions of the final rule 

governing the limits applicable to 

banking entities’ interests in and 

relationships with those funds. Under 

the final rule, as in the statute, a 

banking entity that conducts the 

activities described in section 13(f) of 

the BHC Act is subject to the restrictions 

on transactions with a tender option 

bond vehicle, including guaranteeing or 

insuring the performance of the tender 

option bond vehicle, contained in 

section 13(f) of the BHC Act. As a result, 

a banking entity is not permitted to 

provide credit enhancement, liquidity 

support, and other similar services if it 

serves in a capacity covered by section 

13(f) with the tender option bond 

program.2061 An unaffiliated third party 

may provide such services if it does not 

have a relationship with the tender 

option bond vehicle that triggers 

application of section 13(f). The extent 

to which the final rule causes a 

disruption to the securitization of, and 

market for, municipal tender option 

bonds may also affect the economic 

burden and effects on the municipal 

bond market and its participants, 

including money market mutual 

funds 2062 and issuers of municipal 

securities. The Agencies recognize that 

a potential economic burden may be an 

increase in financing costs to 

municipalities as a result of a decrease 

in demand for the types of municipal 

securities customarily included in 

municipal tender option bond 

vehicles 2063 and therefore potential 

effects on the depth and liquidity of the 

market for certain types of municipal 

securities.2064

5. Venture Capital Funds 

Some private equity funds that make 

investments in early-stage start-up 

companies or other companies with 

significant growth potential (‘‘venture 

capital funds’’) would be investment 

companies but for the exclusion 

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

the Investment Company Act. Venture 

capital funds would therefore qualify as 

a covered fund under the proposal. The 

proposal specifically requested 

comment on whether venture capital 

funds should be excluded from the 

definition of ‘‘covered fund.’’ 

Some commenters argued that venture 

capital funds should be treated 

differently than other covered funds and 

excluded from the definition. These 

commenters argued that, unlike 

conventional hedge funds and private 

equity funds, venture capital funds do 

not possess high leverage and do not 

engage in risky trading activities of the 

type section 13 of the BHC Act was 

designed to address.2065 These 

commenters contended that investments 

and relationships by banking entities in 

venture capital funds would be 

consistent with safety and soundness; 

provide important funding and 

expertise and other services to start-up 

companies; and provide positive 

benefits to employment, GDP, growth, 

and innovation.2066 These commenters 

argued that restricting banking entities’ 

ability to invest in or sponsor venture 

capital funds would have a negative 

impact on companies and the U.S. 

economy generally.2067 Some 

commenters asserted that bank 

investments in venture capital funds are 

important to the success of venture 

capital,2068 with some citing a 

consulting firm’s data indicating that 

approximately 7 percent of all venture 

capital is provided by banks.2069 One 

commenter argued, therefore, that 

‘‘preventing banks from investing in 

venture thus could depress U.S. GDP by 

roughly 1.5% (or $215 billion annually) 

and eliminate nearly 1% of all U.S. 

private sector employment over the long 

term,’’ and the funding gap that would 

result if banks could not invest in 

venture capital funds would not be met 


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2070See SVB. 

2071See, e.g., SVB (arguing that the definition of 

‘‘venture capital fund’’ in section 203(l)–1 of the 

Investment Advisers Act and the SEC’s Form PF 

reporting requirements for investment advisers to 

private funds would be instructive for defining an 

exclusion for venture capital funds for purposes of 

section 13 of the BHC Act). 

2072See Occupy. 

2073See Sens. Merkley & Levin (Feb. 2012). 

2074See S. Rep. No. 111–176, at 71–3 (2010) (‘‘S. 

Rep. No. 111–176’’); H. Rep. No. 111–517, at 866 

(2010) (‘‘H. Rep. No. 111–517’’). H. Rep. No. 111– 

517 contains the conference report accompanying 

the version of H.R. 4173 that was debated in 

conference. See S. Rep. No. 111–176, at 74 (‘‘The 

Committee believes that venture capital funds, a 

subset of private investment funds specializing in 

long-term equity investment in small or start-up 

businesses, do not present the same risks as the 

large private funds whose advisers are required to 

register with the SEC under this title.’’). Compare 

Restoring American Financial Stability Act of 2010, 

S. 3217, 111th Cong. Sec. 408 (2010) (as passed by 

the Senate) with The Wall Street Reform and 

Consumer Protection Act of 2009, H.R. 4173, 111th 

Cong. (2009) (as passed by the House) (‘‘H.R. 4173’’) 

and Dodd-Frank Act (2010). 

2075But see Rep. Honda. 

2076These funds all typically offer their shares on 

an unregistered basis in reliance on section 4(a)(2) 

of the Securities Act of 1933 or Regulation D 

thereunder (17 CFR 230.500 through 230.508). 

2077As noted above, some commenters quantified 

the importance of banking entities to the provision 

of venture capital by providing information 

indicating that approximately 7 percent of all 

venture capital is provided by banks. See, e.g., SVB 

(citing ‘‘The Venture Capital Industry: A Preqin 

Special Report,’’ published by Preqin, Ltd. (Oct. 

2010)). The 7% estimate commenters identified 

includes information on investors based in North 

America, Europe, and Asia; thus, although 

potentially indicative of the extent of venture 

capital investing by banking entities in venture 

capital funds, the estimate does not specifically 

address the proportion of investment by banking 

entities in venture capital funds that are covered 

funds, as those terms are defined in the final rule. 

2078See 12 U.S.C. 1843(k)(4)(H); 12 CFR 225.170 

et seq. 

2079See 15 U.S.C. 80a–54. Companies that have 

elected to be treated as a business development 

company are subject to limits under the Investment 

Company Act, including: (i) Limits on how much 

debt the business development company may incur; 

(ii) prohibitions on certain affiliated transactions; 

(iii) regulation and examination by the SEC; and (iv) 

registration and filing requirements. 

by other market participants if bank 

investments in venture capital were 

restricted.2070 Several commenters 

recommended that venture capital funds 

be excluded if they: (i) Do not 

fundamentally engage in proprietary 

trading; (ii) do not use leverage to 

increase investment returns; and (iii) 

typically invest in high-growth start-up 

companies as compared to more mature 

publicly traded companies.2071

Conversely, one commenter alleged 

that there was no credible way to 

exclude venture capital funds without 

providing a means to circumvent the 

requirements of section 13 and the final 

rule.2072 Another commenter argued 

that venture capital funds do in fact 

engage in risky activities and that, 

instead of making investments in 

venture capital funds, banking entities 

may directly extend credit to start-up 

companies in a safe and sound 

manner.2073

The final rule does not provide an 

exclusion for venture capital funds. The 

Agencies believe that the statutory 

language of section 13 does not support 

providing an exclusion for venture 

capital funds from the definition of 

covered fund. Congress explicitly 

recognized and treated venture capital 

funds as a subset of private equity funds 

in various parts of the Dodd-Frank Act 

and accorded distinct treatment for 

venture capital fund advisers by 

exempting them from registration 

requirements under the Investment 

Advisers Act.2074 This indicates that 

Congress knew how to distinguish 

venture capital funds from other types 

of private equity funds when it desired 

to do so.2075 No such distinction 

appears in section 13 of the BHC Act. 

Because Congress chose to distinguish 

between private equity and venture 

capital in one part of the Dodd-Frank 

Act, but chose not to do so for purposes 

of section 13, the Agencies believe it is 

appropriate to follow this Congressional 

determination. 

In addition to the language of the 

statute, it appears to the Agencies that 

the activities and risk profiles for 

banking entities regarding sponsorship 

of, and investment in, venture capital 

funds and private equity funds are not 

readily distinguishable. Many key 

structural and operational 

characteristics of venture capital funds 

are substantially similar to those of 

hedge funds and private equity funds, 

thereby making it difficult to define 

venture capital funds in a manner that 

would not provide banking entities with 

an opportunity to evade the restrictions 

of section 13 of the BHC Act. 

For instance, in addition to relying on 

the same exemptions under the 

Securities Act,2076 venture capital 

funds, private equity funds and hedge 

funds all rely on the exclusion in 

section 3(c)(1) or 3(c)(7) from the 

definition of investment company under 

the Investment Company Act. Moreover, 

like private equity funds, venture 

capital funds pool funds from multiple 

investors and invest those funds in 

interests of portfolio companies for the 

purpose of profiting from the resale of 

those interests. Indeed, funds that are 

called ‘‘venture capital funds’’ may 

invest in the very same entities and to 

the same extent as do funds that call 

themselves private equity funds. 

Venture capital funds, like private 

equity funds, also typically charge 

incentive compensation to fund 

investors based on the price 

appreciation achieved on the 

investments held by the fund and 

provide a return of principal plus gains 

at specific times during the limited life 

of the fund. Not including venture 

capital funds in the definition of 

covered fund, therefore, could allow 

banking entities, either directly or 

indirectly, to engage in the type of 

activities section 13 was designed to 

address. 

While the final rule does not provide 

a separate exclusion for venture capital 

funds from the definition of covered 

fund, the Agencies recognize that 

certain venture capital investments by 

banking entities provide capital and 

funding to nascent or early-stage 

companies and small businesses and 

also may provide these companies 

expertise and other services.2077 Other 

provisions of the final rule or the statute 

may facilitate, or at least not impede, 

other forms of investing that may 

provide the same or similar benefits. For 

example, in addition to permitting a 

banking entity to organize and offer a 

covered fund in section 13(d)(1)(G), 

section 13 of the BHC Act does not 

prohibit a banking entity, to the extent 

otherwise permitted under applicable 

law, from making a venture capital-style 

investment in a company or business so 

long as that investment is not through 

or in a covered fund, such as through a 

direct investment made pursuant to 

merchant banking authority 2078 or 

through business development 

companies which are not covered funds 

and, like venture capital funds, often 

invest in small, early-stage 

companies.2079

Thus, to the extent that banking 

entities are required to reduce their 

investments in venture capital funds, 

certain of these investments may be 

redirected to the types of entities in 

which venture capital funds invest 

through alternative means. To the extent 

that banking entities may reduce their 

investments in venture capital funds 

that are covered funds, the potential 

funding gap for venture capital funds 

may also be offset, in whole or in part, 

by investments from firms that are not 

banking entities and thus not subject to 

section 13’s restrictions. 

6. Credit Funds 

Several commenters requested that 

the final rule explicitly exclude from the 

definition of covered fund entities that 

are generally formed as partnerships 

with third-party capital and invest in 

loans or make loans or otherwise extend 

the type of credit that banks are 


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2080See, e.g., Goldman (Covered Funds); ABA 

(Keating); Credit Suisse (Williams); Comm. on 

Capital Markets Regulation; Chamber (Feb. 2012). 

2081See ABA (Keating); Goldman (Covered 

Funds). 

2082See Credit Suisse (Williams). 

2083See Goldman (Covered Funds). 

2084See SIFMA et al. (Covered Funds) (Feb. 

2012); see also. ABA (Keating); Chamber (Feb. 

2012). 

2085See, e.g., ABA (Keating), Credit Suisse 

(Williams), Arnold & Porter (as it relates to 

commodity pools). Section 2(a)(13) of the 

Investment Company Act generally defines an ESC 

as ‘‘any investment company or similar issuer all 

of the outstanding securities of which (other than 

short-term paper) are beneficially owned’’ by 

employees and certain related persons (e.g., 

employees’ immediate family members). 

2086Section 6(b) of the Investment Company Act 

provides, in part, that ‘‘[u]pon application by any 

employees’ security company, the Commission 

shall by order exempt such company from the 

provisions of this title and of the rules and 

regulations hereunder, if and to the extent that such 

exemption is consistent with the protection of 

investors.’’ 

2087See Credit Suisse (Williams). 

2088See proposed rule § 75.10(b)(3). 

2089See Joint Proposal, 76 FR at 68897. 

authorized to undertake on their own 

balance sheet (‘‘credit funds’’).2080 Two 

commenters contended that the 

language of section 13(g)(2) indicates 

that Congress did not intend section 13 

of the BHC Act to limit a banking 

entity’s ability to extend credit.2081

They argued that lending is a 

fundamental banking activity, whether 

accomplished through direct loans or 

through a fund structure. These 

commenters argued that credit funds 

functioned like syndicated loans that 

enable borrowers to secure credit during 

periods of market distress and reduce 

the concentration of risk for both 

individual banking entities and the 

banking system as a whole. 

Commenters suggested different 

approaches for excluding credit funds 

from the definition of covered fund. One 

commenter recommended excluding an 

entity that would otherwise be a 

covered fund if more than 50 percent of 

its assets consist of loans.2082 Another 

commenter proposed defining a credit 

fund as an entity that met a number of 

criteria designed to ensure the entity 

only held loans or otherwise engaged in 

prudent lending activity.2083 Another 

commenter requested that the Agencies 

use their authority under section 

13(d)(1)(J) to permit a banking entity to 

sponsor, invest in, or enter into covered 

transactions with related credit funds 

that are covered funds.2084

The Agencies, however, are unable 

effectively to distinguish credit funds 

from other types of private equity funds 

or hedge funds in a manner that would 

give effect to the language and purpose 

of section 13 and not raise concerns 

about banking entities being able to 

evade the requirements of section 13. 

Moreover, the Agencies also believe that 

the final rule largely addresses 

commenters’ concerns in other ways 

because some credit funds may be able 

to rely on another exclusion from the 

definition of covered fund in the final 

rule such as the exclusion for joint 

ventures or the exclusion, discussed 

above, for loan securitizations. To the 

extent that a credit fund may rely on 

another exclusion from the definition of 

covered fund, it would not be a covered 

fund under section 13 of the BHC Act. 

7. Employee Securities Companies 

Several commenters argued that 

employee securities companies 

(‘‘ESCs’’) should be explicitly excluded 

from the definition of covered fund.2085

One commenter alleged that, though 

many ESCs could qualify for the 

exemption in section 6(b) of the 

Investment Company Act, they often opt 

to rely on section 3(c)(1) or 3(c)(7) 

instead due to the fact that the section 

6(b) exemption is available only upon 

application to the SEC.2086 According to 

this commenter, the limitations 

contained in section 13 on employee 

investments and intercompany 

transactions with covered funds would 

severely limit the ability of a banking 

entity to design competitive employee 

compensation arrangements.2087 This 

commenter also argued that an 

exclusion should be provided for any 

investment vehicle that satisfies the 

definition of an ESC under section 

2(a)(13) of the Investment Company Act. 

After considering carefully the 

comments received on the proposed 

rule, the final rule does not provide a 

specific exclusion for ESCs because the 

Agencies believe that these vehicles 

may avoid being a covered fund by 

either complying with the conditions of 

another exclusion from the definition of 

covered fund or seeking and receiving 

an exemption available under section 

6(b) of the Investment Company Act. As 

such, the Agencies believe a banking 

entity has a reasonable alternative to 

design competitive employee 

compensation arrangements. The 

Agencies recognize that preparing an 

application under section 6(b) of the 

Investment Company Act or modifying 

an ESC’s activities to meet the terms of 

another exclusion from the covered 

fund definition is not without costs, but 

have determined to provide specific 

exclusions for entities that do not 

function as investment funds, consistent 

with the purpose of section 13, or in 

response to other unique considerations 

(e.g., to provide consistent treatment for 

certain foreign and domestic pension 

plans). These considerations do not 

support a separate exclusion for ESCs. 

The Agencies also note that nonqualified plans are not exempt from the 

Investment Company Act under 3(c)(11) 

and thus would be covered funds if they 

are operating in reliance on section 

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

Company Act. Some of these nonqualified plans may be formed as 

employees’ securities companies, 

however, and could qualify for an 

exemption under section 6(b) of the 

Investment Company Act for employees’ 

securities companies as discussed 

above. 

e. Definition of ‘‘Ownership Interest’’ 

The proposed rule defined 

‘‘ownership interest’’ in a covered fund 

to mean any equity, partnership, or 

other similar interest (including, 

without limitation, a share, equity 

security, warrant, option, general 

partnership interest, limited partnership 

interest, membership interest, trust 

certificate, or other similar instrument) 

in a covered fund, whether voting or 

nonvoting, as well as any derivative of 

such an interest.2088 This definition 

focused on the attributes of the interest 

and whether it provided a banking 

entity with economic exposure to the 

profits and losses of the covered fund, 

rather than its form. The proposal thus 

would also have included a debt 

security or other interest in a covered 

fund as an ownership interest if it 

exhibited substantially the same 

characteristics as an equity or other 

ownership interest (e.g., provides the 

holder with voting rights, the 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).2089 As 

described further below, the proposed 

rule excluded carried interest (termed 

‘‘restricted profit interest’’ in the final 

rule) from the definition of ownership 

interest. 

Many commenters argued that the 

proposed definition of ownership 

interest was too broad and urged 

excluding one or more types of interests 

from the definition. A number of 

commenters raised concerns regarding 

the difficulty of applying the ownership 

interest definition to securitization 

structures and questioned whether the 

definition of ownership interest might 

apply to a debt security issued by, or a 

debt interest in, a covered fund that has 

some characteristics similar to an equity 


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2090See AFME et al.; AFR et al. (Feb. 2012); ASF 

(Feb. 2012); BoA; Cadwalader (Municipal 

Securities); Credit Suisse (Williams); Deutsche Bank 

(Repackaging Transactions); Occupy; RBC; SIFMA 

et al. (Covered Funds) (Feb. 2012); SIFMA 

(Securitization) (Feb. 2012); TCW. For example, 

securitization structures generally provide that 

either the most senior or the most junior tranche 

notes have controlling voting rights. One 

commenter argued that under the proposed 

ownership interest definition, a banking entity 

could be deemed to have an ownership interest in 

an entity it does not own or sponsor simply due to 

its obtaining voting rights. See ASF (Feb. 2012). As 

a further example, one commenter alleged that 

securitization structures generally are not viewed as 

providing economic exposure to the profits and 

losses of the issuer in the same manner as equity 

interests in hedge funds and private equity funds. 

This commenter argued that the ownership interest 

definition should include only those interests that 

permit the banking entity to share without limit in 

the profits and losses or that earn a return that is 

based on the performance of the underlying assets. 

See SIFMA (Securitization) (Feb. 2012). 

2091See SIFMA et al. (Covered Funds) (Feb. 

2012). 

2092See AFME et al.; ASF (Feb. 2012); BoA; 

Cadwalader (Municipal Securities); RBC; SIFMA 

(Securitization) (Feb. 2012). These commenters 

argued that the ownership interest definition 

should not include tender option bond programs 

and other debt asset-backed securities. Two of these 

commenters argued that debt asset-backed 

securities should not be viewed as ownership 

interests because: (i) they are not typically viewed 

as having economic exposure to profits and losses 

of an ABS Issuer; (ii) they have a limited life, 

periodic fixed or fluctuating cumulative payments, 

and are senior to equity of the issuer should the 

issuer fail; (iii) they do not have perpetual life with 

broad voting rights, appreciation in the market 

value of the issuer and non-cumulative dividends, 

and subordination to the claims of debt holders if 

the issuer fails; and (iv) their limited voting rights 

(such as the rights to replace a servicer or manager) 

and such rights are protective in nature and similar 

to voting rights that accompany securities 

traditionally classified by the Agencies as debt 

securities (including securities formally structured 

as equity). See AFME et al.; SIFMA (Securitization) 

(Feb. 2012). One of these commenters argued that 

the ownership interest definition should be limited 

to those interests that share in the profits or losses 

of the relevant entity on an unlimited basis or that 

otherwise earn a return that is specifically based 

upon the performance of the underlying assets 

because the senior tranche in an asset-based 

securities transaction often has substantial voting 

rights and banking entities should not be penalized 

for requiring or otherwise obtaining voting rights 

that protect their interests. This commenter also 

expressed the view that banking entities should not 

be restricted from owning debt classes of new assetbacked securities because ‘‘doing so would 

substantially constrict the market for asset-backed 

securities.’’ See ASF (Feb. 2012). 2093See AFR et al. (Feb. 2012); Credit Suisse 

(Williams); Occupy. One of these commenters 

argued that any general statement about what 

instruments would be considered an ‘‘ownership 

interest’’ for purposes of securitization structures 

would be problematic and easy to evade because 

transaction documents underlying securitization 

structures are not standardized. This commenter 

suggested as an alternative using a safe harbor for 

standardized, pre-specified securitization 

structures. See AFR et al. (Feb. 2012). Another of 

these commenters argued that ‘‘it is difficult to 

characterize holders of ABS securities in most 

securitization structures as having ‘ownership 

interests’ in any common understanding of the 

term’’ and the concept of ownership interest is a 

‘‘poor fit for the securitization market, underscoring 

the benefits of excluding securitization issuers from 

the definition of covered fund entirely.’’ See Credit 

Suisse (Williams). 

2094See Credit Suisse (Williams). 

2095See Credit Suisse (Williams) (arguing that 

such arrangements are a fundamental part of a 

bank’s lending activities). 

2096See final rule § 75.10(d)(6). The concept of a 

restricted profit share was referred to as ‘‘carried 

interest’’ in the proposed rule, a term that is often 

used as a generic reference to performance-based 

allocations or compensation. The Agencies have 

instead used the term ‘‘restricted profit interest’’ in 

the final rule to avoid any confusion that could 

result from using a term that is also used in other 

contexts. The final rule focuses only on whether a 

profit interest is excluded from the definition of 

ownership interest under section 13, and the final 

rule does not address in any way the treatment of 

such profit interests under other laws, including 

under Federal income tax law. 

2097Each of these factors are designed to clarify 

the interests identified in the proposed definition 

of ownership interest as noted above. 

or other ownership interest.2090 One 

commenter argued that the ownership 

interest definition should not include 

debt instruments with equity features 

unless the Agencies determine with 

respect to a particular debt instrument, 

after appropriate notice and opportunity 

for hearing, that the equity features are 

so pervasive that the debt instrument is 

the functional equivalent of an equity 

interest or partnership interest and was 

structured to evade the prohibitions and 

restrictions in the proposal.2091 Several 

commenters argued that the Agencies 

should explicitly exclude certain debt 

instruments with equity features from 

the ownership interest definition.2092

Finally, certain commenters argued that, 

because the application of the 

ownership interest definition to 

securitization structures was 

problematic, alternative regulatory 

treatment was appropriate.2093

One commenter expressed concern 

over the proposal’s inclusion of 

‘‘derivatives’’ of ownership interests in 

the definition of ownership interest and 

recommended certain derivative 

interests of ownership interests in hedge 

funds and private equity funds not be 

included within the definition of 

ownership interest.2094 This commenter 

also recommended that the Agencies 

expressly exclude from the definition of 

ownership interest lending 

arrangements with a covered fund that 

contain protective covenants linking the 

interest rate on the loan to the profits of 

the borrowing fund.2095

As discussed in detail below, the 

Agencies are adopting the definition of 

‘‘ownership interest’’ largely as 

proposed but clarifying the scope of that 

definition, including with respect to the 

inclusion of interests that are linked to 

profits and losses of a covered fund and 

the exclusion for a restricted profit 

interest in a covered fund.2096 The 

definition is centered on equity 

interests, partnership interests, 

membership interests, trust certificates, 

and similar interests, and would not 

generally cover typical extensions of 

credit the terms of which provide for 

payment of stated principal and interest 

calculated at a fixed rate or at a floating 

rate based on an index or interbank rate. 

However, as under the proposal, to the 

extent that a debt security or other 

interest in a covered fund exhibits 

specified characteristics that are similar 

to those of equity or other ownership 

interests (e.g., provides the holder with 

the ability to participate in the election 

or removal of a party with investment 

discretion, the right or ability to share 

in the covered fund’s profits or losses, 

or the ability, directly or pursuant to a 

contract or synthetic interest, to earn a 

return based on the performance of the 

fund’s underlying holdings or 

investments), the instrument would be 

an ownership interest under the final 

rule. 

In response to commenters and in 

order to provide clarity about the types 

of interests that would be considered 

within the scope of ownership interest, 

the Agencies have revised the definition 

of ‘‘ownership interest’’ to define the 

term more clearly. The Agencies are not 

explicitly excluding or including debt 

securities, instruments or interests with 

equity features as requested by some 

commenters, but are instead identifying 

certain specific characteristics that 

would cause a particular interest, 

regardless of the name or legal form of 

that interest, to be included within the 

definition of ownership interest. The 

Agencies believe that this elaboration on 

the characteristics of an ownership 

interest will enable parties, including 

securitization structures, to more easily 

analyze whether their interest is an 

ownership interest, regardless of the 

type of legal entity or the name of the 

particular interest. 

As adopted, the final rule provides 

that an ownership interest would be any 

interest in or security issued by a 

covered fund that exhibits any of the 

following features or characteristics on 

a current, future, or contingent 

basis: 2097

• has the right to participate in the 

selection or removal of a general 

partner, managing member, member of 

the board of directors or trustees, 

investment manager, investment 

adviser, or commodity trading advisor 

of the covered fund. For purposes of the 

rule, this would not include the rights 

of a creditor to exercise remedies upon 

the occurrence of an event of default or 


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2098This characteristic exists for both multi-class 

and single-class covered funds. In the context of an 

entity that issues shares, this right could cover, for 

example, common shares, as well as preferred 

shares the dividend payments of which are 

determined by reference to the performance of the 

covered fund. 

2099The reference to ‘‘all or a portion of excess 

spread’’ is meant to include within the definition 

of ownership interest the right to receive any excess 

spread which remains after the excess spread is 

used to pay expenses, maintain credit enhancement 

such as overcollateralization or is otherwise 

reduced. 

2100This characteristic does not refer to any 

reduction in the stated claim to principal or interest 

of a holder of an interest that occurs either as a 

result of a bona fide subsequent renegotiation of the 

terms of an interest or as a result of a bankruptcy, 

insolvency, or similar proceeding. 

2101This provision is not intended to encompass 

derivative transactions entered into in connection 

with typical prime brokerage activities of banking 

entities. However, the activities of banking entities 

are subject to the anti-evasion provisions. 2102See supra note 2090. 2103See supra note 2092. 

similar rights arising due to an 

acceleration event; 

• has the right under the terms of the 

interest to receive a share of the income, 

gains or profits of the covered fund. 

This would apply regardless of whether 

the right is pro rata with other owners 

or holders of interests; 2098

• has the right to receive the 

underlying assets of the covered fund, 

after all other interests have been 

redeemed and/or paid in full 

(commonly known as the ‘‘residual’’ in 

securitizations). For purposes of the 

rule, this would not include the rights 

of a creditor to exercise remedies upon 

the occurrence of an event of default or 

similar rights arising due to an 

acceleration event; 

• has the right to receive all or a 

portion of excess spread (the positive 

difference, if any, between the aggregate 

interest payments received from the 

underlying assets of the covered fund 

and the aggregate interest paid to the 

holders of other outstanding 

interests); 2099

• provides that the amounts payable 

by the covered fund with respect to the 

interest could, under the terms of the 

interest, be reduced based on losses 

arising from the underlying assets of the 

covered fund, such as allocation of 

losses, write-downs or charge-offs of the 

outstanding principal balance, or 

reductions in the amount of interest due 

and payable on the interest; 2100

• receives income on a pass-through 

basis from the covered fund, or has a 

rate of return that is determined by 

reference to the performance of the 

underlying assets of the covered 

fund.2101 This provision would not 

include an interest that is entitled to 

receive dividend amounts calculated at 

a fixed or at a floating rate based on an 

index or interbank rate such as LIBOR; 

or 

• any synthetic right to have, receive 

or be allocated any of the rights above. 

This provision would not permit 

banking entities to obtain synthetic or 

derivative exposure to any of the 

characteristics identified above in order 

to avoid being considered to have an 

ownership interest in the covered fund. 

This definition of ‘‘ownership 

interest’’ is intended to address 

commenters’ concerns regarding the 

applicability of the ownership interest 

definition to different types of interests. 

The Agencies believe defining 

‘‘ownership interest’’ in this way will 

allow existing as well as potential 

holders of interests in covered funds, 

including securitizations, to effectively 

determine whether they have an 

ownership interest. As an example, this 

definition would include preferred 

stock, as well as a lending arrangement 

with a covered fund in which the 

interest or other payments are 

calculated by reference to the profits of 

the fund. As a contrasting example, the 

Agencies believe that a loan that 

provides for a step-up in interest rate 

margin when a covered fund has fallen 

below or breached a NAV trigger or 

other negotiated covenant would not 

generally be an ownership interest. 

Banking entities will be expected to 

evaluate the specific terms of their 

interests to determine whether any of 

the specified characteristics exist. In 

this manner, the Agencies believe that 

the definition of ownership interest in 

the final rule is clearer than under the 

proposal and thus should be less 

burdensome for banking entities in their 

determination of whether certain rights 

would cause an interest to be an 

ownership interest for purposes of 

compliance with the rule. 

As indicated above, many 

commenters on securitizations under 

the proposed rule made arguments 

regarding the difficulty of applying the 

proposal’s definition of ownership 

interest to securitization structures, 

contending that the definition should 

not include debt instruments with 

equity features, or that the final rule 

should provide a safe harbor under 

which the use of a standardized, prespecified securitization structure would 

not give rise to an ownership 

interest.2102 The Agencies are not 

adopting a separate definition of 

ownership interest for securitization 

transactions, providing for differing 

treatment of financial instruments, or 

providing a safe harbor as requested by 

some commenters. The revised 

definition of ownership interest will 

apply regardless of the type of legal 

entity or the name or legal form of the 

particular interest. The determination of 

whether an interest is an ownership 

interest under the final rule will depend 

on the features and characteristics of the 

particular interest, including the rights 

the particular interest provides its 

holder, including not only voting rights 

but also the right to receive a share of 

the income, gains, or profits of a covered 

fund, the right to receive a residual, the 

right to receive excess spread, and any 

synthetic or derivative that would 

provide similar rights. While some 

commenters argued that securities 

issued in asset-backed securities 

transactions and by tender option bond 

issuers should not be viewed as 

ownership interests due to the nature of 

the securities issued or the possible lack 

of exposure to profits and losses,2103 the 

Agencies do not believe that the type of 

covered fund involved or the type of 

security issued is an appropriate basis 

for determining whether there is an 

ownership interest for purposes of the 

restrictions contained in section 

13(a)(1)(B) of the BHC Act. The 

Agencies believe that making 

distinctions in the definition of 

ownership interest based on the type of 

entity or the type of security, in which 

many of the same rights exist as for 

other types of ownership interests, 

would not be consistent with the 

statutory restrictions on ownership. 

Similarly, while some commenters 

argued that including a safe harbor for 

standardized securitization structures 

would be more effective in identifying 

an ownership interest in securitizations, 

the Agencies believe that the type of 

interest and the rights associated with 

the interest are more appropriate to 

determine whether an interest is an 

ownership interest and is necessary to 

avoid potential evasion of the 

ownership restrictions contained in 

section 13 of the BHC Act. 

The Agencies understand that the 

definition of ownership interest in the 

final rule may include interests in a 

covered fund that might not be 

considered an ownership interest or 

equity interest in other contexts. For 

instance, it may include loans with an 

interest rate determined by reference to 

the performance of a covered fund or 

senior debt interests issued in a 

securitization. While the definition of 

ownership interest may affect the ability 

of a banking entity to hold such 

interests, whether existing or in the 

future, the Agencies believe that the 

definition of ownership interest as 


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5980 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

2104See proposed rule § 75.10(b)(3)(ii). 

2105See, e.g., Occupy; AFR et al. (Feb. 2012). 

2106See Public Citizens; see also Occupy. 

2107See AFR et al. (Feb. 2012). 

2108See Occupy; Public Citizens; AFR et al. (Feb. 

2012). 

2109See, e.g., SIFMA et al. (Covered Funds) (Feb. 

2012); TCW; Credit Suisse (Williams); SVB. 

2110See Credit Suisse (Williams). 

2111See TCW. 

2112See Credit Suisse (Williams). 

2113See TCW. 

2114See Credit Suisse (Williams). 

2115 Joint Proposal, 76 FR at 68899. 

adopted in the final rule is more 

effective in preventing possible evasion 

of section 13 by capturing interests that 

may be characterized as debt but confer 

benefits of ownership, including voting 

rights and/or the ability to participate in 

profits or losses of the covered fund. 

The definition of ownership interest 

in the final rule, like the proposed rule, 

includes derivatives of the interests 

described above. Derivatives of 

ownership interests provide holders 

with economic exposure to the profits 

and losses of the covered fund or an 

ability to earn a return based on the 

performance of the fund’s underlying 

holdings or investments in a manner 

substantially similar to an ownership 

interest. The Agencies believe the final 

rule’s approach appropriately addresses 

the statutory purpose to limit a banking 

entity’s economic exposure to covered 

funds, irrespective of the legal form, 

name, or issuer of that ownership 

interest. 

As noted above, the proposed 

definition of ownership interest did not 

include carried interest (termed 

‘‘restricted profit interest’’ in the final 

rule). The proposal recognized that 

many banking entities that serve as 

investment adviser or provide other 

services to a covered fund are routinely 

compensated for services they provide 

to the fund through receipt of carried 

interest. As a result, the proposed rule 

provided that an ownership interest 

with respect to a covered fund did not 

include an interest held by a banking 

entity (or an affiliate, subsidiary or 

employee thereof) in a covered fund for 

which the banking entity (or an affiliate, 

subsidiary or employee thereof) served 

as investment manager, investment 

adviser, or commodity trading advisor, 

so long as certain enumerated 

conditions were met.2104

The enumerated conditions contained 

in the proposal were designed to narrow 

the scope of the exclusion of carried 

interest from the definition of 

‘‘ownership interest’’ so as to 

distinguish between an investor’s 

economic risks and a service provider’s 

performance-based compensation. This 

was designed to limit the ability of a 

banking entity to structure carried 

interest in a manner that would evade 

section 13’s restriction on the amount of 

ownership interests a banking entity 

may have as an investment in a covered 

fund. 

Commenters disagreed over whether 

the definition of ownership interest 

should exclude carried interest. For 

instance, some commenters did not 

support excluding carried interest from 

the definition of ownership interest, 

arguing that such an exclusion was too 

permissive and inconsistent with the 

statute because, for instance, carried 

interest derives its value in part by 

tracking gains on price movements of 

investments by the fund.2105 One 

commenter argued that, despite the fact 

that carried interest is typically 

provided as compensation for services 

provided to a fund, carried interest is a 

form of investment and therefore should 

be included as an ownership 

interest.2106 Another commenter argued 

that permitting banking entities to hold 

an unrestricted amount of carried 

interest could create an indirect and 

undesirable link between prohibited 

proprietary trading and covered fund 

activities.2107 These commenters also 

argued that treating carried interest as 

compensation for providing services 

would be inconsistent with the manner 

in which carried interest is treated for 

tax purposes.2108

Other commenters, however, 

supported excluding carried interest 

from the definition of an ownership 

interest and argued the exclusion was 

consistent with the words and purpose 

of section 13.2109 One commenter 

argued that carried interest is readily 

distinguished from an investment in a 

covered fund because carried interest 

normally does not expose a banking 

entity to a covered fund’s losses (other 

than in limited instances such as when 

a ‘‘clawback’’ provision is triggered).2110

Another commenter argued that 

permitting a banking entity to receive 

carried interest without being subject to 

the requirements of section 13 regarding 

ownership interests better aligns the 

interest of the investment manager with 

that of the fund and its investors.2111

Another commenter supported 

expanding the definition of carried 

interest to include an interest received 

by a banking entity in return for 

qualifying services (e.g., lending, 

placement, distribution, or equity 

financing) provided to the investment 

manager of the fund, but not directly 

provided to the fund itself.2112

The proposal established four criteria 

that must be met in order for carried 

interest to be excluded from the 

definition of ownership interest. First, 

the proposal required that carried 

interest have the sole purpose and effect 

of permitting the banking entity or an 

employee thereof to share in the covered 

fund’s profits as performance 

compensation for services provided to 

the fund. While most commenters did 

not object to this criterion, one 

commenter argued that the wording of 

this approach would appear to prohibit 

an employee of the banking entity from 

retaining a carried interest after the 

employee has changed employment.2113

This commenter argued that the 

determination of the carried interest’s 

purpose should be made only at the 

time the interest is granted, thereby 

enabling an employee to retain the 

carried interest if and when the 

employee no longer provides 

investment management, investment 

advisory, or similar services to the fund 

or is no longer employed at the banking 

entity. 

Second, the proposal required that 

carried interest, once allocated, be 

distributed to the banking entity 

promptly after it is earned or, if not so 

distributed, not share in the subsequent 

profits and losses of the covered fund. 

One commenter urged the Agencies to 

allow the ‘‘reserve’’ portion of carried 

interest that for tax purposes is allocated 

to the investment manager or 

investment adviser, but invested 

alongside the fund and not formally 

allocated or distributed by the fund, also 

to qualify for the exclusion as carried 

interest.2114 This commenter also 

suggested that this criterion should not 

affect the common European structure 

in which allocated carried interest may 

share in the subsequent losses, but not 

the profits, of the fund. 

Third, under the proposal a banking 

entity (including its affiliates or 

employees) was not permitted to 

provide funds to the covered fund in 

connection with receiving a carried 

interest. The proposal specifically 

requested comment on whether the 

exemption for carried interest, including 

this requirement, was consistent with 

the current tax treatment and 

requirements of carried interest 

arrangements.2115 Commenters urged 

the Agencies to relax or amend this 

criterion so that banking entities, 

including their affiliates and employees, 

whether directly or indirectly through a 

fund vehicle, would be permitted to 

make minimal capital contributions to 

the fund (typically less than 1 percent) 

in connection with the receipt of carried 

interest to the extent that such 

contributions provide the basis for 


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2116See TCW; SIFMA (Covered Funds) (Feb. 

2012); Credit Suisse (Williams). 

2117See ASF (Feb. 2012); see also Credit Suisse 

(Williams); SVB. 

2118See TCW. 

2119See supra note 2096 and accompanying text. 2120See final rule § 75.10(d)(6)(ii). 

treating the interest as carried interest 

for tax purposes.2116 However, these 

commenters supported the proposal’s 

requirement that any amount 

contributed by a banking entity in 

connection with receiving a carried 

interest should be aggregated with the 

banking entity’s ownership interests for 

purposes of the 3 percent investment 

limits. 

Fourth, the proposal provided that 

carried interest may not be transferable 

by the banking entity (or the affiliate, 

subsidiary or employee thereof) except 

to another affiliate or subsidiary of the 

banking entity. Commenters generally 

urged removing the proposal’s 

limitations on transferability and 

argued, among other things, that this 

criterion could prevent a banking entity 

(or its affiliate or employee) from 

transferring the carried interest in 

connection with selling or otherwise 

transferring the provision of advisory or 

other services that gave rise to the 

carried interest.2117 Similarly, one 

commenter argued that the final rule 

should not require carried interest to be 

re-characterized as an ownership 

interest if it is transferred among 

employees, family members of 

employees or to estate planning vehicles 

upon an employee’s death.2118

After considering carefully comments 

received on the proposal, the Agencies 

have determined to retain in the final 

rule the exclusion from the definition of 

‘‘ownership interest’’ for a restricted 

profit interest (termed ‘‘carried interest’’ 

in the proposed rule 2119) largely as 

provided in the proposed rule. The final 

rule, like the proposal, recognizes that 

banking entities that serve as investment 

adviser or provide other services to a 

covered fund are routinely compensated 

for such services through receipt of a 

restricted profit interest. The final rule, 

also like the proposal, generally 

excludes restricted profit interest from 

the definition of ownership interest 

subject to conditions designed to 

distinguish restricted profit interest, 

which serves as a form of compensation, 

from an investment in the fund 

prohibited (or limited) by section 13. As 

explained in detail below, the definition 

of restricted profit interest in the final 

rule has been modified from the 

proposal in several aspects to respond to 

commenters’ concerns and to more 

effectively capture the types of 

compensation that is often granted in 

exchange for services provided to a 

fund. However, like the proposal, the 

final rule continues to contain a number 

of requirements designed to ensure that 

restricted profit interest functions as 

compensation for providing certain 

services to a covered fund and does not 

permit a banking entity to evade the 

investment limitations or other 

requirements of section 13. 

Under the final rule, restricted profit 

interest is defined to include an interest 

held by an entity (or employee or former 

employee thereof) that serves as 

investment manager, investment 

adviser, commodity trading advisor, or 

other service provider so long as: (i) The 

sole purpose and effect of the interest is 

to allow the entity (or an employee or 

former employee thereof) to share in the 

profits of the covered fund as 

performance compensation for the 

investment management, investment 

advisory, commodity trading advisory, 

or other services provided to the 

covered fund by the entity (or employee 

or former employee thereof), provided 

that the entity (or employee or former 

employee thereof) may be obligated 

under the terms of such interest to 

return profits previously received; (ii) 

all such profit, once allocated, is 

distributed to the entity (or employee or 

former employee thereof) promptly after 

being earned or, if not so distributed, is 

retained by the covered fund for the sole 

purpose of establishing a reserve 

amount to satisfy contractual obligations 

with respect to subsequent losses of the 

covered fund and such undistributed 

profit of the entity (or employee or 

former employee thereof) does not share 

in subsequent investment gains of the 

covered fund; (iii) any amounts invested 

in the covered fund, including any 

amounts paid by the entity (or employee 

or former employee thereof) in 

connection with obtaining the restricted 

profit interest, are within the investment 

limitations of § 75.12; and (iv) the 

interest is not transferable by the entity 

(or employee or former employee 

thereof) except to an affiliate thereof (or 

an employee of the banking entity or 

affiliate), to immediate family members, 

or through the intestacy of the employee 

or former employee, or in connection 

with a sale of the business that gave rise 

to the restricted profit interest by the 

entity (or employee or former employee 

thereof) to an unaffiliated party that 

provides investment management, 

investment advisory, commodity trading 

advisory, or other services to the 

fund.2120 The final rule, like the 

proposal, permits any entity (or the 

affiliate or employee thereof) to receive 

or hold restricted profit interest if the 

entity (or the affiliate or employee 

thereof) serves as investment manager, 

investment adviser, commodity trading 

advisor, or other service provider to the 

covered fund. For example, an entity 

that provides services to the covered 

fund in a capacity as sub-adviser or 

placement agent would be eligible to 

receive or hold restricted profit interest. 

As requested by commenters, the first 

condition in the final rule, in contrast to 

the proposal, permits an employee or 

former employee to retain a restricted 

profit interest after a change in 

employment status so long as the 

restricted profit interest was originally 

received as compensation for qualifying 

services provided to the covered fund. 

Also in response to issues raised by 

commenters, the second condition in 

the final rule has been modified to 

permit so-called ‘‘clawback’’ features 

whereby restricted profit interest that 

has been provided to an investment 

manager, investment adviser, 

commodity trading advisor, or similar 

service provider may be taken back if 

certain subsequent events occur, such as 

if the fund fails to achieve a specified 

preferred rate of return or if liabilities or 

subsequent losses are incurred by the 

fund. Under these circumstances, the 

Agencies believe it is appropriate to 

allow the allocated but undistributed 

profits to be clawed back from the 

service provider’s performance 

compensation, and the final rule has 

been amended to allow this practice. 

The final rule makes clear, however, 

that the undistributed profits may only 

be held in the fund in connection with 

such a clawback arrangement. 

Undistributed profits that remain in the 

covered fund after they have been 

allocated without connection to such an 

arrangement would be deemed to be an 

investment in the fund and would be an 

ownership interest under the final rule. 

Importantly, the final rule also retains 

the limitation in the proposal that 

undistributed profit may not share in 

subsequent investment gains of the 

covered fund. This limitation (together 

with the limited circumstances under 

which the undistributed profit may be 

retained in the fund) appears necessary 

in order to distinguish restricted profit 

interest, which functions as 

performance compensation and is not 

intended to be a form of investment, 

from an ownership interest, which is 

designed to be an investment. The 

Agencies believe that this approach 

achieves an appropriate balance 

between accommodating receipt of 

restricted profit interest, including such 


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2121The Agencies believe that this addresses a 

commenter’s concern regarding the ‘‘reserve’’ 

portion of carried interest discussed above; however 

such amounts may not share in subsequent 

investment gains of the covered fund for the reasons 

also discussed above. 

2122See proposed rule § 75.2(t); 17 CFR 230.901— 

230.905. 

2123See, e.g., Occupy. 

2124See Sens. Merkley & Levin (Feb. 2012) (citing 

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

(statement of Sen. Merkley)). 

2125See, e.g., Union Asset; EFAMA; BVI; AFME 

et al.; IIB/EBF; Credit Suisse (Williams); Hong Kong 

Inv. Funds Ass’n.; PEGCC; UBS; Allen & Overy (on 

behalf of Canadian Banks); Allen & Overy (on behalf 

of Foreign Bank Group); AFG. 

2126See PEGCC; Allen & Overy (on behalf of 

Canadian Banks); Allen & Overy (on behalf of 

Foreign Bank Group); ICI (Feb. 2012); Credit Suisse 

(Williams). 

2127See IIB/EBF; Credit Suisse (Williams); ICI 

(Feb. 2012); ICI Global; PEGCC. 

2128See IIB/EBF; ICI Global; Credit Suisse 

(Williams). 

2129See Allen & Overy (on behalf of Foreign Bank 

Group); IIB/EBF; PEGCC; Union Asset. 

2130See, e.g., MFA; TCW. 

amounts held in ‘‘reserve,’’ 2121 and 

limiting the ability of a banking entity 

to evade the investment limitations of 

section 13. The Agencies expect to 

review restricted profit interests to 

ensure banking entities do not use the 

exclusion for restricted profit interest in 

a manner that functions as an evasion of 

section 13. 

As noted above, the Agencies 

understand that entities that provide 

investment management, investment 

advisory, commodity trading advisory 

or other services to a covered fund may, 

in connection with receiving restricted 

profit interest, be required to hold a 

small amount of ownership interests in 

a fund to provide the basis for desired 

tax treatment of restricted profit interest. 

Accordingly, the third condition of the 

final rule allows an entity that provides 

qualifying services to a fund to 

contribute funds to, and have an 

ownership interest in, the fund in 

connection with receiving restricted 

profit interest. As under the proposal, 

the amount of the contribution must be 

counted toward the investment limits 

under section 13(d)(4) and § 75.12 of the 

final rule. This would include 

attribution to the banking entity of sums 

invested by employees in connection 

with obtaining a restricted profit 

interest. Thus, the final rule permits a 

banking entity that provides investment 

management, investment advisory, or 

commodity trading advisory services to 

have both an ownership interest in, and 

receive restricted profit interest from, 

the covered fund, so long as the 

aggregate of the sums invested in all 

ownership interests acquired or retained 

by the banking entity (including a 

general partnership interest), either in 

connection with receiving the restricted 

profit interest or as an investment, are 

within the investment limitations in 

section 13(d)(4) and § 75.12 of the final 

rule. The Agencies believe this more 

appropriately implements the 

requirements of section 13 of the BHC 

Act by permitting banking entities to 

continue to provide customer-driven 

investment management services 

through organizing and offering covered 

funds, while also abiding by the 

investment limitations of section 13. 

In response to comments, the fourth 

condition of the final rule permits the 

transfer of a restricted profit interest in 

connection with a sale to an unaffiliated 

party that provides investment 

management, investment advisory, 

commodity trading advisory, or other 

services to the fund. In response to 

comments, the final rule also permits 

the transfer of a restricted profit interest 

to immediate family members of the 

banking entity’s employees or former 

employees that provide investment 

management, investment advisory, 

commodity trading advisory, or other 

services to the covered fund, or in 

connection with the death of such 

employee. Also in response to 

comments, the final rule permits the 

transfer of a restricted profit interest to 

an affiliate or employee that provides 

investment management, investment 

advisory, commodity trading advisory, 

or other services to the covered fund. 

However, the final rule, like the 

proposed rule, would treat a restricted 

profit interest as an ownership interest 

if the restricted profit interest is 

otherwise transferable. This remaining 

restriction recognizes that a freely 

transferable restricted profit interest has 

the same economic benefits as an 

ownership interest and is essential to 

differentiating a restricted profit interest 

from an ownership interest. 

f. Definition of ‘‘Resident of the United 

States’’ 

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

provides that a foreign banking entity 

may acquire or retain an ownership 

interest in or act as sponsor to a covered 

fund, but only if that activity is 

conducted according to the 

requirements of the statute, including 

that no ownership interest in the 

covered fund is offered for sale or sold 

to a ‘‘resident of the United States.’’ The 

statute does not define this term. 

Under the proposed rule, the term 

‘‘resident of the United States’’ was used 

in the context of the exemptions for 

covered trading and covered fund 

activities. As proposed, the definition of 

resident of the United States was 

similar, but not identical, to the SEC’s 

definition of U.S. person in Regulation 

S, which governs offerings of securities 

outside of the United States.2122 The 

Agencies proposed this approach in 

order to promote consistency and 

understanding among market 

participants that have experience with 

the concept from the SEC’s Regulation 

S. 

Some commenters supported the 

proposed definition of resident of the 

United States.2123 One commenter 

suggested that the proposed rule defined 

resident of the United States too broadly 

and inappropriately precluded 

investments in U.S. funds by foreign 

banking entities.2124

Other commenters generally argued 

that the final rule should adopt the 

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

SEC’s Regulation S without the 

modifications in the proposed rule.2125

According to many commenters, market 

participants are familiar with and rely 

upon the body of law interpreting U.S. 

Person under Regulation S.2126 They 

argued that, to the extent that the 

definitions of ‘‘resident of the United 

States’’ under section 13 and ‘‘U.S. 

person’’ under Regulation S differ, this 

would create unnecessary uncertainty 

and increase compliance burdens 

associated with monitoring multiple 

definitions.2127 Other commenters urged 

the Agencies not to depart from the 

treatment of international parties and 

organizations (e.g., the International 

Monetary Fund and the World Bank) 

under the SEC’s Regulation S.2128

Many commenters contended that, 

because the definition of resident of the 

United States in the proposal was 

generally broader than the definition of 

U.S. person under Regulation S, many 

additional types of persons, entities and 

investors would be deemed residents of 

the United States for purposes of the 

foreign activity exemptions. 

Commenters argued that this would 

limit the potential for foreign banking 

entities to effectively use those 

statutorily provided exemptions. A few 

commenters noted that using a 

definition in the foreign fund exemption 

that differs from the definition in 

Regulation S loses the advantage of 

using a term that is already understood 

by market participants and that avoids 

confusion and limits compliance 

costs.2129

Other commenters suggested that 

defining resident of the United States as 

proposed presented problems for 

investment funds managed by U.S. 

investment advisers, even those without 

U.S. investors.2130 Some commenters 

argued that, under the proposed 


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2131See AFG; BVI. See also MFA; TCW. 

Similarly, these commenters argued that although 

treated as a non-U.S. person under Regulation S, a 

non-U.S. fund organized as a trust in accordance 

with local law with a limited number of U.S. 

investors would have been a resident of the United 

States. Under the proposal, this foreign fund could 

not invest in another foreign covered fund seeking 

to rely on the exemption for covered fund activities 

or investments that occur solely outside of the 

United States. 

2132See IIB/EBF; Credit Suisse (Williams); UBS; 

JPMC. 

2133See 156 Cong. Reg. S.5894–5895 (daily ed. 

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

2134Offers and Sales, Securities Act Release No. 

6863 (Apr. 24, 1990) 55 FR 18306 (May 2, 1990). 

2135See final rule § 75.10(d)(8). 

2136See infra Part VI.B.4.b.3. 

2137See 12 U.S.C. 1851(h)(5). 

2138See 12 U.S.C. 1851(a)(1). 

2139See proposed rule 75.10(b)(5). 

2140A number of comments received regarding 

the definition of sponsor relate to securitization 

structures and are addressed below. There also were 

a few comments urging that insurance companies 

not be considered to sponsor their separate 

accounts. See Sutherland (on behalf of Comm. of 

Annuity Insurers); Nationwide. The Agencies 

believe these concerns should be addressed by the 

exclusion of separate accounts from the definition 

of covered fund, as discussed in Part VI.B.1.c.6. of 

this SUPPLEMENTARY INFORMATION. 

2141See, e.g., ASF (Feb. 2012); BNY Mellon et al.; 

Credit Suisse (Williams). 

2142See proposed rule § 75.10(b)(6); see also 29 

U.S.C. 1103(a)(1). 

2143See, e.g., Arnold & Porter; Ass’n. of Global 

Custodians; BNY Mellon et al.; SIFMA et al. 

(Covered Funds) (Feb. 2012); State Street (Feb. 

2012); see also Fin. Services Roundtable (June 14, 

2011) (recommending the definition of directed 

trustee under the Board’s Regulation R be used, 

which defines directed trustee to mean ‘‘a trustee 

that does not exercise investment discretion with 

respect to the account’’). 

definition, a foreign fund managed by a 

U.S. investment adviser or sub-adviser 

that is not otherwise subject to section 

13 might be deemed a resident of the 

United States, thereby disqualifying the 

fund from relying on the foreign funds 

exemption, a result inconsistent with 

the purpose of section 13 and the 

statutory exemption in section 

13(d)(1)(I).2131

Commenters also argued that the 

proposed definition raised issues for 

compensation plans of international 

organizations that are subject to section 

13 of the BHC Act. Several commenters 

argued that U.S. employees of a foreign 

banking entity should not be considered 

residents of the United States if they 

invest in a non-U.S. covered fund 

pursuant to a bona fide employee 

investment, retirement or compensation 

program.2132 The Agencies have 

carefully considered the comments 

received on the definition of resident of 

the United States, and have determined 

to modify the final rule as discussed 

below. The term ‘‘resident of the United 

States’’ is not defined in the statute and 

is used by the statute to clarify when 

foreign activity or investment of a 

foreign banking entity qualifies for the 

foreign funds exemption in section 

13(d)(1)(I). The purpose of this 

exemption is to enable foreign banking 

entities to continue to engage in foreign 

funds activities and investments that do 

not have a sufficient nexus to the United 

States so as to present risk to U.S. 

investors or the U.S. financial 

system.2133 The purpose of Regulation S 

is to provide a safe harbor from the 

registration provisions under the 

Securities Act for offerings that take 

place outside of the United States.2134

The Agencies believe that, because 

the covered funds provisions of the final 

rule involve sponsoring covered funds 

and offering and selling securities 

issued by funds (as compared to 

counterparty transactional 

relationships), the securities law 

framework reflected in Regulation S 

would most effectively achieve the 

purpose of the foreign funds exemption. 

As noted by commenters and discussed 

above, market participants are familiar 

with and rely upon the body of law 

interpreting U.S. Person under 

Regulation S, and differing definitions 

under section 13 and Regulation S could 

create uncertainty and increase 

compliance burdens associated with 

monitoring multiple definitions. The 

Agencies therefore have defined the 

term ‘‘resident of the United States’’ in 

the final rule to mean a ‘‘U.S. person’’ 

as defined in Regulation S.2135

In addition, as explained in detail 

below in Part VI.B.4.b.3. of this 

SUPPLEMENTARY INFORMATION, the final 

rule provides that an ownership interest 

is offered for sale or sold to a resident 

of the United States if it is sold in an 

offering that ‘‘targets’’ residents of the 

United States.2136 As explained in more 

detail in that section, this approach is 

consistent with Regulation S. 

g. Definition of ‘‘Sponsor’’ 

Section 13(h)(5) of the BHC Act 

defines ‘‘sponsor’’ to mean: (i) serving as 

a general partner, managing member, or 

trustee of a covered fund; (ii) in any 

manner selecting or controlling (or to 

have employees, officers, or directors, or 

agents who constitute) a majority of the 

directors, trustees, or management of a 

covered fund; or (iii) sharing with a 

covered fund, for corporate, marketing, 

promotional, or other purposes, the 

same name or a variation of the same 

name.2137 Sponsor is a key definition 

because it defines, in part, the scope of 

activities to which the prohibition in 

section 13(a)(1) applies.2138

Under the proposal, the term sponsor 

would have been defined largely as in 

the statute.2139 Nearly all commenters 

who addressed the definition of sponsor 

argued that the definition was too broad 

and suggested various ways to narrow or 

limit the definition.2140 Commenters 

generally expressed concerns that a 

sponsor to a covered fund became 

subject to the restrictions of section 

13(f), limiting the relationships of the 

banking entity with the covered fund. 

Commenters argued this would prevent 

banking entities from providing many 

customary services to covered funds.2141

The proposal excluded from the 

definition of ‘‘trustee’’ as used in the 

term sponsor a trustee that does not 

exercise investment discretion with 

respect to a covered fund, including a 

directed trustee, as that term is used in 

section 403(a)(1) of the Employee’s 

Retirement Income Security Act 

(‘‘ERISA’’) (29 U.S.C. 1103(a)(1)).2142 On 

the other hand, the proposal provided 

that any banking entity that directs a 

directed trustee, or that possesses 

authority and discretion to manage and 

control the assets of a covered fund for 

which a directed trustee serves as 

trustee, would be considered a trustee of 

the covered fund. 

Commenters generally supported the 

exception for directed trustees in the 

proposed rule but argued that the 

exception was too narrow because it 

only referred to directed trustees under 

section 403(a)(1) of the ERISA and did 

not include other similar custodial or 

administrative arrangements that may 

not meet those requirements or be 

subject to ERISA.2143 These commenters 

argued that banking entities that serve 

as trustees or custodians of covered 

funds may provide a limited range of 

ministerial services or exercise limited 

fiduciary duties that, while not subject 

to ERISA or beyond those permitted for 

a directed trustee under ERISA, 

nevertheless do not involve the exercise 

of investment discretion or control over 

the operations of the covered fund in 

the same manner as a general partner or 

managing member. Some of these 

commenters advocated defining 

‘‘directed trustee’’ more expansively to 

include any situation in which a 

banking entity serves solely in a 

directed, fiduciary, or administrative 

role where a third-party and not the 

banking entity exercises investment 

discretion. 

In particular, some commenters also 

argued that a trustee should not be 

viewed as having investment discretion, 

and therefore should not be treated as a 

sponsor, if it possesses only the 

authority to terminate an investment 

adviser to a covered fund and to appoint 

another unaffiliated investment adviser 


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2144See BNY Mellon et al. (providing proposed 

rule text or suggesting in the alternative 

clarification regarding the phrase ‘‘exercise 

investment discretion’’ in the final rule preamble); 

Ass’n. of Global Custodians; ICI Global; State Street 

(Feb. 2012). 

2145See Ass’n. of Global Custodians; SIFMA et al. 

(Covered Funds) (Feb. 2012); ABA (Keating); AFG; 

AFTI; BNY Mellon et al.; EFAMA; IMA; State Street 

(Feb. 2012). 

2146See Arnold & Porter. To the extent that a 

client trust account would not be an investment 

company but for the exclusion contained in section 

3(c)(1) or 3(c)(7) of the Investment Company Act, 

such as the exclusion for common trust funds under 

section 3(c)(3) of that Act, it would not be a covered 

fund regardless of whether a banking entity acts as 

trustee. 

2147See BNY Mellon et al. 

2148See EFAMA; F&C; IRSG; Union Asset. 

2149See SIFMA et al. (Covered Funds) (Feb. 2012) 

(recommending the Agencies adopt independence 

guidelines similar to the FDIC’s guidelines for 

determining whether audit committee members of 

insured depository institutions are ‘‘independent’’ 

of management); Credit Suisse (Williams). 2150See Credit Suisse (Williams) (arguing that 

such an approach would be consistent with the 

existing BHC Act concept of control with respect to 

funds). 

2151A number of comments were also received 

regarding the restriction on name sharing that is one 

of the requirements of section 13(d)(1)(G) and 

§ 75.11 of the proposed rule. These comments are 

discussed in Part VI.B.2.a.5. of this SUPPLEMENTARY

INFORMATION. 

2152See Credit Suisse (Williams); see also ABA 

(Keating); BlackRock; Goldman (Covered Funds); 

SIFMA et al. (Covered Funds) (Feb. 2012); TCW 

(proposing similarly to limit the name-sharing 

restriction to the insured depository institution in 

context of section 13(d)(1)(G)). 

2153See Goldman (Covered Funds). 

2154See Credit Suisse (Williams); see also 

Goldman (Covered Funds). 

2155See Credit Suisse (Williams). 

2156See final rule § 75.10(d)(9). Some commenters 

asserted that custodians and service providers 

should not treated as sponsors under the final rule. 

The Agencies note, however, that a banking entity 

is not a sponsor under the final rule unless it serves 

in one or more of the capacities specified in the 

definition; controls or makes up the fund’s board 

of directors or management as described in the final 

rule; or shares the same name or a variation of the 

same name with the fund as described in the final 

in order to fulfill a demonstrable legal 

or contractual obligation of the trustee, 

or the formal but unexercised power to 

make investment decisions for a covered 

fund in circumstances where one or 

more unaffiliated investment advisers 

have been appointed to manage fund 

assets. Some commenters argued in 

favor of excluding trustees serving 

under non-U.S. trust arrangements 

pursuant to which they may have legal 

or contractual authority to, but in fact 

do not, exercise investment discretion 

(i.e., the entity has the formal authority 

to appoint an investment adviser to a 

trust but does so only in extraordinary 

circumstances such as appointing a 

successor investment adviser).2144

A few commenters requested 

confirmation that a banking entity 

acting as a custodian should not be 

considered a sponsor of a covered 

fund.2145 One commenter argued that 

traditional client trust accounts for 

which a bank serves as discretionary 

trustee should not, by implication, 

themselves become ‘‘covered funds’’ 

that are ‘‘sponsored’’ by the bank.2146

One commenter argued that any 

person performing similar functions to a 

directed trustee (such as a fund 

management company established 

under Irish law), regardless of its formal 

title or position, also should be 

excluded if the person does not exercise 

investment discretion.2147 Some 

commenters argued more generally for 

an exclusion from the definition of 

trustee (and therefore from the 

definition of sponsor) for entities that 

act as service providers (such as 

custodians, trustees, or administrators) 

to non-U.S. regulated funds, arguing 

that European laws already impose 

significant obligations on entities 

serving in these roles.2148

Under both section 13 of the BHC Act 

and the proposal, the definition of 

sponsor also included the ability to 

select or control (or to have employees, 

officers, directors, or agents who 

constitute) a majority of the directors, 

trustees or management of a covered 

fund. Some commenters argued that an 

entity should not be treated as a sponsor 

of a covered fund when it selects a 

majority of the initial directors, trustees 

or management of a covered fund that 

are independent of the banking entity, 

so long as the banking entity may not 

remove or replace the directors, trustees, 

or management and directors are 

subsequently either chosen by others or 

self-perpetuating.2149 One of these 

commenters argued similarly that a 

banking entity should not be deemed to 

sponsor a covered fund if it selects an 

independent general partner, managing 

member or trustee of a new fund, so 

long as the general partner, managing 

member or trustee may not be 

terminated and replaced by the banking 

entity.2150 Commenters argued that 

initial selection of these parties was 

inherently part of, and necessary to 

allow, the formation of a covered fund 

and would not provide a banking entity 

with ongoing control over the fund to a 

degree that the banking entity should be 

considered to be a sponsor. 

The statute and proposed rule also 

defined the term sponsor to include an 

entity that shares, for corporate, 

marketing, promotional, or other 

purposes, the same name or a variation 

of the same name, with a covered fund. 

One commenter argued in favor of a 

narrower interpretation of this statutory 

provision.2151 This commenter argued 

that a covered fund should be permitted 

to share the name of the asset manager 

that advises the fund without the asset 

manager becoming a sponsor so long as 

the asset manager does not share the 

same name as an affiliated insured 

depository institution or the ultimate 

parent of an affiliated insured 

depository institution.2152 Another 

commenter argued that the proposal 

would put U.S. banking entities at a 

competitive disadvantage relative to 

non-banking entities and foreign 

banks.2153 These commenters argued 

that the costs of rebranding covered 

funds or an asset manager would far 

outweigh any potential benefit in terms 

of reducing the risk that a banking entity 

may be pressured to ‘‘bail out’’ a 

covered fund with a name similar to its 

investment manager.2154 One 

commenter also requested clarification 

that the name sharing prohibition does 

not apply in the context of offering 

documents that carry the names of the 

manager, sponsor, distributor, as well as 

the name of the fund itself.2155 This 

commenter also advocated that, because 

of the costs associated with changing a 

fund name, the Agencies give specific 

guidance regarding how similar a name 

may be so as not to be a ‘‘variation of 

the same name’’ for purposes of the 

definition of sponsor and the activities 

permitted under section 13(d)(1)(G) and 

§ 75.11 of the rule. 

The Agencies have carefully 

considered comments received in light 

of the terms of the statute. Section 

13(h)(5) of the BHC Act specifically 

defines the term ‘‘sponsor’’ for purposes 

of section 13. The Agencies recognize 

that the broad definition of sponsor in 

the statute will result in some of the 

effects commenters identified, as 

discussed above. 

The final rule generally retains the 

definition of ‘‘sponsor’’ in the statute 

and the proposed rule, although with 

certain modifications and clarifications 

to respond to comments received 

regarding the exclusion for ‘‘directed 

trustees.’’ As in the proposed rule, the 

definition of sponsor in the final rule 

covers an entity that (i) serves as general 

partner, managing member, or trustee of 

a covered fund, or that serves as a 

commodity pool operator of a covered 

fund as defined in § 75.10(b)(1)(ii) of the 

final rule, (ii) in any manner selects or 

controls (or has employees, officers, or 

directors, or agents who constitute) a 

majority of the directors, trustees, or 

management of a covered fund, or (iii) 

shares with a covered fund, for 

corporate, marketing, promotional, or 

other purposes, the same name or a 

variation of the same name.2156


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rule. See, e.g., supra note 2156 and accompanying 

text. See also infra note 2160. 

2157See supra note 2149 and accompanying text. 

2158Similarly, a banking entity may share the 

same name or a variation of the same name with 

a covered fund so long as the banking entity does 

not organize and offer the covered fund in 

accordance with section 13(d)(1)(G) and § 75.11. 

2159See, e.g., supra notes 2143–2144 and 

accompanying text. See also supra note 2156. 

2160See final rule § 75.10(d)(10). With respect to 

the concept of a ‘‘directed trustee’’ under foreign 

law, commenters generally requested changes only 

if non-U.S. mutual fund equivalents were not 

excluded from the definition of covered fund. As 

discussed above, the final rule explicitly excludes 

foreign public funds from the definition of covered 

fund, which should address these commenters 

concerns. See final rule § 75.10(c)(1). 

2161See supra notes 2151–2155 and 

accompanying text. 

2162See infra note 2164. 

2163See supra note 2153 and accompanying text. 

2164For example, one commenter argued that it 

would need to rebrand approximately 500 

established funds under the rule proposal if the 

final rule was not modified to exclude established 

and regulated funds in foreign jurisdictions. See 

Goldman (Covered Funds). 

2165See Allen & Overy (on behalf of Foreign Bank 

Group); ASF (Feb. 2012); Credit Suisse (Williams); 

SIFMA (Securitization) (Feb. 2012); Wells Fargo 

(Covered Funds). One of these commenters argued 

that servicers will not have the right to control the 

decision-making and operational functions of the 

issuer. See SIFMA (Securitization) (Feb. 2012). 

Another commenter stated that servicers do not 

have the authority to select assets or make 

investment decisions on behalf of investors. See 

PNC. 

2166See ASF (Feb. 2012). 

While commenters urged the 

Agencies to provide an exemption from 

the definition of sponsor for a banking 

entity that selects the initial directors, 

trustees, or management of a fund,2157

the final rule has not been modified in 

this manner because the initial selection 

of the directors, trustees or management 

of a fund is an action characteristic of 

a sponsor and is essential to the creation 

of a covered fund. The Agencies note, 

however, that the statute and the final 

rule allow banking entities to sponsor 

covered funds, including selecting the 

initial board of directors, trustees and 

management, so long as the banking 

entity observes certain requirements and 

conforms any initial investment in the 

covered fund to the limits in the statute 

and regulation during the relevant 

conformance period as discussed in Part 

VI.B.3.b. of this SUPPLEMENTARY

INFORMATION.2158 Moreover, a banking 

entity that does not continue to select or 

control a majority of the board of 

directors would not be considered to be 

a sponsor under this part of the 

definition once that role or control 

terminates. In the case of a covered fund 

that will have a self-perpetuating board 

of directors or a board selected by the 

fund’s shareholders, this would not be 

considered to have occurred until the 

board has held its first re-selection of 

directors or first shareholder vote on 

directors without selection or control by 

the banking entity. 

As explained below, the Agencies 

believe that, in context, the term trustee 

in the definition of the term sponsor 

refers to a trustee with investment 

discretion. Consistent with this view, 

commenters urged the Agencies to 

exclude from the definition of sponsor 

certain trustees and parties commenters 

asserted acted in a similar capacity, as 

discussed above.2159 The final rule 

therefore has been modified to exclude 

from the definition of trustee: (i) a 

trustee that does not exercise 

investment discretion with respect to a 

covered fund, including a trustee that is 

subject to the direction of an 

unaffiliated named fiduciary who is not 

a trustee pursuant to section 403(a)(1) of 

the Employee’s Retirement Income 

Security Act (29 U.S.C. 1103(a)(1)); or 

(ii) a trustee that is subject to fiduciary 

standards imposed under foreign law 

that are substantially equivalent to those 

described in paragraph (i).2160 Under 

the final rule, a trustee would be 

excluded if the trustee does not have 

any investment discretion, but is 

required to ensure that the underlying 

assets are appropriately segregated for 

the benefit of the trust. Similarly, a 

trustee would be excluded if the trustee 

has no investment discretion but is 

authorized to replace an investment 

adviser with an unaffiliated party when 

the investment adviser resigns. With 

respect to an issuing entity of assetbacked securities and as explained 

below, a directed trustee excluded from 

the definition of sponsor would include 

a person that conducts their actions 

solely in accordance with directions 

prepared by an unaffiliated party. 

The Agencies believe that this 

exclusion is appropriate because the 

relevant prong of the definition of 

sponsor (i.e., serving as general partner, 

managing member, or trustee) specifies 

entities that have the ongoing ability to 

exercise control over a fund; directed 

trustees excluded from definition of 

sponsor in the final rule do not appear 

to have this ability and thus do not 

appear to be the type of entity that this 

prong of the definition of sponsor was 

intended to capture. If a trustee were 

itself to assume the role of investment 

adviser, or have the ability to exercise 

investment discretion with respect to 

the covered fund, the trustee would not 

qualify for this exclusion. The final rule 

does not include within the definition 

of sponsor custodians or administrators 

of covered funds unless they otherwise 

meet the definitional qualifications set 

forth in section 13 and the final rule. 

The definition of sponsor will 

continue to cover entities that share the 

same name or variation of the same 

name of a covered fund for corporate, 

marketing, promotional, or other 

purposes, consistent with the definition 

of sponsor in section 13(h)(5). The 

Agencies recognize that some 

commenters urged the Agencies to 

modify this aspect of the definition of 

sponsor, and that the name-sharing 

prohibition included in the definition of 

sponsor (and in the conditions for the 

organize and offer exemption) will 

require some banking entities to rebrand 

their covered funds, which may prove 

expensive and will limit the extent to 

which banking entities may continue to 

benefit from brand equity they have 

developed.2161 The costs a banking 

entity would incur to rebrand its 

covered funds would depend on the 

cost to rebrand the banking entity’s 

current funds, as well as the banking 

entity’s ability to attract new investor 

capital to its current and future covered 

funds. The total burden per banking 

entity, therefore, would depend on the 

brand equity as well as the number of 

covered funds that share a similar 

name.2162 One commenter argued that, 

as a result, banking entities subject to 

section 13 may be at a competitive 

disadvantage to other firms that are not 

subject to these or similar 

restrictions.2163 The Agencies believe 

that the final rule addresses some 

commenters’ concerns to an extent by 

adopting a more tailored definition of 

covered, including a focused definition 

of foreign funds that will be covered 

funds and an exclusion for foreign 

public funds.2164 In addition, to the 

extent that a banking entity would 

otherwise come under pressure for 

reputational reasons to directly or 

indirectly assist a covered fund under 

distress that bears the banking entity’s 

name, the name-sharing prohibition 

could reduce the risk to the banking 

entity this assistance could pose. 

1. Definition of Sponsor With Respect to 

Securitizations 

Commenters on the definition of 

sponsor in the context of securitization 

vehicles generally argued that the 

proposed definition of sponsor was too 

broad and requested clarification that 

various roles that banking entities might 

serve within a securitization structure 

would be excluded from the definition 

of sponsor, including servicers; 2165

backup servicers and master 

servicers; 2166 collateral agents and 


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2167 Id. 

2168See Allen & Overy (on behalf of Foreign Bank 

Group); ASF (Feb. 2012). 

2169 Id. 

2170See Cleary Gottlieb; Credit Suisse (Williams); 

SIFMA (Securitization) (Feb. 2012); Wells Fargo 

(Covered Funds). One of these commentators 

argued that placement agents and underwriters will 

not have the right to control the decision-making 

and operational functions of the issuer. See SIFMA 

(Securitization) (Feb. 2012). 

2171See Cleary Gottlieb (‘‘party that structures the 

asset-backed securities’’); SIFMA (Securitization) 

(Feb. 2012). 

2172See Credit Suisse (Williams); Wells Fargo 

(Covered Funds). 

2173See SIFMA (Securitization) (Feb. 2012) 

(arguing that Regulation AB sponsors will not have 

the right to control the decision-making and 

operational functions of the issuer after they deposit 

the assets). 

2174See Credit Suisse (Williams). 

2175See ASF (Feb. 2012); Wells Fargo (Covered 

Funds). 

2176See Allen & Overy (on behalf of Foreign Bank 

Group). 

2177See SIFMA (Securitization) (Feb. 2012). 

2178See Credit Suisse (Williams). 

2179See Occupy. 

2180See ASF (Feb. 2012); Credit Suisse 

(Williams). 

2181See ASF (Feb. 2012) (arguing that service 

providers, including trustees, custodians, collateral 

agents, servicers, master servicers, backup servicers, 

securities administrators, remarketing agents and 

collateral administrators, should not be considered 

the sponsor or investment manager of a fund under 

section 13 of the BHC Act because they have roles 

that are principally ministerial in nature and do not 

generally involve investment discretion or 

management and control activities); PNC (arguing 

that a banking entity should not be deemed a 

sponsor simply by serving as underwriter, 

distributor, placement agent, originator, depositor, 

investment adviser, servicer, administrative agent, 

securitizer or similar role because these parties do 

not have the authority to select assets or make 

investment decisions on behalf of investors). 

2182See Allen & Overy (on behalf of Foreign Bank 

Group); ASF (Feb. 2012); SIFMA (Securitization) 

(Feb. 2012). One commenter argued that the limited 

discretion that a servicer, trustee or custodian may 

have to either invest funds within certain 

parameters, liquidate assets following a default on 

the asset or the securitization default, or mitigate 

losses subject to a servicing standard, should not be 

considered a sponsor because these entities do not 

exercise the level of management and control 

exercised by the general partner or managing 

member of a hedge fund or private equity fund. 

Another commenter argued that to the extent that 

any of these parties exercises discretion, such 

discretion (A) involves decisions made after another 

party defaults (e.g., post-event of default collateral 

sale), (B) prescribed by the transaction documents 

(e.g., choosing among a limited number of eligible 

investments) and (C) governed by standards of care 

(e.g., the servicing standards). See ASF (Feb. 2012). 

Another commenter requested clarification that the 

exclusion of trustees that do not exercise 

investment discretion would also cover trustees that 

(A) direct investment of amounts in accordance 

with the applicable transaction documents, (B) act 

as servicer pending the appointment of a successor 

or (C) liquidate collateral. See SIFMA 

(Securitization) (Feb. 2012). One commenter argued 

that the definition of sponsor should not include an 

investment manager unless the investment manager 

(A) serves in one of the capacities designated in the 

definition of sponsor and can be replaced at the 

discretion of one or more entities serving in such 

capacity or with or without cause by the security 

holders or (B) has the ‘‘discretion to acquire or 

dispose of assets in the securitization for the 

primary purpose of recognizing gains or decreasing 

losses resulting from market value changes.’’ Id. 

2183See Credit Suisse (Williams); SIFMA 

(Securitization) (Feb. 2012); TCW (arguing that the 

investment manager is typically unaffiliated with 

the general partner or equivalent of such fund, does 

not control the board of directors, is not responsible 

for the operations or books and records of the fund 

and generally does not perform any other 

significant function for the fund, such as acting as 

transfer agent). 

2184As discussed above, commenters argued that 

that various roles that banking entities might serve 

within a securitization structure should be 

excluded from the definition of sponsor. See supra 

notes 2165–2175 and accompanying text. 

2185The Agencies also note that, while the 

entities commenters identified may not fall into the 

definition of sponsor, the ability of a banking entity 

to acquire and retain an interest in a securitization 

that is a covered fund will depend on whether it 

conducts its activity in a manner permitted under 

one of the exemptions contained in section 13(d)(1) 

of the BHC Act, such as the exemption for 

organizing and offering a covered fund. 

administrators; 2167 custodians; 2168

indenture trustees; 2169 underwriters, 

distributors, placement agents; 2170

arrangers, structuring agents; 2171

originators, depositors, securitizers; 2172

‘‘sponsors’’ under the SEC’s Regulation 

AB; 2173 administrative agents; 2174 and 

securities administrators and 

remarketing agents.2175 Commenters 

argued that these parties should not be 

included in the definition of sponsor 

because such parties have clearly 

defined and extremely limited authority 

and discretion,2176 do not have the right 

to control the decision-making and 

operational functions of the issuer,2177

and would not have ‘‘control’’ under 

BHC Act control precedent.2178

Conversely, one commentator supported 

defining sponsor under the proposed 

rule to include the Regulation AB 

sponsor, the servicer and the investment 

manager.2179 Commenters also made 

arguments regarding the potential 

detrimental effects to securitization and 

credit markets if banking entities are 

prohibited from acting as sponsors of 

securitizations.2180

Commenters disagreed as to whether 

or not a sponsor under the final rule 

should include a party with any 

investment discretion, some investment 

discretion or complete investment 

discretion. Some commenters argued 

that certain parties should not be 

considered a sponsor because they were 

not an investment advisor or did not 

have investment discretion.2181 Other 

commenters argued that an entity 

should not be considered a sponsor 

even though it has limited investment 

discretion,2182 while others argued that 

investment advisers and parties with 

investment discretion should not be 

included in the definition of 

sponsor.2183

After considering comments received 

and the language and purpose of section 

13, the Agencies have determined not to 

adopt a separate definition of sponsor 

for issuers of covered funds that are 

issuers of an asset-backed security. As 

described above and consistent with the 

statute, the definition of sponsor only 

includes parties that: (i) Serve as a 

general partner, managing member, or 

trustee (other than a directed trustee) of 

a covered fund; (ii) have the right to 

select or control a majority of the 

directors, trustees, or management of a 

covered fund; or (iii) share with a 

covered fund, for corporate, marketing, 

promotional, or other purposes, the 

same name or a variation of the same 

name. If the parties that commenters 

described do not serve in those 

capacities for a covered fund, do not 

have those rights with respect to a 

covered fund or do not share a name 

with a covered fund, such parties would 

not be a sponsor for purposes of the 

final rule, and, therefore, they would 

not be subject to the restrictions 

applicable to the sponsor of a covered 

fund, including the restrictions 

contained in section 13(f).2184

Additionally, the Agencies believe 

that the exclusion of loan securitizations 

from the definition of covered fund 

under the final rule addresses many of 

the commenters’ concerns about the 

sponsor definition because this 

exclusion limits the types of 

securitizations that are covered funds 

and subject to the final rule. Similarly, 

the exclusion of certain ABCP conduits 

from the definition of covered fund will 

mean that the restrictions under section 

13(f) will not apply to qualifying assetbacked commercial paper conduits. 

As with any other covered fund under 

the final rule, the term sponsor would 

include a trustee that has the right to 

exercise any investment discretion for 

the securitization. For issuers of assetbacked securities, this would generally 

not include a trustee that executes 

decision-making, including investment 

of funds prior to the occurrence of an 

event of default, solely according to the 

provisions of a written contract or at the 

written direction of an unaffiliated 

party. In addition, under the rule as 

adopted a trustee with investment 

discretion may avoid characterization as 

a sponsor if it irrevocably delegates all 

of its investment discretion to another 

unaffiliated party with respect to the 

covered fund. The Agencies believe that 

these considerations regarding when a 

trustee is a sponsor responds to 

commenters’ concerns regarding the 

roles of trustees in securitizations.2185


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2186 156 Cong. Rec. S5889 (daily ed. July 15, 2010) 

(statement of Sen. Hagan) (arguing that section 13 

permits a banking entity to engage in a certain level 

of traditional asset management business). 

2187See final rule § 75.11; proposed rule § 75.11. 

2188See proposed rule §§ 75.11(a)—(h). 

2189While section 13(d)(1)(G) of the BHC Act 

does not explicitly mention ‘‘commodity trading 

advisory services,’’ the Agencies proposed to treat 

commodity trading advisory services in the same 

way as investment advisory services because the 

proposed rule would have included commodity 

pools within the definition of ‘‘covered fund.’’ One 

commenter argued that a covered banking entity 

should not be permitted to qualify for the 

exemption in section 13(d)(1)(G) based on 

providing commodity trading advisory services. See 

Occupy. The Agencies believe that commodity 

trading advisors provide services to commodity 

pools that are similar to the services an investment 

adviser provides to a hedge fund or private equity 

fund. Because certain commodity pools are 

included within the definition of covered fund, 

banking entities may organize and offer these 

commodity pools as a means of providing these 

services to customers. 

2190See proposed rule § 75.11(a)–(h). 

2191See, e.g., Arnold & Porter. 

2192See Arnold & Porter; F&C. 2193See, e.g., EFAMA; ICI Global; JPMC. 

2. Section 75.11: Activities Permitted in 

Connection With Organizing and 

Offering a Covered Fund 

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

permits a banking entity to make 

investments in and sponsor covered 

funds within certain limits in 

connection with organizing and offering 

the covered fund.2186 Section 75.11 of 

the final rule implements this statutory 

exemption, and includes several 

changes from the proposed rule in 

response to concerns raised by 

commenters as described in detail 

below.2187

a. Scope of Exemption 

Section 75.11 of the proposed rule 

described the conditions that must be 

met in order to qualify for the 

exemption provided by section 

13(d)(1)(G) for covered fund activities 

conducted in connection with 

organizing and offering a covered 

fund.2188 These conditions generally 

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

statute, and included: (i) The banking 

entity must provide bona fide trust, 

fiduciary, investment advisory, or 

commodity trading advisory 

services; 2189 (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 in accordance with the 

limitations on amounts and value of 

those interests as permitted under 

subpart C of the proposed rule; (iv) the 

banking entity must comply with the 

restrictions governing relationships with 

covered funds under § 75.16 of the 

proposed rule; (v) the banking entity 

may not, directly or indirectly, 

guarantee, assume, or otherwise insure 

the obligations or performance of the 

covered fund or of any covered fund in 

which such covered fund invests; (vi) 

the covered fund, for corporate, 

marketing, promotional, or other 

purposes, may not share the same name 

or a variation of the same name with the 

banking entity (or an affiliate or 

subsidiary thereof), and may not use the 

word ‘‘bank’’ in its name; (vii) no 

director or employee of the banking 

entity may take or retain an ownership 

interest in the covered fund, except for 

any director or employee of the banking 

entity who is directly engaged in 

providing investment advisory or other 

services to the covered fund; (viii) the 

banking entity must clearly and 

conspicuously disclose, in writing, to 

any prospective and actual investor in 

the covered fund (such as through 

disclosure in the covered fund’s offering 

documents) the enumerated disclosures 

contained in § 75.11(h) of the proposed 

rule; and (ix) the banking entity must 

comply with any additional rules of the 

appropriate Agency or Agencies, 

designed to ensure that losses in such 

covered fund are borne solely by 

investors in the covered fund and not by 

the banking entity.2190

Commenters raised concern that the 

proposed rule could be read to extend 

the prohibition on covered fund 

activities beyond the scope intended by 

the statute.2191 Because the proposed 

exemption was applicable to banking 

entities engaged in ‘‘organizing and 

offering’’ a covered fund, commenters 

were concerned that the proposed rule 

might be interpreted to prohibit a 

banking entity from engaging in 

activities that are part of organizing and 

offering a covered fund but that are not 

prohibited under the covered fund 

prohibition. In this regard, commenters 

contended that the activity of 

‘‘organizing and offering’’ a covered 

fund would include serving as 

investment adviser, distributor, broker, 

and other activities not prohibited by 

section 13 of the BHC Act and not 

involving the acquisition or retention of 

an ownership interest in or sponsorship 

of a covered fund as those terms are 

defined in section 13.2192

The Agencies have modified the final 

rule to address this concern, which 

reflects a reading of the proposal not 

intended by the Agencies. Section 

13(d)(1)(G) of the BHC Act by its terms 

provides an exemption from section 

13(a) of the BHC Act, which prohibits a 

banking entity from acquiring or 

retaining an equity, partnership or other 

ownership interest in or sponsoring a 

covered fund. To the extent that an 

activity is not prohibited by section 

13(a), no exemption to that statutory 

prohibition is needed to conduct that 

activity. However, it is common for 

prohibited and non-prohibited activities 

to be conducted together in connection 

with offering and organizing a covered 

fund. For example, an entity that 

provides investment advisory services 

to a covered fund (an activity not itself 

prohibited by section 13(a)(1)(B) of the 

BHC Act) often acquires an ownership 

interest in a covered fund and/or 

appoints a majority of management of 

the covered fund (which is included in 

the definition of sponsor under the 

statute), both of which are covered by 

the statutory prohibition in section 

13(a)(1)(B). In that case, the banking 

entity may engage in the prohibited 

activity as part of organizing and 

offering a covered fund only if the 

prohibited activity is conducted in 

accordance with the requirements in the 

exemption in section 13(d)(1)(G) or 

some other exemption. 

The final rule reflects this view in that 

it permits a banking entity to invest in 

or sponsor a covered fund in connection 

with organizing and offering the fund, 

which may involve activities that are 

not prohibited by section 13. Under the 

final rule, a banking entity that serves as 

an investment adviser to a covered fund 

(including a sub-adviser), for example, 

may permissibly invest in the covered 

fund to the extent the banking entity 

complies with the requirements of 

section 13(d)(1)(G) of the Act. An entity 

that serves only as investment adviser, 

without making any investment or 

conducting any activity covered by the 

prohibition in section 13(a), would not 

be covered by the prohibition in section 

13(a) and thus would not need to rely 

on section 13(d)(1)(G) and § 75.11 of the 

final rule to conduct that investment 

advisory activity. 

As described in more detail below, a 

number of commenters expressed 

concern about applying the 

requirements of section 13(d)(1)(G) and 

the final rule outside of the United 

States, including with respect to foreign 

public funds organized and offered by 

foreign banking entities, particularly in 

situations where requirements in foreign 

jurisdictions may conflict with the 

requirements of section 13 of the BHC 

Act and implementing regulations.2193


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2194See final rule § 75.10(b)(1)(iii). 2195See final rule § 75.10(c)(1). 2196See 12 U.S.C. 1851(d)(1)(G)(i); proposed rule 

§ 75.11(a). 2197See 156 Cong. Rec. at S5897 (daily ed. July 

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

2198See Ass’n of Institutional Investors (Feb. 

2012); SIFMA et al. (Covered Funds) (Feb. 2012); 

JPMC. 

2199See Sens. Merkley & Levin (Feb. 2012); AFR 

et al. (Feb. 2012); Occupy; Public Citizen. 

2200See Sens. Merkley & Levin. 

2201See final rule § 75.11(a)(1)–(2). See Part 

VI.B.2.b. below for a discussion of these 

requirements in the context of a banking entity that 

organizes and offers a covered fund that is an 

issuing entity of asset-backed securities. 

2202See, e.g., 12 U.S.C. 1843(c)(4), (c)(8), (K), 12 

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

225.125 (with respect to a bank holding company); 

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

respect to a national bank); 12 U.S.C. Part 362 (with 

respect to a state non-member bank). 

The Agencies believe that many of the 

concerns raised with respect to applying 

section 13(d)(1)(G) and the proposed 

rule outside the United States have been 

addressed through the revised definition 

of covered fund described above and 

revisions to the exemption provided for 

activities conducted solely outside the 

United States. In particular, the revised 

definition of covered fund makes clear 

that a foreign fund offered outside the 

United States is only a covered fund 

under specified circumstances with 

respect to a banking entity that is, or is 

controlled directly or indirectly by a 

banking entity that is, located in or 

organized or established under the laws 

of the United States or of any State.2194

Furthermore, foreign public funds are 

excluded from the definition of covered 

fund in the final rule.2195 Consequently, 

a foreign banking entity may invest in 

or organize and offer a variety of funds 

outside of the United States without 

becoming subject to the requirements of 

section 13(d)(1)(G) and § 75.11 of the 

final rule, such as the name-sharing 

restriction or limitations on director and 

employee investments. 

1. Fiduciary Services 

In order to qualify for the exemption 

for activities related to organizing and 

offering a covered fund, section 

13(d)(1)(G) generally requires that a 

banking entity provide bona fide trust, 

fiduciary, investment advisory, or 

commodity trading advisory services, 

that the covered fund be organized and 

offered in connection with providing 

these services, and that the banking 

entity providing those services offer the 

covered fund only to persons that are 

customers of those services of the 

banking entity.2196 These requirements 

were largely mirrored in the proposed 

rule. Requiring a customer relationship 

in connection with organizing and 

offering a covered fund helps to ensure 

that a banking entity is engaging in the 

covered fund activity for others and not 

on the banking entity’s own behalf.2197

As noted in the proposal, section 

13(d)(1)(G)(ii) of the BHC Act does not 

explicitly require that the customer 

relationship be pre-existing. 

Accordingly, the Agencies explained in 

the proposal that the customer 

relationship may be established through 

or in connection with the banking 

entity’s organization and offering of a 

covered fund, so long as that fund is a 

manifestation of the provision by the 

banking entity of bona fide trust, 

fiduciary, investment advisory, or 

commodity trading advisory services to 

the customer. This application of the 

customer requirement is consistent with 

the manner in which these services are 

provided by banking entities. The 

proposed rule also required that a 

banking entity relying on the authority 

contained in § 75.11 adopt a credible 

plan or similar documentation outlining 

how the banking entity intended to 

provide advisory or similar services to 

its customers through organizing and 

offering such fund. 

Several commenters indicated 

support for this customer requirement 

and, in particular, the Agencies’ view 

that the customer relationship need not 

be a preexisting one.2198 A few 

commenters contended that the statute 

required that a banking entity have a 

pre-existing customer relationship, and 

may not solicit investors outside of its 

existing asset management 

customers.2199 One of these commenters 

argued that this would place banking 

entities at a competitive disadvantage 

compared to investment advisers that 

are not banking entities (and thus not 

subject to the requirements of section 13 

and the final rule), but argued that this 

is a necessary result of section 13.2200

The final rule adopts the language 

largely as proposed, and the Agencies 

continue to believe that the customer 

relationship required under section 

13(d)(1)(G) and the final rule may be 

established through or in connection 

with the banking entity’s organization 

and offering of a covered fund, so long 

as that fund is a manifestation of the 

provision by the banking entity of bona 

fide trust, fiduciary, investment 

advisory, or commodity trading 

advisory services to the customer.2201

The final rule requires that a covered 

fund be organized and offered pursuant 

to a written plan or similar 

documentation outlining how the 

banking entity (or an affiliate thereof) 

intends to provide advisory or similar 

services to its customers through 

organizing and offering the fund. As 

part of this requirement, the plan must 

be credible and indicate that the 

banking entity has conducted 

reasonable analysis to show that the 

fund is organized and offered for the 

purpose of providing bona fide trust, 

fiduciary, investment advisory, or 

commodity trading advisory services to 

customers of the banking entity (or an 

affiliate thereof) and not to evade the 

restrictions of section 13 of the BHC 

Act. 

The language of the final rule also 

adopts the statutory requirements (and 

modifications related to commodity 

pools as discussed above) that the 

banking entity provide bona fide trust, 

fiduciary, investment advisory, or 

commodity trading advisory services, 

and that the covered fund be organized 

and offered only in connection with the 

provision of those services. Banking 

entities provide a wide range of 

customer-oriented services which may 

qualify as bona fide trust, fiduciary, 

investment advisory, or commodity 

trading advisory services.2202

Historically, banking entities have used 

covered funds as a method of providing 

these services to customers in a manner 

that is both cost efficient for the 

customer and allows customers to 

benefit from access to advice and 

services that might not otherwise be 

available to them. These benefits apply 

to long-established customers as well as 

individuals or entities that have no preexisting relationship with the banking 

entity but choose to obtain the benefit 

of trust, fiduciary, investment advisory, 

or commodity trading advisory services 

through participation in the covered 

fund. Covered funds also allow 

customers to gauge the historical record 

of the banking entity in providing these 

services by reviewing the funds’ past 

performance. 

The statute does not require that a 

covered fund be offered only to preexisting customers of the banking entity, 

and the Agencies believe that imposing 

such a requirement would not improve 

the quality of the trust, fiduciary, 

investment advisory, or commodity 

trading advisory service, enhance the 

safety and soundness of the banking 

entity, or reduce the risks to the 

customers or the banking entity. In each 

case, the banking entity provides trust, 

fiduciary or advisory services to a 

covered fund for the benefit of the 

banking entity’s customers, and the 

statute recognizes that organizing and 

offering a covered fund is a legitimate 

method for providing that service. In 

addition, the banking entity must abide 

by all the statutory and prudential 


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2203See 12 U.S.C. 1851(d)(1)(G)(iii). 

2204See proposed rule and final rule § 75.12. 

2205 12 U.S.C. 1851(d)(1)(G)(iv); proposed rule 

§ 75.11(d). 

2206See Part VI.B.5. below. The comments 

received on section 13(f) and § 75.16 of the 

proposed rule are described below. 

2207 12 U.S.C. 1851(d)(1)(G)(v); proposed rule 

§ 75.11(e). 

2208See 156 Cong. Rec. S5897 (daily ed. July 15, 

2010) (statement of Sen. Merkley). 

2209See Occupy. 

2210See RMA. 

2211 12 U.S.C. 1851(d)(1)(G)(vi); proposed rule 

§ 75.11(f). 

2212Similar 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). 

2213See ABA (Keating); Ass’n of Institutional 

Investors (Feb. 2012); Blackrock; EFAMA; SIFMA et 

al. (Covered Funds) (Feb. 2012); TCW; Katten (on 

behalf of Int’l Clients); Union Asset. 

2214See, e.g., ABA (Keating); Ass’n of 

Institutional Investors (Feb. 2012); Blackrock; see 

also SVB; Katten (on behalf of Int’l Clients); SIFMA 

et al. (Covered Funds) (Feb. 2012); UBS. 

requirements imposed by section 13 and 

the entity’s supervisors on the provision 

of those services. The Agencies do not 

believe that a pre-existing customer 

relationship requirement would be 

meaningful because it could easily be 

satisfied by a prospective customer 

seeking to invest in a covered fund by 

first establishing an account with a 

banking entity or purchasing another 

product (e.g., a brokerage account or 

shares of a mutual fund). 

2. Compliance With Investment 

Limitations 

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

limits the ability of a banking entity that 

organizes and offers a covered fund to 

acquire or retain an ownership interest 

in that covered fund as an 

investment.2203 Both the proposed rule 

and the final rule implement this 

provision by requiring that a banking 

entity limit its investments in a covered 

fund that the banking entity organizes 

and offers as provided in § 75.12.2204

Comments received on investment 

limitations in the proposed rule, and 

modifications made to the final rule 

implementing these limitations, are 

described in Part VI.B.3. below. 

3. Compliance With Section 13(f) of the 

BHC Act 

Section 75.11(d) of the proposed rule 

required that the banking entity comply 

with the limitations on relationships 

with covered funds imposed by section 

13(f) of the BHC Act.2205 The final rule 

adopts this requirement and provides 

that the banking entity (and its affiliates) 

must comply with the requirements of 

§ 75.14. Section 13(f) of the BHC Act 

prohibits certain transactions or 

relationships that would be covered by 

section 23A of the Federal Reserve Act, 

and provides that any permitted 

transaction is subject to section 23B of 

the Federal Reserve Act, in each 

instance as if such banking entity were 

a member bank and such covered fund 

were an affiliate thereof.2206 These 

limitations apply in several contexts, 

and are contained in § 75.14 of the final 

rule, discussed in detail below in Part 

VI.B.5. 

4. No Guarantees or Insurance of Fund 

Performance 

Section 75.11(e) of the proposed rule 

prohibited a banking entity that 

organizes and offers a covered fund 

from, directly or indirectly, 

guaranteeing, assuming or otherwise 

insuring the obligations or performance 

of the covered fund or any covered fund 

in which such covered fund invests.2207

This prong implemented section 

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

intended to prevent a banking entity 

from engaging in bailouts of a covered 

fund in which the banking entity has an 

interest.2208

There were only a few comments 

received on this aspect of the proposal. 

One commenter supported the 

restriction on guarantees as effective 

and consistent with the statute.2209

One commenter argued that the final 

rule should not prohibit borrower 

default indemnification services (i.e., 

the guarantee of collateral sufficiency 

upon a securities borrower’s default) 

provided to lending clients by agent 

banks in connection with securities 

lending transactions involving a covered 

fund.2210 This commenter argued that 

borrower default indemnification 

services guarantee only the deficit 

between the mark to market value of 

cash collateral received and the amount 

of any borrower default, and are 

therefore different from and more 

limited than the type of general 

investment performance or obligation 

guarantee that section 13 was designed 

to prevent. 

The Agencies believe that the statute 

does not permit either full or partial 

guarantees of the obligations of a 

covered fund that the banking entity 

organizes and offers. Accordingly, the 

final rule, like the proposed rule, 

continues to mirror the statutory 

restriction on direct or indirect 

guarantees of the obligations or 

performance of a covered fund by a 

banking entity in connection with 

reliance on the exemption provided in 

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

However, in response to comments 

received on the proposal, the Agencies 

note that the provision of a borrower 

default indemnification by a banking 

entity to a lending client in connection 

with securities lending transactions 

involving a covered fund is not 

prohibited. This type of indemnification 

is not a guarantee of the performance or 

obligations of a covered fund because it 

represents a guarantee to the customer 

or borrower of the obligation of the 

counterparty to perform and not a 

guarantee of the performance or 

underlying obligations of the covered 

fund. The requirement of the final rule 

that a banking entity and its affiliates 

not guarantee the obligations or 

performance of a covered fund that it 

organizes and offers therefore does not 

prohibit a banking entity from providing 

borrower default indemnifications to 

customers. 

5. Limitation on Name Sharing With a 

Covered Fund 

Section 75.11(f) of the proposed rule 

prohibited the covered fund from 

sharing the same name or a variation of 

the same name with the banking entity 

that relies on the exemption in section 

13(d)(1)(G) of the BHC Act.2211 The 

proposed rule also prohibited the 

covered fund from using the word 

‘‘bank’’ in its name.2212

The name-sharing restriction was one 

of the most commented upon aspects of 

§ 75.11. A number of commenters on 

this section expressed the view that the 

name-sharing restriction in section 

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

proposed rule was too strict. In 

particular, a number of commenters 

argued that the name-sharing restriction 

should allow an asset manager to share 

its name with a sponsored covered fund 

so long as the covered fund does not 

share the name of the insured 

depository institution or its affiliated 

holding company or use the word 

‘‘bank.’’ 2213

Commenters argued that the namesharing restriction as proposed would 

impose significant business and 

branding burdens on the industry 

without providing incremental benefit 

to the public.2214 These commenters 

argued that it would be unduly 

burdensome and costly for funds 

currently affiliated with banking entities 

or managers that are themselves banking 

entities to change the name of their 

affiliated funds and that many of these 

funds have developed a reputation in 

the marketplace based on the current 

name of the fund and/or fund manager. 


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2215See Ass’n of Institutional Investors (Feb. 

2012); Katten (on behalf of Int’l Clients); SIFMA et 

al. (Covered Funds) (Feb. 2012). 

2216See Ass’n of Institutional Investors (Feb. 

2012); SIFMA et al. (Covered Funds) (Feb. 2012); T. 

Rowe Price; TCW. 

2217See TCW; Union Asset. 

2218See T. Rowe Price. 

2219See, e.g., UBS. 

2220See Credit Suisse (Williams); EFAMA; JPMC; 

Katten (on behalf of Int’l Clients); Union Asset; IAA; 

ICI Global; UBS; SIFMA et al. (Covered Funds) (Feb. 

2012) (citing Directive 2004/39/EC of the European 

Parliament and Council). 

2221See BVI; EFAMA; JPMC; UBS; Union Asset; 

ICI Global; IAA. 

2222See UBS; Union Asset; ICI Global. 

2223See, e.g., AFG; ICI Global; JPMC. 

2224See Arnold & Porter (citing SEC Division of 

Investment Management, Letter to Registrants (May 

13, 1993); Memorandum to SEC Chairman Breeden 

from Division of Investment Management (May 6, 

1993); FDIC, Board, OCC, OTS, Interagency 

Statement on Retail Sales of Non-Deposit 

Investment Products (Feb. 14, 1994)). 

2225See Occupy the SEC at 165. 

2226See id. 

2227See final rule § 75.11(f). 

2228See 12 U.S.C. 1851(d)(1)(G)(vi) and (h)(1). 

2229For example, one commenter alleged that it 

would need to rebrand approximately 500 

established funds if the final rule was not modified 

to exclude established and regulated funds in 

foreign jurisdictions. See Goldman (Covered 

Funds). 

2230See final rule § 75.10(b)(1)(ii) and (c)(1). 

2231See Part VI.B.1.g. 

Some of these commenters argued that 

the name-sharing restriction would 

place asset managers and funds 

affiliated with banking entities at a 

competitive disadvantage to other asset 

managers and funds.2215

A few commenters argued that the 

rationale for the name-sharing 

restriction (i.e., to discourage bailing out 

funds) was already addressed under 

other restrictions of section 13(d)(1)(G) 

and the proposed rule that prohibit a 

banking entity from, directly or 

indirectly, guaranteeing, assuming or 

otherwise insuring the obligations or 

performance of the covered fund or of 

any covered fund in which such 

covered fund invested and that require 

disclosure that investments in the 

covered fund are not insured by the 

Federal Deposit Insurance 

Corporation.2216 These commenters 

questioned the necessity for the namesharing restriction when a prohibition 

on bailing out funds is already in place 

and where there is disclosure that 

investors bear the risk of loss in the 

fund. Some of these commenters 

contended it was unlikely that investors 

in a covered fund with an SECregistered investment adviser that has a 

name unrelated to the name of an 

insured depository institution would be 

misled to believe that the fund would be 

backed in any way by a related insured 

depository institution or the Federal 

Deposit Insurance Corporation.2217 One 

of these commenters argued that the 

name-sharing restriction should not 

apply to organizations where insured 

depository institutions represent a de 

minimis component of the 

organization’s operations.2218

Other commenters recommended that 

the name-sharing restriction not be 

applied to covered funds that rely on 

the exemption for covered fund 

activities and investments that occur 

solely outside of the United States.2219

A few commenters expressed concern 

that the name-sharing restriction could 

be incompatible with regulatory 

requirements in certain foreign 

jurisdictions that a covered fund’s name 

must indicate the fund’s connection 

with the fund sponsor.2220 One 

commenter argued that it is common 

practice in Germany to disclose the 

designation of the sponsoring 

investment manager in the fund name in 

order to provide transparency to 

investors, while a few commenters 

contended that European jurisdictions, 

including the U.K., require an 

authorized fund to have a name 

representative of the authorized 

investment manager to avoid misleading 

fund investors.2221 Commenters also 

argued that the name-sharing restriction 

was inconsistent with the laws of 

Ireland and Hong Kong.2222 Certain 

commenters argued that the impact of 

the name-sharing restriction would be 

particularly unfair to non-U.S. retail 

funds like European UCITS if such 

funds are not allowed to use the name 

of the bank while U.S. mutual funds 

would not be subject to the same 

restriction.2223

By contrast, some commenters 

supported the name-sharing restriction. 

For example, one commenter indicated 

that the use of the word ‘‘bank’’ or a 

shared name in the fund’s name was 

already strongly discouraged by prior 

guidance.2224 Another commenter 

supported the name-sharing restriction 

but argued it did not go far enough 

because it did not apply to funds that a 

banking entity was permissibly allowed 

to sponsor and invest in under other 

provisions of section 13.2225 According 

to this commenter, covered funds 

permitted under other exemptions 

should not be allowed to share the same 

name with the banking entity.2226

After carefully considering comments 

and the express terms of the statute, the 

final rule includes the name-sharing 

restriction as proposed.2227 The namesharing restriction is imposed by the 

statute and prohibits a banking entity 

from sharing the same name or variation 

of the same name with a covered fund. 

The statute also defines the scope of the 

prohibition by defining the term 

‘‘banking entity’’ to generally include 

any affiliate or subsidiary of an insured 

depository institution or any company 

that controls an insured depository 

institution.2228

However, the Agencies believe that 

many of the concerns raised by 

commenters with respect to this 

provision should be addressed through 

the revised definition of covered fund in 

the final rule, and modifications to the 

exemption for covered fund activities 

and investments that occur solely 

outside of the United States.2229 For 

example, as discussed in greater detail 

above in Part VI.B.1.c.1., foreign public 

funds sold outside the United States are 

excluded from the definition of covered 

fund.2230 In addition, pursuant to the 

definition of covered fund in the final 

rule, a foreign fund only becomes a 

covered fund with respect to a U.S. 

banking entity (including a foreign 

affiliate of that U.S. banking entity) that 

acts as sponsor to, or has an ownership 

interest in, the fund. Moreover, 

numerous funds operate successfully 

with names that differ from the name of 

the fund sponsor or adviser. 

The Agencies recognize, however, 

that the statutory name-sharing 

restriction may affect some entities that 

will be covered funds and that cannot 

rely on another permitted activity 

exemption under section 13(d)(1) and 

the final rule. The name-sharing 

restriction may result in certain costs 

and other economic burdens for banking 

entities that advise these funds, as 

discussed in greater detail in Part 

VI.B.1.g. above.2231 However, as the 

Agencies also note above, to the extent 

that the restriction results in a banking 

entity not otherwise coming under 

pressure for reputational reasons to 

directly or indirectly assist a covered 

fund under distress that shares the 

banking entity’s name, the name-sharing 

prohibition could reduce the risk to the 

banking entity that this assistance might 

pose. The Agencies also expect that the 

conformance period, both for 

compliance with section 13 of the BHC 

Act generally and for funds that are 

illiquid funds, should be sufficient to 

allow covered funds to take the steps 

necessary to comply with the namesharing restriction in the statute and 

final rule. 

6. Limitation on Ownership by Directors 

and Employees 

Section 75.11(g) of the proposed rule 

implemented section 13(d)(1)(G)(vii) of 

the BHC Act. That statutory provision 

prohibits any director or employee of 


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2232See 12 U.S.C. 1851(d)(1)(G)(vii); proposed 

rule § 75.11(g). 

2233See 156 Cong. Rec. S5897 (daily ed. July 15, 

2010) (statement of Sen. Merkley). 

2234See Occupy. 

2235See Arnold & Porter. 

2236See Arnold & Porter; BOK, Credit Suisse 

(Williams); Fin. Services Roundtable (Jun. 14, 

2011); PEGCC; T. Rowe Price. 

2237See Credit Suisse (Williams). 

2238See T. Rowe Price. 

2239See Credit Suisse (Williams); Fin. Services 

Roundtable (Jun. 14, 2011). 

2240See Credit Suisse (Williams); Fin. Services 

Roundtable (Jun. 14, 2011). 

2241See BOK (citing proposed rule at § 75.17); 

Arnold & Porter. 

2242See SVB. 

2243See EFAMA; BVI; IAA; ICI Global; JPMC; 

Union Asset. 

2244See Annex II para. 1(m). Directive 2011/61/ 

EU of the European Parliament and the Council of 

8 June 2011 on Alternative Investment Fund 

Managers. 

2245See EFAMA; Union Asset. 

2246See final rule § 75.11(g). 

2247See final rule §§ 75.10(c)(1) and 75.10(c)(5). 

2248See 12 U.S.C. 1851(d)(1)(G)(vii). 

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.2232 This allows an 

individual employed by a banking 

entity, who also acts as fund manager or 

adviser (for example), to acquire or 

retain an ownership interest in a 

covered fund that aligns the manager or 

adviser’s incentives with those of the 

banking entity’s customers.2233

One commenter argued that only 

employees or directors who provide 

investment advisory services should be 

allowed to make an investment in the 

fund and that the rule should not allow 

employees or directors who provide 

other, unspecified services to invest in 

a fund.2234 This commenter argued that 

the proposed rule would allow nonadviser banking entity employees who 

have no need to maintain ‘‘skin in the 

game’’ to earn profit on the fund’s 

performance. According to another 

commenter, fiduciary clients of banking 

organizations often are less interested in 

whether the fund manager or other 

service providers have money in the 

fund than whether the client’s own 

account manager, and those individuals 

above him/her who are responsible for 

investment decisions, have allocated his 

or her own assets in the same way and 

into the same general asset classes and 

funds as the client’s fiduciary account is 

being allocated.2235

The more prevalent view among 

commenters was that the proposed rule 

should be revised and expanded to 

permit investments in a sponsored fund 

by a broader group of banking entity 

directors, officers, and employees, 

directly or indirectly through employee 

benefit programs or trust and fiduciary 

accounts, regardless of whether the 

individual provides services to the 

covered fund.2236 Some commenters 

argued that narrowly limiting 

permissible director and employee 

investments could put asset managers 

affiliated with an insured depository 

institution at a competitive 

disadvantage relative to managers that 

are not affiliated with an insured 

depository institution,2237 as well as 

make it more difficult for banking 

entities to offer their U.S. and non-U.S. 

employees similar choices in retirement 

plans.2238

Two commenters urged that the 

supervisors of a fund’s portfolio 

managers or investment advisers should 

be permitted to invest.2239 These 

commenters also argued that 

individuals who provide support 

services to the fund, including 

administrative, oversight and risk 

management, legal compliance, 

regulatory, product structuring, deal 

sourcing and origination, deal 

evaluation and diligence, investor 

relations, sales and marketing, tax, 

accounting, valuation and other 

operational support services, should be 

permitted to invest in the fund. These 

commenters also requested confirmation 

that any director, including an 

individual serving on the board or 

investment committee of a fund or its 

manager, should be permitted to 

invest.2240 Another commenter argued 

that employees and directors should be 

permitted to make their own individual 

investment decisions independently 

without regard to whether they provide 

services to the covered fund.2241 One 

commenter contended that a 

grandfathering approach is necessary to 

address situations where a pre-existing 

covered fund already has investments 

from directors and employees who do 

not directly provide services to the fund 

because the fund may be unable to force 

those individuals out of the fund.2242

A number of commenters argued that, 

if defined too narrowly, this restriction 

may conflict with the laws of other 

jurisdictions that require advisers and/ 

or their directors and employees to 

invest in the funds they manage.2243 For 

example, several commenters argued 

that this requirement will directly 

conflict with the European Alternative 

Investment Fund Managers 

Directive.2244 Two commenters 

contended that certain jurisdictions, 

including the Netherlands, require 

directors and other personnel of fund 

managers to hold fund units or shares of 

funds managed by the fund manager as 

part of their pensions.2245

The final rule retains the requirement 

limiting the ownership of a covered 

fund by directors and employees of a 

banking entity (or an affiliate thereof) 

relying on the exemption in section 

13(d)(1)(G) of the BHC Act.2246 This 

limitation is imposed by statute on 

banking entities that rely on this 

exemption. If a director or employee 

does not provide services to the fund, 

they may not invest in that fund. As in 

the statute, the final rule allows 

employees who provide services to the 

fund other than investment advisory 

services to invest in the fund. Under the 

final rule, directors or employees who 

provide investment advice or 

investment management services to the 

fund may invest in that fund. Similarly, 

directors or employees who provide 

services that enable the provision of 

investment advice or investment 

management, such as oversight and risk 

management, deal origination, due 

diligence, administrative or other 

support services, may also invest in the 

fund. In response to comments, the final 

rule has been modified to make clear 

that a former director or employee may 

retain an interest in a covered fund if 

the director or employee acquired the 

interest while serving as a director or 

employee of the banking entity and 

providing investment advisory or other 

services to the covered fund. 

The Agencies believe that many of the 

concerns raised by commenters 

regarding the effects of this limitation 

on foreign funds are addressed through 

the scope of foreign funds that will be 

covered funds, and revisions to the 

exemption provided for covered fund 

activities and investments that occur 

solely outside of the United States. 

Moreover, the final rule excludes 

foreign public funds and broad-based 

foreign pension funds from the 

definition of covered fund and they are 

thus not subject to the restrictions of 

section 13 or the final rule.2247

Section 13 clearly contemplates 

investments by certain employees and 

directors of the banking entity.2248

However, the Agencies continue to 

believe that certain director or employee 

investments in a covered fund may 

provide an opportunity for a banking 

entity to evade the limitations regarding 

the amount or value of ownership 

interests a banking entity may acquire or 

retain in a covered fund or funds 

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

Act and the final rule. In order to 

address this concern, the final rule 

attributes an ownership interest in a 


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2249 12 U.S.C. 1851(d)(1)(G)(viii); proposed rule 

§ 75.11(h). 

2250To 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. 

2251See, e.g., Occupy. 

2252See Arnold & Porter. 

2253See Occupy. 

2254See Katten (on behalf of Int’l Clients). 

2255See final rule § 75.10(b)(1)(iii). 

2256See 12 U.S.C. 1851(d)(1)(G)(viii). 

2257The relevant agencies issued a proposed rule 

to implement the requirements of section 15G of the 

Exchange Act, as required under section 941 of the 

Dodd-Frank Act. See Credit Risk Retention, 76 FR 

24090 (Apr. 29, 2011). Those agencies recently 

issued a re-proposal of the risk-retention 

requirements. See Credit Risk Retention, 78 FR 

57928 (Sept. 20, 2013). 

2258See proposed rule § 75.14(a)(2)(iii). 

2259See Sens. Merkley & Levin (Feb. 2012); Alfred 

Brock. 

2260See, e.g., AFME et al.; SIFMA (Securitization) 

(Feb. 2012); JPMC; BoA. 

covered fund acquired or retained by a 

director or employee to a banking entity 

for purposes of the investment limits in 

section 13(d)(4) under certain 

circumstances. This attribution is 

discussed in detail below in Part 

VI.B.3.f. 

7. Disclosure Requirements 

Section 75.11(h) of the proposed rule 

required that, in connection with 

organizing and offering a covered fund, 

the banking entity clearly and 

conspicuously disclose, in writing, to 

prospective and actual investors in the 

covered fund that any losses in the 

covered fund will be borne solely by 

investors in the covered fund and not by 

the banking entity and its affiliates or 

subsidiaries; and that the banking 

entity’s and its affiliates’ or subsidiaries’ 

losses in the covered fund will be 

limited to losses attributable to the 

ownership interests in the covered fund 

held by the banking entity and its 

affiliates or subsidiaries in their 

capacity as investors in the covered 

fund. In addition, the proposed rule 

required that a banking entity disclose, 

in writing: (i) that each investor should 

read the fund offering documents before 

investing in the covered fund; (ii) that 

the ownership interests in the covered 

fund are not insured by the FDIC, and 

are not deposits, obligations of, or 

endorsed or guaranteed in any way, by 

any banking entity (unless that happens 

to be the case); and (iii) the role of the 

banking entity and its affiliates, 

subsidiaries, and employees in 

sponsoring or providing any services to 

the covered fund. The proposed rule 

also required banking entities to comply 

with any additional rules of the 

appropriate Agency designed to ensure 

that losses in any covered fund are 

borne solely by the investors in the 

covered fund and not by the banking 

entity.2249 In proposing the rule, the 

Agencies indicated that a banking entity 

may satisfy these disclosure 

requirements by making the required 

disclosures in the covered fund’s 

offering documents.2250

A few commenters supported the 

disclosure requirement as effective and 

consistent with the statute.2251 One 

commenter stated that the disclosures 

required in section 13(d)(1)(G)(viii) of 

the Act and the proposed rule are 

consistent with disclosures in the 

banking agencies’ February 1994 

‘‘Interagency Statement on Retail Sales 

of Non-deposit Investment Products’’ 

and other FINRA and SEC guidance.2252

One commenter suggested that the rule 

include a requirement that the 

disclosures be issued in plain 

English.2253

Another commenter argued that the 

Agencies should revise the disclosure 

requirements under the proposal so that 

offering materials of non-U.S. funds 

provided to non-U.S. investors outside 

the United States need not include the 

specified disclosures nor refer to the 

FDIC or other specific U.S. agencies.2254

This commenter argued that a non-U.S. 

person investing in a non-U.S. fund 

offered or sponsored by a non-U.S. 

banking entity has no expectation that 

the fund or its interests would be 

insured by the FDIC. The Agencies 

believe this concern is addressed 

through the revised definition of 

covered fund, which generally provides 

that a foreign fund offered outside of the 

United States will only be a covered 

fund with respect to a U.S. banking 

entity (including a foreign affiliate of the 

U.S. banking entity) that acts as sponsor 

to, or invests in, the fund.2255

The final rule adopts the proposed 

disclosure requirements substantially as 

proposed. As explained above, these 

disclosures are largely required by the 

statute.2256 The proposed requirement 

to disclose that ownership interests in a 

covered fund are not insured by the 

FDIC, and are not deposits, obligations 

of, or endorsed or guaranteed in any 

way, by any banking entity (unless that 

happens to be the case) is not expressly 

required by the statute. However, 

section 13(d)(1)(G)(iii) permits the 

Agencies to impose additional rules 

designed to ensure that losses in a 

covered fund are borne solely by 

investors in the fund and not by a 

banking entity. The Agencies believe 

that requiring a banking entity to make 

this disclosure as part of organizing and 

offering a covered fund furthers this 

purpose by removing the potential for 

misperception that a covered fund 

sponsored by a banking entity (which by 

definition must be affiliated with a 

depository institution insured by the 

FDIC) is guaranteed by that insured 

institution or the FDIC. Moreover, as 

noted above, this disclosure is already 

commonly provided by banking entities. 

b. Organizing and Offering an Issuing 

Entity of Asset-Backed Securities 

To the extent that an issuing entity of 

asset-backed securities is a covered 

fund, the investment limitations 

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

Act also would limit the ability of a 

banking entity to acquire or retain an 

investment in that issuer. Section 941 of 

the Dodd-Frank Act added a new 

section 15G of the Exchange Act (15 

U.S.C. 78o–11) which requires a 

banking entity to retain and maintain a 

certain minimum interest in certain 

asset-backed securities.2257 In order to 

give effect to this separate requirement 

under the Dodd-Frank Act, § 75.14(a)(2) 

of the proposed rule permitted a 

banking entity that is a ‘‘securitizer’’ or 

‘‘originator’’ under the provisions of that 

Act to acquire or retain an ownership 

interest in an issuer of asset-backed 

securities, in an amount (or value of 

economic interest) required to comply 

with the minimum requirements of 

section 15G of the Exchange Act and 

any implementing regulations issued 

thereunder.2258 The proposal also 

permitted a banking entity to act as 

sponsor to the securitization. 

Commenters expressed a variety of 

views on the treatment of interests in 

securitizations held under risk retention 

pursuant to the proposed rule. Some 

commenters argued that the proposal 

was effective as written and represented 

a reasonable way to reconcile the two 

sections of the Dodd-Frank Act 

consistent with the risk-reducing 

objective of section 13 of the BHC 

Act.2259 Other commenters also 

supported the proposal’s recognition 

that banking entities may be required to 

hold a certain amount of risk in a 

securitization that would also be a 

covered fund, but argued that the 

proposed exemption was too 

narrow.2260

After carefully considering the 

comments received on the proposal, as 

well as the language and purpose of 

section 13 of the BHC Act, the final rule 

provides an exemption that permits a 

banking entity to organize and offer a 


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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 5993 

2261See final rule § 75.11(b). 

2262As used in this SUPPLEMENTARY INFORMATION, 

the term ‘‘securitization’’ means a transaction or 

series of transactions that result in the issuance of 

asset-backed securities. 

2263See final rule § 75.11(b) (providing the 

requirements for a banking entity that is organizing 

and offering a covered fund that is an issuing entity 

of asset-backed securities by reference to the 

requirements of § 75.11(a), as discussed above). 

2264As explained in detail below in Part VI.B.3. 

addressing the limitations on investments in 

covered funds by a banking entity, the final rule 

permits a banking entity to acquire and retain 

ownership interests in a covered fund in order to 

comply with section 15G of the Exchange Act (15 

U.S.C.78o–11) in an amount that does not exceed 

the amount required to comply with the banking 

entity’s chosen method of compliance under section 

15G and the implementing regulations issued 

thereunder. 

covered fund that is an issuing entity of 

asset-backed securities.2261 The 

Agencies have determined to provide 

this exemption in order to address the 

unique circumstances and ownership 

structures presented by 

securitizations.2262 Under the final rule, 

a banking entity may permissibly 

organize and offer a covered fund that 

is an issuing entity of asset-backed 

securities so long as the banking entity 

(and its affiliates) comply with all of the 

requirements of § 75.11(a)(3) through 

(a)(8).2263 As discussed above, the 

requirements of § 75.11(a)(3) through 

75.11(a)(8) are that: (i) The banking 

entity and its affiliates do not acquire or 

retain an ownership interest in the 

covered fund except as permitted under 

§ 75.12 of the final rule; 2264 (ii) the 

banking entity and its affiliates comply 

with the requirements of § 75.14 of the 

final rule; (iii) the banking entity and its 

affiliates do not, directly or indirectly, 

guarantee, assume, or otherwise insure 

the obligations or performance of the 

covered fund or of any covered fund in 

which such covered fund invests; (iv) 

the covered fund, for corporate, 

marketing, promotional, or other 

purposes, does not share the same name 

or variation of the same name with the 

banking entity (or an affiliate thereof) 

and does not use the word ‘‘bank’’ in its 

name; (v) no director or employee of the 

banking entity (or an affiliate thereof) 

takes or retains an ownership interest in 

the covered fund except under the 

limited circumstances noted in the final 

rule; and (vi) the banking entity 

complies with the disclosure 

requirements regarding covered funds in 

the final rule. 

The Agencies believe that the 

requirements of the exemption for 

organizing and offering a covered fund 

that is an issuing entity of asset-backed 

securities, which are in most aspects 

consistent with the exemption for 

organizing and offering a covered fund 

in section 13(d)(1)(G), provide 

limitations on a banking entity’s 

securitization activities involving 

covered funds that are consistent with 

the limitations imposed with respect to 

organizing and offering a covered fund 

that is not an issuing entity of assetbacked securities. For instance, a 

banking entity may not share the same 

name as a covered fund that is an 

issuing entity of asset-backed securities 

and is prohibited from guaranteeing or 

otherwise ‘‘bailing out’’ a covered fund 

that is an issuing entity of asset-backed 

securities, including being required to 

comply with section 13(f) of the BHC 

Act regarding covered transactions with 

the covered fund. Furthermore, like a 

banking entity’s investment in any 

covered fund, the final rule limits the 

ability of a banking entity to invest in 

a covered fund that is an issuing entity 

of asset-backed securities unless it 

meets the requirements of § 75.12. 

Unlike many other covered funds, the 

Agencies understand that banking 

entities might not act in a fiduciary 

capacity when they organize and offer a 

covered fund that is a securitization 

vehicle. For instance, as part of 

organizing and offering a securitization 

vehicle, one or more parties may 

typically organize and initiate the 

securitization by selling or transferring 

assets, either directly or indirectly, to an 

issuing entity of asset-backed securities. 

An entity that provides these services 

typically does so as a service to provide 

investors and the entity’s customers 

with the ability to invest in the assets in 

a manner and to a degree that they may 

otherwise be unable to do. In order to 

identify certain activities that would be 

included as organizing and offering a 

securitization, the final rule provides 

that organizing and offering an issuing 

entity of asset-backed securities means 

acting as the securitizer, as that term is 

used in section 15G(a)(3) of the 

Exchange Act, for the issuer, or 

acquiring or retaining an ownership 

interest in the issuer in compliance with 

the implementing regulations issued 

under section 15G of that Act. 

The final rule reflects, as discussed 

above, that one or more parties that 

organize and offer an issuing entity of 

asset-backed securities may not provide 

any of the services identified in 

§ 75.11(a)(1). In this case the banking 

entity is not required to comply with 

§ 75.11(a)(1) or (a)(2). Section 75.11(b) of 

the final rule is designed to address 

situations where, as discussed above, a 

banking entity does not act in a 

fiduciary capacity when it organizes and 

offers a covered fund that is a 

securitization vehicle. With respect to 

any securitization vehicle that retains a 

collateral manager for investment advice 

regarding the assets of the securitization 

vehicle, such a collateral manager 

would be required to comply with all of 

the provisions of § 75.11(a) to acquire 

and retain an ownership interest in such 

securitization vehicle. 

The final rule therefore both identifies 

certain activities that would be included 

as organizing and offering a 

securitization and modifies the 

requirements of § 75.11 to reflect 

differences between securitizations and 

other types of covered funds, as 

discussed above. The Agencies believe, 

therefore, that the final rule 

appropriately addresses the type of 

activity that is usually associated with 

organizing and offering a securitization 

and also comports with the manner in 

which Congress chose to define the type 

of parties engaged in activities that 

merit special attention related to issuing 

entities of asset-backed securities in 

another part of the Dodd-Frank Act. 

The Agencies have determined to 

provide this exemption by using their 

authority in section 13(d)(1)(J) of the 

BHC Act and believe that this 

exemption promotes and protects the 

safety and soundness of banking entities 

and the financial stability of the United 

States. Many companies and other 

entities utilize securitization 

transactions to efficiently manage, 

allocate and distribute risks throughout 

the markets in a manner consistent with 

meeting the demands of their investors. 

Companies also utilize securitizations in 

order to help provide liquidity to certain 

asset classes or portions of the market 

that, absent this liquidity, may 

experience decreased liquidity and 

increased costs of funding. For instance, 

if banking entities were not permitted to 

organize and offer a securitization, the 

Agencies believe this would result in 

increased costs of funding or credit for 

many businesses of all sizes that are 

engaged in activities that section 13 of 

the BHC Act was not designed to 

address. Additionally, this exemption 

enables banking entities to acquire and 

retain ownership interests in a covered 

fund to comply with section 15G of the 

Exchange Act, which requires certain 

parties to a securitization transaction to 

retain a minimum amount of risk in a 

securitization, a requirement not 

applicable to covered funds that are not 

securitizations. The Agencies therefore 

have determined that this exemption 

will promote and protect the safety and 

soundness of banking entities and the 

financial stability of the United States 

by facilitating the benefits 

securitizations can provide as discussed 

above, and also by enabling banking 


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5994 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

2265See 12 U.S.C. 1851(d)(1)(B). 

2266See Cleary Gottlieb et al.; JPMC; Credit Suisse 

(Williams). 

2267See BoA; Cleary Gottlieb; Credit Suisse 

(Williams); SIFMA et al. (Covered Funds) (Feb. 

2012); see also Deutsche Bank (Fund-Linked 

Products); SIFMA (Securitization) (Feb. 2012). 

Other commenters argued that application of 

Section 13(f) of the BHC Act would prohibit the 

underwriting and market making by a banking 

entity of the securities of a covered fund that such 

banking entity sponsors, organizes and offers or 

provides investment management advice or services 

because Section 13(f) of the BHC Act prohibits the 

purchase of securities by a banking entity from such 

a covered fund. See, e.g., ASF (Feb. 2012); Cleary 

Gottlieb; Credit Suisse (Williams); SIFMA 

(Securitization) (Feb. 2012); FSA (Feb. 2012). 

2268See JPMC; Cleary Gottlieb. 

2269See final rule § 75.11(c). 

2270A discussion of the implementation of 

section 13(d)(1)(D) and (F) with regard to the final 

rule’s limitations on covered fund investments and 

activities is provided in the section that relates to 

permitted covered fund interests and activities by 

a regulated insurance company and § 75.13(c) of the 

final rule. 

entities to comply with section 15G of 

the Exchange Act. 

The Agencies believe it would not be 

consistent with the safety and 

soundness of banking entities or the 

financial stability of the United States to 

prevent banking entities from acquiring 

or retaining ownership interests in 

securitizations as part of the permitted 

activity of organizing and offering 

securitizations or from meeting any 

applicable requirements related to 

securitizations, including those imposed 

under section 15G of the Exchange Act. 

The Agencies note that the exemption 

for organizing and offering a 

securitization does not relieve banking 

entities of any requirements that they 

may be subject to with respect to their 

investments in or relationships with a 

securitization, such as any applicable 

requirements regarding conflicts of 

interest relating to certain 

securitizations under section 27B of the 

Securities Act of 1933. 

c. Underwriting and Market Making for 

a Covered Fund 

Section 13(d)(1)(B) permits a banking 

entity to purchase and sell securities 

and other instruments described in 

13(h)(4) in connection with certain 

underwriting or market making-related 

activities.2265 The proposal did not 

discuss how this exemption applied in 

the context of underwriting or market 

making of ownership interests in 

covered funds. 

Commenters argued that the scope of 

the permitted activities under sections 

13(d)(1)(B), (D) and (F), which 

respectively set out permitted activities 

of underwriting and market makingrelated activities, activities on behalf of 

customers, and activities by a regulated 

insurance company, apply to all of the 

activities prohibited under section 13(a), 

whether those activities would involve 

proprietary trading or ownership of or 

acting as a sponsor to covered funds.2266

Commenters argued that the statutory 

exemption for underwriting and market 

making-related activities is applicable to 

both proprietary trading and covered 

fund activities, and recommended that 

the final rule allow banking entities to 

hold ownership interests and other 

securities of covered funds for the 

purpose of underwriting and engaging 

in market making-related activities.2267

Commenters noted that many structured 

finance vehicles rely on sections 3(c)(1) 

and 3(c)(7) of the Investment Company 

Act, and argued that, without a market 

making exemption for securities of 

covered funds, banking entities would 

be unable to engage in customer-driven 

underwriting and market making 

activity with respect to securities issued 

by entities such as collateralized loan 

obligation issuers and non-U.S. 

exchange-traded funds.2268

After careful review of the comments 

in light of the statutory provisions, the 

final rule has been modified to provide 

a covered fund specific provision for 

underwriting and market making-related 

activities of ownership interests in 

covered funds. These underwriting and 

market making activities are within the 

scope of permitted activities under the 

final rule so long as: 

• The banking entity conducts the 

activities in accordance with the 

requirements of § 75.4(a) or § 75.4(b), 

respectively; 

• With respect to any banking entity 

(or an affiliate thereof) that: acts as a 

sponsor, investment adviser or 

commodity trading advisor to a 

particular covered fund or otherwise 

acquires and retains an ownership 

interest in such covered fund in reliance 

on § 75.11(a); acquires and retains an 

ownership interest in such covered fund 

and is either a securitizer, as that term 

is used in section 15G(a)(3) of the 

Exchange Act, or is acquiring and 

retaining an ownership interest in such 

covered fund in compliance with 

section 15G of that Act and the 

implementing regulations issued 

thereunder each as permitted by 

§ 75.11(b); or, directly or indirectly, 

guarantees, assumes, or otherwise 

insures the obligations or performance 

of the covered fund or of any covered 

fund in which such fund invests, then 

in each such case any ownership 

interests acquired or retained by the 

banking entity and its affiliates in 

connection with underwriting and 

market making related activities for that 

particular covered fund are included in 

the calculation of ownership interests 

permitted to be held by the banking 

entity and its affiliates under the 

limitations of § 75.12(a)(2)(ii) and 

§ 75.12(d); and 

• With respect to any banking entity, 

the aggregate value of all ownership 

interests of the banking entity and its 

affiliates in all covered funds acquired 

and retained under § 75.11, including 

all covered funds in which the banking 

entity holds an ownership interest in 

connection with underwriting and 

market making related activities under 

§ 75.11(c), are included in the 

calculation of all ownership interests 

under § 75.12(a)(2)(iii) and 

§ 75.12(d).2269

The Agencies believe that providing a 

separate provision relating to permitted 

underwriting and market making-related 

activities for ownership interests in 

covered funds is supported by section 

13(d)(1)(B) of the BHC Act.2270 The 

exemption for underwriting and market 

making-related activities under section 

13(d)(1)(B), by its terms, is a statutorily 

permitted activity and exemption from 

the prohibitions in section 13(a), 

whether on proprietary trading or on 

covered fund activities. Applying the 

statutory exemption in this manner 

accommodates the capital raising 

activities of covered funds and other 

issuers in accordance with the 

underwriting and market making 

provisions under the statute. 

The final rule provides that a banking 

entity must include any ownership 

interests that it acquires or retains in 

connection with underwriting and 

market making-related activities for a 

particular covered fund for purposes of 

the per-fund limitation under 

§ 75.12(a)(2)(ii) if the banking entity: (i) 

Acts as a sponsor, investment adviser or 

commodity trading advisor to the 

covered fund; (ii) otherwise acquires 

and retains an ownership interest in the 

covered fund as permitted under 

§ 75.11(a); (iii) acquires and retains an 

ownership interest in the covered fund 

and is either a securitizer, as that term 

is used in section 15G(a)(3) of the 

Exchange Act, or is acquiring and 

retaining an ownership interest in the 

covered fund in compliance with 

section 15G of that Act and the 

implementing regulations issued 

thereunder each as permitted by 

§ 75.11(b); or (iv) directly or indirectly 

guarantees, assumes, or otherwise 

insures the obligations or performance 

of the covered fund or of any covered 

fund in which such fund invests. This 

is designed to prevent any unintended 


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2271See final rule § 75.11(c)(3). 

2272See Cleary Gottlieb; Credit Suisse (Williams). 

2273See final rule § 75.11(c)(1). 

2274 12 U.S.C. 1851(d)(4); proposed rule § 75.12. 

2275See proposed rule §§ 75.12(a)(1)(i); 

75.12(a)(2)(i)(A) and (B); 75.12(b). 

2276See id. at §§ 75.12(a)(1)(ii); 75.12(a)(2)(ii); 

75.12(c). 

2277See, e.g., SIFMA et al. (Covered Funds) (Feb. 

2012); SSgA (Feb. 2012); T. Rowe Price; Credit 

Suisse (Williams); Allen & Overy (on behalf of 

Canadian Banks);TCW. 

expansion of ownership of covered 

funds by banking entities that are 

subject to the per fund limitations under 

§ 75.12. 

These banking entities will have a 

limited ability to engage in underwriting 

or market making-related activities for a 

covered fund for which the banking 

entity’s investments are subject to the 

per-fund limitations in § 75.12 as 

discussed above. Such a banking entity 

will have more flexibility to underwrite 

and make a market in the ownership 

interests of such a covered fund in 

connection with organizing and offering 

the covered fund during the fund’s 

seeding period, since during the seeding 

period a banking entity may own in 

excess of three percent of the covered 

fund, subject to the other requirements 

in § 75.12. 

The final rule also provides that all 

banking entities that engage in 

underwriting and market-making related 

activities in covered funds are required 

to include the aggregate value of all 

ownership interests of the banking 

entity in all covered funds acquired and 

retained under § 75.11, including in 

connection with underwriting and 

market making-related activities under 

§ 75.11(c), in the calculation of the 

aggregate covered fund ownership 

interest limitations under 

§ 75.12(a)(2)(iii) (and make the 

associated deduction from tier one 

capital for purposes of calculating 

compliance with applicable regulatory 

capital requirements).2271

Some commenters asked that the 

Agencies permit banking entities to 

engage in market making and 

underwriting in non-sponsored covered 

fund interests.2272 The final rule permits 

a banking entity that does not hold an 

ownership interest in the covered fund 

in reliance on §§ 75.11(a) or 75.11(b) of 

the final rule, is not a sponsor of the 

covered fund, is not an investment 

adviser or commodity trading advisor to 

the covered fund, and does not, directly 

or indirectly, guarantee, assume, or 

otherwise insure the obligations or 

performance of the covered fund or of 

any covered fund in which such fund 

invests to rely on the market-making 

and underwriting exemption in 

§ 75.11(c) provided that the banking 

entity meets all of the requirements of 

that exemption. These conditions 

include the aggregate funds limitation 

and the capital deduction contained in 

§ 75.12 after including all ownership 

interest held by the banking entity and 

its affiliates under § 75.11, including 

ownership interests acquired or retained 

under the exemption for underwriting 

and market making-related activities in 

§ 75.11(c). In accordance with section 

13(d)(1) of the BHC Act, the Agencies 

have determined that these restrictions 

on reliance on the market-making and 

underwriting exemption provided by 

section 13(d)(1)(B) are appropriate to 

address the purposes of section 13 of the 

BHC Act, which is aimed at assuring 

that banking entities do not bail-out a 

covered fund and maintain sufficient 

capital against the risks of ownership of 

covered funds. The Agencies note, 

however, that the guarantee restriction 

is not intended to prevent a banking 

entity from entering into arrangements 

with a covered fund that are not entered 

into for the purpose of guaranteeing the 

obligations or performance of the 

covered fund. For example, this 

restriction is not intended to prohibit a 

banking entity from entering into or 

providing liquidity facilities or letters of 

credit for covered funds; however, it 

would apply to arrangements such as a 

put of the ownership interest in the 

covered fund to the banking entity. The 

determination of whether an 

arrangement would fall within this 

guarantee restriction would depend on 

the facts and circumstances. 

The Agencies emphasize that any 

banking entity that engages in 

underwriting or market making-related 

activities in covered funds must comply 

with all of the conditions applicable to 

such activity as set forth in section 

§§ 75.4(a) and 75.4(b).2273 Thus, 

holdings of a single covered fund would 

be subject to limitations on risk as well 

as length of holding period, among other 

applicable limitations and requirements. 

These requirements are designed 

specifically to address a banking entity’s 

underwriting and market making-related 

activities and to prohibit holding 

exposures in excess of reasonably 

expected near term demand of clients, 

customers and counterparties. 

3. Section 75.12: Permitted Investment 

in a Covered Fund 

a. Proposed Rule 

Section 75.12 of the proposed rule 

implemented section 13(d)(4) of the 

BHC Act and described the limited 

circumstances under which a banking 

entity may acquire or retain an 

ownership interest in a covered fund 

that the banking entity (which includes 

its subsidiaries and affiliates) organizes 

and offers.2274 Section 13(d)(4)(A) of the 

BHC Act permits a banking entity to 

acquire and retain an ownership interest 

in a covered fund that the banking 

entity organizes and offers for the 

purpose of: (i) Establishing the fund and 

providing the fund with sufficient 

initial equity for investment to permit 

the fund to attract unaffiliated investors; 

or (ii) making a de minimis investment 

in the fund, subject to several 

limitations. Section 13(d)(4)(B) of the 

BHC Act requires that investments by a 

banking entity in a covered fund must, 

not later than one year after the date of 

establishment of the fund, be reduced to 

an amount that is not more than three 

percent of the total outstanding 

ownership interests of the fund. 

Consistent with the statute, § 75.12 of 

the proposal provided that, after 

expiration of the seeding period, a 

banking entity’s investment in a single 

covered fund may not represent more 

than three percent of the total 

outstanding ownership interests in the 

covered fund (the ‘‘per-fund 

limitation’’).2275 In addition, as 

provided in the statute, the proposal 

provided that the total amount invested 

by a banking entity in all covered funds 

may not exceed three percent of the tier 

1 capital of the banking entity (the 

‘‘aggregate funds limitation’’).2276

b. Duration of Seeding Period for New 

Covered Funds 

Commenters argued that it is essential 

to serving their customers efficiently 

that a banking entity be permitted to 

acquire and retain an ownership interest 

in a covered fund that it organizes and 

offers as a de minimis investment or for 

the purpose of establishing the fund. A 

number of commenters contended that a 

banking entity typically invests a 

limited amount of its own capital in a 

fund (‘‘seed capital’’) as part of 

organizing the fund to produce 

investment performance as a record of 

the fund’s investment strategy (‘‘track 

record’’).2277 Once a track record for the 

fund is established, the banking entity 

markets the fund to unaffiliated 

investors. 

Commenters argued that the one-year 

seeding period provided in the 

proposed rule would be too short to 

establish a track record for many types 

of covered funds. Commenters argued 

that the duration of the track record 

investors typically demand before 

investing in a new fund depends on a 

number of factors (e.g., the type of fund, 


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2278See et al. (Covered Funds) (Feb. 2012); see 

also Ass’n of Institutional Investors (Feb. 2012); 

Bank of Montreal et al. (Jan. 2012); Allen & Overy 

(on behalf of Canadian Banks); Credit Suisse 

(Williams); Japanese Bankers Ass’n; SSgA (Feb. 

2012); T. Rowe Price; Union Asset. One commenter 

argued that this limitation would constrain 

portfolio composition of a covered fund due to an 

inability of a fund to raise sufficient capital to make 

larger investments. See Credit Suisse (Williams). 

2279See AFG; Union Asset. 

2280See SIFMA (Mar. 2012); see also Credit 

Suisse (Williams). 

2281See AFR et al. (Feb. 2012); Occupy; Public 

Citizen; Sens. Merkley & Levin (Feb. 2012). 

2282See Occupy; Sens. Merkley & Levin (Feb. 

2012); see also 156 Cong. Rec. S5897 (daily ed. July 

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

2283See, e.g., Public Citizen. 

2284See final rule § 75.12(a)(1). 

2285 12 U.S.C. 1851(d)(4). 

2286See id. at 1851(d)(4)(C). 

2287See SIFMA et al. (Mar. 2012); Credit Suisse 

(Williams); EFAMA: Hong Kong Inv. Funds Ass’n; 

AFG; Union Asset. 2288 Importantly, the statute recognizes that a 

banking entity may need more than the automatic 

one-year seeding period to build a track record and/ 

or market its interests to unaffiliated investors; 

therefore, a banking entity may apply for an 

extension of the seeding period as provided in 

75.12(e) of the final rule as discussed below in Part 

VI.B.3.h. 

investment strategy, and potential 

investors). According to commenters, an 

inability to demonstrate a track record 

over multiple years may reduce the 

allocation of capital by investors who 

are unable to gain an understanding of 

the investment strategy, risk profile, and 

potential performance of the fund.2278

Commenters provided alternative 

suggestions regarding how to define the 

start of the seeding period for purposes 

of applying the statutory exception for 

investments during the seeding period. 

For example, two commenters 

recommended that the Agencies treat a 

private equity fund as being established 

on the date on which the fund begins its 

asset-acquisition phase and is closed to 

new investors, and a hedge fund as 

established on the date on which the 

fund has reached its target amount of 

funding and begins investing according 

to the fund’s stated investment 

objectives.2279 Another commenter 

suggested that the permitted seeding 

period begin on the date on which thirdparty investors are first admitted to the 

fund.2280

Several commenters expressed 

concern that the per-fund limitation 

could be subject to evasion unless the 

Agencies require that the seeding period 

begin at the time funds are first invested 

by the banking entity in the fund.2281

Some of these commenters suggested 

the Agencies impose a dollar cap of $10 

million on the seed capital that a 

banking entity may provide to a newly 

organized covered fund in addition to 

the statutory limits based on the amount 

of the fund’s shares and the amount of 

the banking entity’s tier 1 capital.2282

These commenters argued that an 

explicit quantitative limit better 

accounted for the size of some banking 

entities, which otherwise made the 

potential amount of capital placed in 

covered funds quite large.2283

The Agencies have considered 

carefully the comments on the proposal 

and have made several modifications to 

the final rule to more clearly explain 

how the limitations apply during the 

seeding period. The final rule continues 

to provide that a banking entity may 

invest in a covered fund that it 

organizes and offers either in 

connection with establishing the fund, 

or as a de minimis investment.2284

Importantly, the statute does not permit 

a banking entity to invest in a covered 

fund unless the banking entity organizes 

or offers the covered fund or qualifies 

for another exemption. As explained 

more fully in the discussion of § 75.11 

above, a wide variety of activities are 

encompassed in organizing and offering 

a covered fund. Under the statute, 

which generally prohibits investments 

in covered funds, a banking entity may 

invest in a covered fund under the 

exemptions provided in section 13(d)(1) 

of the BHC Act, including section 

13(d)(1)(G) and the provisions of section 

13(d)(4), only if the banking entity 

engages in one or more of these 

permitted activities with regard to that 

covered fund and complies with all 

applicable limitations under the final 

rule regarding investments in a covered 

fund. 

As noted above, the statute allows a 

banking entity to acquire and hold all of 

the ownership interests in a covered 

fund for the purpose of establishing the 

fund and providing the fund with 

sufficient initial equity for investment to 

permit the fund to attract unaffiliated 

investors.2285 However, the statute also 

imposes a limit on the duration of an 

investment made in connection with 

seeding a covered fund. At the end of 

that period, the investment must 

conform to the limits on de minimis 

investments set by the statute. In 

keeping with the terms of the statute, 

the final rule, like the proposal, allows 

banking entities a seeding period of oneyear for all covered funds. The statute 

also allows the Board to extend that 

period, upon an application by a 

banking entity, for two additional years 

if the Board finds an extension to be 

consistent with safety and soundness 

and in the public interest.2286 As 

explained below, the final rule, like the 

proposal, incorporates this process and 

sets forth the factors the Board will 

consider when determining whether to 

allow an extended seeding period. The 

Board and the Agencies will monitor 

these extension requests to ensure that 

banking entities do not seek extensions 

for the purpose of evading the 

restrictions on covered funds or to 

engage in prohibited proprietary 

trading. 

As noted above, the proposal did not 

specify ‘‘date of establishment,’’ and 

commenters suggested a variety of dates 

that could serve as the date of 

establishment for purposes of 

determining the duration of the seeding 

period and the per-fund limitations on 

ownership interests in a covered 

fund.2287 After considering comments 

received on the proposal, the Agencies 

have modified the final rule to include 

a definition of ‘‘date of establishment’’ 

for a covered fund. In general, the date 

of establishment is the date on which an 

investment adviser or similar party 

begins to make investments that execute 

an investment or trading strategy for the 

covered fund. The Agencies perceive 

the act of making investments to execute 

an investment or trading strategy as 

demonstrating that the fund has begun 

its existence and is no longer simply a 

plan or proposal. In order to account for 

the unique circumstances and manner 

in which securitizations are established, 

for a covered fund that is an issuing 

entity of asset-backed securities, the 

date of establishment under the final 

rule is the date on which the assets are 

initially transferred into the issuing 

entity of the asset-backed securities. 

This is the date that the entity is formed 

and the securities are generally sold 

around this time. The Agencies believe 

this is the appropriate time for the date 

of establishment for securitizations 

because this is the date that the 

securitization risks are transferred to the 

owners of the securitization vehicle. 

Once the assets have been transferred, 

the securitization has been established 

and securities of the issuer may 

typically be priced in support of 

organizing and offering the issuer. 

Setting a later time, such as when the 

fund becomes fully subscribed or the 

assets have been fully assembled, could 

permit a banking entity to engage in 

prohibited proprietary trading under the 

guise of waiting for investors that may 

never materialize.2288

The statute also requires a banking 

entity to actively seek unaffiliated 

investors to reduce or dilute the entity’s 

ownership interest to the amount 

permitted under the statute. This 

requirement is included in the final 


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2289See proposed rule § 75.12(b)(2). 

2290See proposed rule § 75.12(b)(4). 

2291See Joint Proposal, 76 FR at 68904. 

2292See ABA (Keating); BoA; Arnold & Porter; 

BOK; Scale; SVB. 

2293See ABA (Keating) (alleging that this is 

similar to the SEC’s approach to the definition of 

venture capital fund for the purposes of being 

exempt from investment advisor registration). 

2294The relevant agencies issued a proposed rule 

to implement the requirements of section 15G of the 

Exchange Act, as required under section 941 of the 

Dodd-Frank Act. See Credit Risk Retention, 76 FR 

24090 (Apr. 29, 2011). Those agencies recently 

issued a re-proposal of the risk-retention 

requirements. See Credit Risk Retention, 78 FR 

57928 (Sept. 20, 2013). 

2295See proposed rule § 75.14(a)(2)(iii). 

2296See Sens. Merkley & Levin (Feb. 2012); Alfred 

Brock. 

2297See, e.g., AFME et al.; SIFMA (Securitization) 

(Feb. 2012); JPMC; BoA. 

2298See AFME et al.; SIFMA (Securitization) 

(Feb. 2012); JPMC; BoA. 

2299See BoA. 

2300See AFME et al.; Allen & Overy (on behalf of 

Foreign Bank Group); SIFMA (Securitization) (Feb. 

2012); BoA. 

rule, and underscores the nature of 

covered fund activities under section 

13(d)(1)(G) as a method to provide 

investment advisory, trust and fiduciary 

services to customers rather than allow 

the banking entity to engage in 

prohibited proprietary trading. To 

effectuate the requirements of the 

statute, under the final rule, banking 

entities that organize and offer a covered 

fund must develop and document a plan 

for offering shares in the covered fund 

to other investors and conforming the 

banking entity’s investments to the de 

minimis limits to help monitor and 

ensure compliance with this 

requirement. 

While certain commenters requested 

that the final rule include a quantitative 

dollar limit on the amount of funds a 

banking entity may use to organize and 

offer a covered fund, the Agencies have 

declined to add this limitation in the 

final rule. This type of limit is not 

required by statute. Moreover, the 

Agencies believe that imposing a strict 

dollar limit may not adequately permit 

banking entities to employ trading or 

investment strategies that will attract 

unaffiliated investors, thereby 

precluding banking entities from 

meeting the demands of customers 

contrary to the purpose of section 13. 

c. Limitations on Investments in a 

Single Covered Fund (‘‘Per-Fund 

Limitation’’) 

Section 13(d)(4)(B) imposes limits on 

the amount of ownership interest a 

banking entity may have in any single 

covered fund at the end of the one year 

period (subject to limited extension) 

after the date of establishment of the 

fund (the ‘‘seeding period’’). In 

recognition of the fact that a covered 

fund may have multiple classes or types 

of ownership interests with different 

characteristics or values, the proposal 

required that a banking entity apply the 

limits to both the total value of and total 

amount of the banking entity’s 

ownership interest in a covered fund. 

The proposed rule required a banking 

entity to calculate the per-fund 

limitation using two methods. First, a 

banking entity was required to calculate 

the value of its investments and capital 

contributions made with respect to any 

ownership interest in a single covered 

fund as a percentage of the value of all 

investments and capital contributions 

made by all persons in that covered 

fund. Second, a banking entity was 

required to determine the total number 

of ownership interests held by the 

banking entity in a single covered fund 

as a percentage of the total number of 

ownership interests held by all persons 

in that covered fund.2289 Both 

calculations were required to be done 

without regard to committed funds not 

yet called for investment. The proposed 

rule also required the banking entity to 

calculate the value and amount of its 

ownership interest in each covered fund 

in the same manner and according to 

the same standards utilized by the 

covered fund for determining the 

aggregate value of the fund’s assets and 

ownership interests.2290 These 

calculations were designed to ensure 

that the banking entity’s investment in 

a covered fund could not result in more 

than three percent of the losses of the 

covered fund being allocated to the 

banking entity’s investment.2291

Commenters did not generally object 

to calculating the per-fund limitation 

based on both number and value of 

ownership interests. Several 

commenters urged the Agencies to allow 

a banking entity to value its investment 

in a covered fund based on the 

acquisition cost of the investment, 

instead of fair market value, 

notwithstanding the manner in which 

the covered fund accounts for or values 

investments for its shareholders 

generally.2292 One commenter suggested 

that the Agencies allow a banking entity 

to choose between acquisition cost and 

fair value so long as the chosen 

valuation method is applied 

consistently to both the numerator and 

denominator when calculating the perfund limitation.2293

To the extent that an issuer of an 

asset-backed security is a covered fund, 

the investment limitations contained in 

section 13(d)(4) of the BHC Act also 

would limit the ability of a banking 

entity to acquire or retain an investment 

in that issuer. Section 941 of the DoddFrank Act added a new section 15G of 

the Exchange Act (15 U.S.C. 78o-11) 

which requires certain parties to a 

securitization transaction, including 

banking entities, to retain and maintain 

a certain minimum interest in certain 

issuers or asset-backed securities.2294 In 

order to give effect to this separate 

requirement under the Dodd-Frank Act, 

§ 75.14(a)(2) of the proposed rule 

permitted a banking entity that is a 

‘‘securitizer’’ or ‘‘originator’’ under that 

provisions of the Act to acquire or retain 

an ownership interest in an issuer of 

asset-backed securities, in an amount (or 

value of economic interest) required to 

comply with the minimum 

requirements of section 15G of the 

Exchange Act and any implementing 

regulations issued thereunder.2295 The 

proposal also permitted a banking entity 

to act as sponsor to the securitization. 

Commenters expressed a variety of 

views on the treatment of interests in 

securitizations held under risk retention 

pursuant to the proposed rule. Some 

commenters argued that the proposal 

was effective as written and represented 

a reasonable way to reconcile the two 

sections of the Dodd-Frank Act 

consistent with the risk-reducing 

objective of section 13 of the BHC 

Act.2296 Other commenters also 

supported the proposal’s recognition 

that banking entities may be required to 

hold a certain amount of risk in a 

securitization that would also be a 

covered fund, but argued that the 

proposed exemption was too 

narrow.2297 Some commenters argued 

that the exemption should be broadened 

to permit a banking entity to hold in 

excess of the minimum amount required 

under section 15G of the Exchange Act 

instead of allowing only the minimum 

amount required by that section.2298

One commenter requested that the final 

rule permit a banking entity to hold an 

amount of risk in a securitization that is 

commensurate with what investors 

demand rather than the minimum 

required by section 15G.2299 Some 

commenters argued that banking entities 

may be subject to similar generally 

applicable requirements to hold risk in 

securitizations under foreign law, such 

as Article 122a of the Capital 

Requirements Directive issued by the 

European Union, and that the final rule 

should permit banking entities to 

comply with these foreign legal 

requirements.2300

Conversely, a few commenters 

objected to the proposed rule’s 

exemption for risk-retention as unclear 

and argued that if the exemption was 


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2301See Occupy. 

2302See Sens. Merkley & Levin (Feb. 2012). 

2303As discussed above in Part VI.B.2.c., the perfund limitation does not apply to ownership 

interests held by a banking entity that acts as 

market maker or underwriter in accordance with 

§ 75.11(c) of the final rule, so long as the banking 

entity does not also organize and offer, or act as 

sponsor, investment adviser or commodity trading 

advisor to, the fund, or, with respect to ownership 

interests in issuing entities of asset-backed 

securities, is not a securitizer who continues to own 

ownership interests or is not an entity that holds 

ownership interests in compliance with Section 

15G of the Exchange Act and the implementing 

regulations adopted thereunder; however, the 

banking entity that is acting as market maker or 

underwriter that is not subject to the per-fund 

limitation must still comply with the other 

requirements set forth in §§ 75.4(a) and 75.4(b), 

respectively, and any other applicable requirements 

set out in § 75.11(c). 

2304The Agencies note that if a banking entity 

acts as investment adviser or commodity trading 

advisor to a covered fund and shares the same name 

or variation of the same name with the fund, then 

that banking entity would be a sponsor and 

therefore subject to the limitations of section 13(f). 

2305 In the context of securitizations, the final rule 

similarly provides that the valuation methodology 

used to calculate the fair market value of the 

ownership interests must be the same for both the 

ownership interests held by a banking entity and 

the ownership interests held by all other investors 

in the covered fund in the same manner and 

according to the same standards. 

2306See Part VI.B.1.e. 2307For example, a depository institution or bank 

holding company should use the same methodology 

as used in the Report of Condition and Income (Call 

Report) for depository institutions and the 

Consolidated Financial Statements for Holding 

Companies (FR Y–9C) for bank holding companies, 

respectively. 

retained, the Agencies should provide 

that any amounts held by a banking 

entity in a securitization that exceed the 

minimum required to satisfy section 

15G of the Exchange Act should count 

towards the aggregate funds limitation 

of the banking entity.2301 One 

commenter argued that the final rule 

should impose higher capital charges for 

interests held in these securitizations 

due to concerns that securitizations 

involve heightened risks due to the 

complexity of their ownership 

structure.2302

The Agencies have carefully 

considered the comments received and 

are adopting the calculation 

requirements for the per-fund limitation 

as proposed with several modifications, 

including modifications designed to 

address the unique characteristics and 

ownership structure of securitizations. 

The final rule, like the proposal, 

requires that a banking entity calculate 

its per-fund investment limit in covered 

funds that are not issuing entities of 

asset-backed securities based on both 

the value of its investments and capital 

contributions in and to each covered 

fund and the total number of ownership 

interests it has in each covered fund. A 

banking entity’s investment (including 

investments by its affiliates) may not 

exceed either three percent of the value 

of the covered fund or three percent of 

the number of ownership interests in 

the covered fund at the end of the 

seeding period. The Agencies continue 

to believe that requiring the per-fund 

limitation to be calculated based on 

these two measures best effectuates the 

terms and purpose of the per-fund 

limitation in the statute. Together, these 

measures ensure that a banking entity’s 

exposure to and ownership of each 

covered fund is limited. Each measure 

alone could provide a distorted view of 

the banking entity’s ownership interest 

and could be more easily manipulated, 

for example by issuing ownership 

interests with high value or special 

governance provisions. As discussed in 

more detail below, the final rule 

contains a separate method for 

calculating the value of investments in 

issuing entities of asset-backed 

securities due to the fact that these 

entities do not have a single class of 

security and thus, the valuation of the 

ownership interests cannot be made on 

a per interest or single class basis. 

The per-fund limitation on ownership 

interests must be measured against the 

total ownership interests of the covered 

fund, as defined in § 75.10 of the final 

rule and as discussed above in Part 

VI.B.1.e. In determining the amount of 

ownership interests held by the banking 

entity and its affiliates, the banking 

entity must include an ownership 

interest permitted under §§ 75.4 and 

75.11 of the final rule.2303 Additionally, 

any banking entity that acts as 

underwriter or market-maker for 

ownership interests of a covered fund 

must do so in compliance with the 

limitations of §§ 75.4(a) and 75.4(b) of 

the final rule, including the limits on 

the amount, types, and risk of the 

underwriting position or market-maker 

inventory as well as in compliance with 

the per-fund limitation, as applicable, 

and the aggregate funds limitations and 

capital deduction in the final rule. The 

Agencies expect to monitor these 

activities to ensure that a banking entity 

does not engage in underwriting or 

market making-related activity in a 

manner that is inconsistent with the 

limitations of the statute and the final 

rule.2304

The final rule requires that the value 

of the ownership interests and 

contributions made by a banking entity 

in each covered fund (that is not an 

issuing entity of an asset-backed 

security) be the fair market value of the 

interest or contribution. The Agencies 

have determined to use fair market 

value as the measurement of value for 

the per-fund value limitation in order to 

ensure comparability with the 

investments made in the covered fund 

by others and limit the potential that the 

valuation measure can be manipulated 

(for example by altering the percentage 

of gains and losses that are associated 

with a particular ownership interest). A 

banking entity should determine fair 

market value for purposes of the final 

rule, including the calculation of both 

the per-fund and aggregate funds 

limitations, in a manner that is 

consistent with its determination of the 

fair market value of its assets for 

financial statement purposes and that 

fair market value would be determined 

in a manner consistent with the 

valuations reported by the relevant 

covered fund unless the banking entity 

determines otherwise for purposes of its 

financial statements and documents the 

reason for any disparity. If fair market 

value cannot be determined, then the 

value shall be the historical cost basis of 

all investments and capital 

contributions made by the banking 

entity to the covered fund. The final 

rule also requires that, once a valuation 

method is chosen, the banking entity 

calculate the value of its investments 

and the investments of all others in the 

covered fund for purposes of the perfund limitation in the same manner and 

according to the same standards.2305

This approach is intended to ensure 

that, for purposes of calculating the perfund limitation, a banking entity does 

not calculate its investment in a covered 

fund in a manner more favorable to the 

banking entity than the method used by 

the covered fund for valuing the 

investments made by others. Under the 

final rule and as explained in more 

detail below, any ownership interest 

acquired or retained by an employee or 

director of the banking entity is 

attributed to the banking entity for 

purposes of the per-fund limitation if 

the banking entity financed the 

purchase of the ownership interest. 

Additionally, any amount contributed 

or paid by a banking entity or its 

employee to obtain an ownership 

interest in connection with obtaining 

the restricted profit interest must be 

included in calculating compliance with 

the per-fund and aggregate funds 

limitations (See Part VI.B.1.e. 

above).2306

In determining the per-fund limitation 

for purposes of § 75.12 of the final rule, 

the banking entity should use the same 

methodology for valuing its investments 

and capital contributions as the banking 

entity uses to prepare its financial 

statements and regulatory reports.2307 In 

particular, the fair market value of a 


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2308See Occupy. 

banking entity’s investments and any 

capital contributions made to a covered 

fund should be the same for purposes of 

§ 75.12 of the final rule as reported on 

the banking entity’s financial statements 

and regulatory reports. Similarly, if fair 

market value of all investments in and 

capital contributions cannot be 

determined for purposes of § 75.12 of 

the final rule, then the banking entity 

should use the same methodology to 

calculate the historical cost basis of the 

investments and any capital 

contributions as the banking entity uses 

to prepare its financial statements and 

regulatory reports. The Agencies will 

review carefully the methodology that a 

banking entity uses to calculate the 

value of its investments in and capital 

contributions made to covered funds as 

part of the process to monitor 

compliance with the final rule. 

The Agencies expect that for the 

majority of covered funds, the party that 

organizes and offers the fund or 

otherwise exercises control over the 

fund will provide a standard 

methodology for valuing interests in the 

fund. However, the Agencies 

understand that for some covered funds, 

including issuing entities of asset 

backed securities, there may be multiple 

parties that organize and offer the fund 

that each utilize a different methodology 

or standard for calculating the value of 

ownership interests of the fund. Going 

forward, the Agencies expect that in 

these circumstances the parties that 

organize and offer the covered fund will 

work together or select a responsible 

party to determine a single standard by 

which all ownership interests in the 

covered fund will be valued. 

One commenter suggested the 

Agencies count both invested funds and 

committed funds not yet called for 

investment towards the per-fund 

limitation.2308 This commenter argued 

that a banking entity has already 

contractually allocated committed-yetuncalled funds to the covered fund and 

that depositors face a risk of loss for 

such funds if the covered fund fails. 

The final rule, like the proposal, does 

not count committed-yet-uncalled funds 

towards the per-fund limitation; instead, 

it counts funds once they are invested. 

This approach reflects the fact that these 

funds may never be called while at the 

same time ensuring that the banking 

entity must comply with the per-fund 

limitation once the funds are called. The 

Agencies note that a banking entity is 

prohibited from guaranteeing or bailing 

out a covered fund that the banking 

entity or one of its affiliates organizes 

and offers by the terms of the statute 

and the final rule and, accordingly, 

would not be permitted to provide 

committed funds to a covered fund in a 

manner inconsistent with the 

limitations in the statute and final rule. 

After carefully considering the 

comments received on the proposal, as 

well as the language and purpose of 

section 13 of the BHC Act, the final rule 

provides that, for purposes of applying 

the per-fund limitation to an investment 

in a covered fund that is an issuing 

entity of an asset-backed security, the 

ownership interest held by the banking 

entity and its affiliates generally may 

not exceed three percent of the fair 

market value of the ownership interests 

of the fund as measured in accordance 

with § 75.12(b)(3), unless a greater 

percentage is retained by the banking 

entity and its affiliates in compliance 

with the requirements of section 15G of 

the Exchange Act and the implementing 

regulations issued thereunder, in which 

case the investment by the banking 

entity and its affiliates in the covered 

fund may not exceed the amount, 

number, or value of ownership interests 

of the fund required under section 15G 

of the Exchange Act and the 

implementing regulations issued 

thereunder. A banking entity may rely 

on any of the options available to it in 

order to meet the requirements of 

section 15G, but for purposes of section 

13 of the BHC Act and this rule, the 

amount held by the banking entity may 

not exceed the amount required under 

the chosen option. Under the final rule, 

if a banking entity’s investment in a 

covered fund is held pursuant to the 

requirements of section 15G of the 

Exchange Act, the banking entity must 

calculate the amount and value of its 

ownership interest for purposes of the 

per-fund limitation as of the date and 

according to the same valuation 

methodology applicable pursuant to the 

requirements of that section and the 

implementing regulations issued 

thereunder. 

While the amount retained in 

compliance with section 15G of the 

Exchange Act and the implementing 

regulations issued thereunder may 

permit a banking entity to own more 

than three percent of the ownership 

interests in a securitization that is a 

covered fund, this approach is 

appropriate to reconcile the competing 

policies of section 13 of the BHC Act 

and section 15G of the Exchange Act 

which requires that a securitizer of 

certain securitizations retain a 

minimum of five percent of the risk of 

the securitization. Congress enacted 

these two apparently conflicting 

provisions in the same Act, and the 

Agencies believe the more specific 

section regarding risk retention in 

securitizations was intended to prevail 

over the more general restriction on 

ownership of covered funds (which 

applies to a broader range of entities). 

The Agencies believe that the risk 

limitation goals of section 13 of the BHC 

Act are met by satisfying the minimum 

requirement of an applicable option 

under section 15G of the Exchange Act 

as the maximum initial investment 

limit, and applying the other limitations 

discussed in this section governing 

aggregate investment in covered funds 

and capital deductions. 

As under the proposal, if a banking 

entity does not have a minimum risk 

retention requirement, that banking 

entity would remain subject to the 

limitations of section 13(d)(4) of the 

BHC Act and § 75.12 on the amount of 

ownership interests it may hold in an 

issuing entity of asset-backed securities. 

A banking entity may not combine the 

amounts under these provisions to 

acquire or retain ownership interests in 

a securitization that exceed the 

aggregate permissible amounts. 

Some commenters requested that the 

Agencies coordinate implementation of 

any exemption for risk-retention 

requirements under section 13 of the 

BHC Act with the issuance of rules 

implementing section 15G of the 

Exchange Act. The Agencies note that 

rules implementing section 15G have 

been proposed but not yet finalized, but 

the Agencies will review the interaction 

between the rules promulgated under 

section 13 of the BHC Act and section 

15G of the Exchange Act once the rules 

under section 15G are finalized. 

Regardless of any action that may be 

taken regarding rules implementing 

section 15G, the final rule permits 

banking entities to own ownership 

interests in and sponsor covered funds 

as discussed above. 

Some commenters also requested that 

the final rule provide an exemption to 

permit banking entities to comply with 

any risk retention requirement imposed 

under foreign law that is similar to 

section 15G of the Exchange Act. The 

Agencies are not revising the rule to 

permit banking entities to own 

ownership interests required to be 

retained pursuant to risk retention-type 

requirements under foreign law. The 

Agencies are providing the exemption 

for the required ownership arising from 

the risk retention provisions under 

section 15G of the Exchange Act in 

order to reconcile the requirements 

under the Dodd-Frank Act applicable to 

ownership of securitization interests; 

however, the Agencies do not believe at 

this time that such reconciliation is 

appropriate with respect to foreign law 


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6000 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

2309See proposed rule § 75.12(b); Joint Proposal, 

76 FR at 68904. 

2310See, e.g., ABA (Keating); Credit Suisse 

(Williams); JPMC. 

2311See final rule § 75.12(b)(2)(i) and (ii). For 

covered funds that are an issuing entity of assetbacked securities, recalculation of the banking 

entity’s permitted ownership for purposes of the 

per-fund limitation is not required unless the 

covered fund sells additional securities. 

2312See 12 U.S.C. 1851(d)(4)(B)(ii)(I). 

2313 In addition, although some commenters 

requested that banking entities be able to hold more 

than the minimum required by section 15G, the 

Agencies are not revising the per fund limitation in 

that manner. One of the purposes of section 13 of 

the BHC Act is to reduce banking entities’ exposure 

to risks from investments in covered funds, and the 

Agencies believe at this time that permitting 

banking entities to retain risk exposure to the 

covered fund in excess of the minimum required to 

be retained would contradict the purposes of 

section 13 of the BHC Act. 

risk retention-type requirements and 

those requirements should not prevail 

over the purpose of section 13 of the 

BHC Act to reduce banking entities’ 

exposure to risks from investments in 

covered funds. 

The Agencies also note that the 

definition of covered fund has been 

modified to exclude certain foreign 

public funds and also any foreign fund 

that is not owned or sponsored by a U.S. 

banking entity. Moreover, the final rule 

permits foreign banking entities to 

engage in covered fund activities and 

investments that occur solely outside of 

the United States without regard to the 

investment limitations of section 

13(d)(4) of the BHC Act and § 75.12 of 

the final rule, which may include 

retaining risk in a securitization to the 

extent required under foreign law. In 

these manners, the final rule permits 

foreign banking entities to comply with 

requirements under foreign law that 

govern their securitization activities or 

investments abroad. However, as noted 

above, section 13 of the BHC Act applies 

to the global operations of U.S. banking 

entities and, as such, U.S. banking 

entities’ investments in foreign 

securitizations that are covered funds 

would remain subject to the investment 

limitations of section 13(d)(4) and 

§ 75.12 of the final rule. 

The proposed rule provided that a 

banking entity must comply with both 

measures of the per-fund limitation at 

all times. The preamble to the proposal 

explained that the Agencies expected a 

banking entity to calculate its per-fund 

limitation no less frequently than the 

frequency with which the fund performs 

such calculation or issues or redeems 

interests, and in no case less frequently 

than quarterly.2309

Several commenters requested that 

the Agencies modify the frequency of 

this calculation and monitoring 

requirement to a standard quarterly 

basis.2310 These commenters argued 

that, although some covered funds may 

provide daily liquidation and 

redemption rights to investors, 

monitoring the per-fund limitation on a 

continuous basis would be costly and 

burdensome and would not provide a 

significant offsetting benefit. 

The Agencies continue to believe that 

for covered funds other than issuing 

entities of asset-backed securities the 

per-fund limitations apply to 

investments in covered funds at all 

times following the end of the seeding 

period. However, to relieve burden and 

costs, while also setting a minimum 

recordkeeping standard, the final rule 

has been modified to require that a 

banking entity calculate the amount and 

value of its ownership interests in 

covered funds other than issuing 

entities of asset-backed securities 

quarterly.2311 The Agencies believe that 

this change will assist in reducing 

unnecessary costs and burdens in 

connection with calculating the perfund limitation, particularly for smaller 

banking entities, and will also facilitate 

consistency with the calculation for the 

aggregate funds limitation (which is also 

determined on a quarterly basis). 

Nevertheless, should a banking entity 

become aware that it has exceeded the 

per-fund limitation for a given fund at 

any time, the Agencies expect the 

banking entity to take steps to ensure 

that the banking entity complies 

promptly with the per-fund 

limitation.2312

The Agencies have also modified the 

timing and methodology of the per-fund 

limitation as it applies to securitizations 

to address the unique circumstances 

and ownership structure presented by 

securitizations, which typically wind 

down over time. Unlike many other 

covered funds, securitizations do not 

generally experience increases in the 

amount of investors or value of 

ownership interests during the life of 

the securitization; rather, they generally 

experience only a contraction of the 

investor base and reduction in the total 

outstanding value of ownership 

interests on an aggregate basis, and may 

do so at different rates under the terms 

of the transaction agreements, meaning 

that the percentage of ownership 

represented by a particular ownership 

interest may increase as the fund 

amortizes but without the banking 

entity adding any funds. The manner in 

which securitizations are organized and 

offered, as well as the amortization of 

securitizations, differs from many other 

covered funds; section 15G of the 

Exchange Act also requires that certain 

parties to securitization transactions, 

which may include banking entities, 

retain a minimum amount of risk in a 

securitization, a requirement not 

applicable to covered funds that are not 

securitizations. Therefore, for purposes 

of calculating a banking entity’s perfund limitation with respect to a 

securitization, the calculation of the perfund limitation shall be based on 

whether section 15G applies and the 

implementing regulations are effective. 

In the case of an ownership interest in 

an issuing entity of an asset-backed 

security that is subject to section 15G of 

the Exchange Act and for which 

effective implementing regulations have 

been issued, the calculation of the perfund limitation shall be made as of the 

date and pursuant to the methodology 

applicable pursuant to the requirements 

of section 15G of the Exchange Act and 

the implementing regulations issued. 

For securitizations executed after the 

effective date of the final rule and prior 

to the adoption and implementation of 

the rules promulgated under section 

15G of the Exchange Act and for 

securitizations for which a fair valuation 

calculation is not required by the 

implementing rules promulgated under 

section 15G of the Exchange Act, the per 

fund limitation is calculated as of the 

date on which the assets are initially 

transferred into the issuing entity of the 

asset-backed securities or such earlier 

date on which the transferred assets 

have been valued for purposes of 

transfer to the covered fund.2313 This 

calculation for issuers of asset backed 

securities is only required to be 

performed once on the date noted 

above, and thereafter only upon the date 

on which the price of additional 

securities of the covered fund to be sold 

to third parties is determined. 

As noted above, the per-fund 

limitations for ownership interests in 

issuing entities of asset-backed 

securities are calculated based only on 

the value of the ownership interest in 

relation to the value of all ownership 

interests in the issuing entity of the 

asset-backed security and are not 

calculated on a class by class, or tranche 

by tranche basis. For purposes of the 

valuation, the aggregate value of all the 

assets that are transferred to the issuing 

entity of the asset-backed securities, and 

any assets otherwise held by the issuing 

entity, are determined based on the 

valuation methodology used for 

determining the value of the assets for 

financial statement purposes. This 

valuation will be the value of the 

ownership interests in the issuing entity 

for purposes of the calculation. A 

banking entity will need to determine 


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2314See 12 U.S.C. 1851(d)(4)(B)(ii)(II). 

2315See ABA (Abernathy). 

2316See, e.g., ABA (Abernathy). 

2317See AFR et al. (Feb. 2012); Public Citizen. 

2318See Public Citizen. 

2319See AFR et al. (Feb. 2012). 

2320See ABA(Keating); BoA; Arnold & Porter; 

BOK; Scale; SVB. 

2321See Occupy. 

2322See ABA (Keating). 

2323See AFR et al. (Feb. 2012); Occupy. 

its percentage ownership in the issuing 

entity based on the its contributions to 

the entity in relation to the 

contributions of all parties and after 

taking into account the value of any 

residual interest in the issuing entity. In 

addition, for purposes of the final rule, 

the asset valuation is as of the date of 

establishment (the date of the asset 

transfer to the issuing entity of the assetbacked securities). 

d. Limitation on Aggregate Permitted 

Investments in All Covered funds 

(‘‘Aggregate Funds Limitation’’) 

In addition to the per-fund limitation, 

section 13(d)(4) of the BHC Act provides 

that the aggregate of a banking entity’s 

investments in all covered funds may 

not exceed three percent of the tier 1 

capital of the banking entity (referred to 

above as the ‘‘aggregate funds 

limitation’’).2314 To implement this 

limitation, the proposed rule required a 

banking entity to determine the 

aggregate value of the banking entity’s 

investments in covered funds by 

calculating the sum of the value of each 

investment in a covered fund, as 

determined in accordance with 

applicable accounting standards. This 

amount was then measured as a 

percentage of the tier 1 capital of the 

banking entity for purposes of 

determining compliance with the 

aggregate funds limitation. For purposes 

of applying the limit, a banking entity 

that is subject to regulatory capital 

requirements was required under the 

proposed rule to measure tier 1 capital 

in accordance with those regulatory 

capital requirements; a banking entity 

that is not a subsidiary of a reporting 

banking entity and that is not itself 

required to report capital in accordance 

with the risk-based capital rules of a 

Federal banking agency was required by 

the proposed rule to calculate its tier 1 

capital based on the total amount of 

shareholders’ equity of the top-tier 

entity as of the last day of the most 

recent calendar quarter, as determined 

under applicable accounting standards. 

Commenters expressed a variety of 

views regarding the aggregate funds 

limitation. One commenter argued that 

basing the aggregate funds limitation on 

the size of tier 1 capital of a banking 

entity provides an advantage to the 

largest institutions with large absolute 

capital bases and disadvantages smaller 

banks that are well capitalized but have 

a smaller absolute capital base.2315 This 

commenter urged the Agencies to 

permit all banking entities to invest in 

covered funds in an amount that is, in 

the aggregate, the greater of $1 billion 

(subject to prudential investment 

limitations and safety and soundness 

concerns), or three percent of tier 1 

capital.2316

In contrast, other commenters urged 

the Agencies to decrease the statutory 

limit in order to prevent the largest 

banking entities from investing amounts 

that, while within the statutory limit, 

could be very large in absolute 

terms.2317 One commenter argued that a 

loss of three percent of tier 1 capital 

would be a material loss reflected in a 

change in stock price.2318 Another 

commenter suggested the Agencies 

consider whether the investment 

supports a large flow of management 

fees linked to market volatility or has 

significant embedded leverage.2319

Some commenters argued that the 

final rule should calculate the value of 

covered fund investments based on 

acquisition cost instead of fair market 

value.2320 These commenters argued 

that using fair value to calculate the 

aggregate funds limitation penalizes 

banking entities for organizing and 

investing in successful funds and, 

conversely, would allow banking 

entities to increase investments in 

unsuccessful funds (the value of which 

would decline relative to the capital of 

the banking entity). 

In contrast, another commenter 

argued that valuation of a covered fund 

investment should include any mark-tomarket increase in a banking entity’s 

aggregate investments in order to keep 

pace with increases in the capital of the 

banking entity.2321

Some commenters discussing the 

frequency of the calculation of the 

aggregate funds limitation supported 

determining the aggregate funds 

limitation on the last day of each 

calendar quarter as required in the 

proposal.2322 Other commenters argued 

that the statute requires compliance at 

all times rather than periodic 

calculations of compliance.2323

After consideration of the comments 

in light of the statutory provisions, the 

Agencies have adopted the requirements 

for calculating the aggregate funds 

limitation as proposed with several 

modifications as explained below. 

Under the final rule, the aggregate value 

is the sum of all amounts paid or 

contributed by the banking entity in 

connection with acquiring or retaining 

an ownership interest in each covered 

fund (together with any amounts paid 

by the entity (or employee thereof) in 

connection with obtaining a restricted 

profit interest under § 75.10(d)(6)(ii)), as 

measured on a historical cost basis. This 

aggregate value is measured against the 

total applicable tier 1 capital for the 

banking entity as explained below. 

For purposes of determining the 

aggregate funds limitation, the final rule 

requires that the value of investments 

made by a banking entity be calculated 

on a historical cost basis. This approach 

limits the aggregate amount of funds a 

banking entity may provide to covered 

funds as a percentage of the banking 

entity’s capital as required by statute. At 

the same time, this approach does not 

permit a banking entity to increase its 

exposure to covered funds in the event 

any investment in a particular covered 

fund declines in value as a result of the 

fund’s investment activities. Permitting 

a banking entity to increase its aggregate 

investments as covered funds lose value 

would permit the banking entity both to 

increase its exposure to covered funds at 

the same time the covered funds it 

already owns are losing value and to 

effectively bail-out investors by 

providing additional capital to troubled 

covered funds. Neither of these actions 

is consistent with the purposes of 

section 13 of the BHC Act. Moreover 

and as explained below, because the 

final rule requires that the banking 

entity deduct from the entity’s capital 

the greater of historical cost (plus 

earnings) or fair market value of its 

investments in covered funds, the 

deduction accounts for any profits 

resulting from investments in covered 

funds. 

Historical cost basis means, with 

respect to a banking entity’s ownership 

interest in a covered fund, the sum of all 

amounts paid or contributed by the 

banking entity to a covered fund in 

connection with acquiring or retaining 

an ownership interest (together with any 

amounts paid by the entity (or employee 

thereof) in connection with obtaining a 

restricted profit interest)), less any 

amounts received as a redemption, sale 

or distribution of such ownership 

interest or restricted profit interest. 

Under the final rule, any reduction of 

the historical cost would not generally 

include gains or losses, fees, income, 

expenses or similar items. However, as 

noted above, the final rule also requires 

that a banking entity deduct any 

earnings from its tier 1 capital even if it 

values its ownership interests in a 

covered fund pursuant to historical cost. 

The concern expressed by 

commenters that the aggregate funds 


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6002 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

2324See 12 U.S.C. 1851(d)(4)(B)(iii). 

2325 Id. at 1851(d)(3). 

2326See Occupy. 

2327See Occupy. 

2328See ABA (Keating); BNY Mellon et al.; PNC; 

SIFMA et al. (Covered Funds) (Feb. 2012); SVB. 

2329See, e.g., SIFMA et al. (Covered Funds) (Feb. 

2012). 

2330 Id. 

2331See ABA (Keating). 

2332See ABA (Keating); see also letter from PNC. 

2333See Arnold & Porter; SVB. 

limitation should account for increases 

in the fair market value of covered funds 

is addressed in other ways under the 

final rule. In particular, the final rule 

requires that for purposes of calculating 

compliance with regulatory capital 

requirements the banking entity deduct 

from the entity’s capital the greater of 

fair market value (or historical cost plus 

earnings) of its investment in each 

covered fund; thus, profits resulting 

from investments in covered funds will 

not inflate the capital of the banking 

entity for regulatory compliance 

purposes. Moreover, as explained above, 

the per-fund limitation is generally 

based on fair market value, which 

maintains the relative level of a banking 

entity’s investment in each covered 

fund. 

As noted above, the aggregate funds 

limitation applies to all investments by 

a banking entity in a covered fund that 

the banking entity or an affiliate thereof 

holds under §§ 75.4 and 75.11 of the 

final rule. The limitation would also 

apply to investments by a banking entity 

made or held during the seeding period 

as part of organizing and offering a 

covered fund, including ownership 

interests held in order to satisfy the 

requirements of section 15G of the 

Exchange Act, as well as ownership 

interests held by a banking entity in the 

capacity of acting as underwriter or 

market-maker. 

As under the proposal, this 

calculation must be made as of the last 

day of each calendar quarter, consistent 

with when tier 1 capital is reported by 

banking entities to the Agencies. 

Because compliance with the aggregate 

funds limitations is calculated based on 

tier 1 capital, the Agencies believe it is 

more appropriate to require the 

calculation to be performed on the same 

schedule as tier 1 capital is reported. 

While the aggregate funds limitation 

must be calculated on a quarterly basis, 

the Agencies expect banking entities to 

monitor investments in covered funds 

regularly and remain in compliance 

with the limitations on covered fund 

investments throughout the quarter. The 

Agencies intend, through their 

respective supervisory processes, to 

monitor covered fund investment 

activity to ensure that a banking entity 

is not attempting to evade the 

requirements of section 13. 

The Agencies recognize that banks 

with large absolute capital bases will be 

able to place a greater amount of capital 

in covered funds compared to banks 

with small absolute capital bases. 

However, the amount of risk exposure to 

a covered fund, despite their different 

investment strategies, will be relatively 

similar across banking entities, which is 

consistent with the language and risklimiting purpose of section 13. 

e. Capital Treatment of an Investment in 

a Covered Fund 

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

provides that, for purposes of 

determining compliance with applicable 

capital standards under section 13(d)(3) 

of that Act, the aggregate amount of 

outstanding investments by a banking 

entity under section 13(d)(4), including 

retained earnings, must be deducted 

from the assets and tangible equity of 

the banking entity, and the amount of 

the deduction must increase 

commensurate with the leverage of the 

covered fund.2324 Section 13(d)(3) 

authorizes the Agencies, by rule, to 

impose additional capital requirements 

and quantitative limitations, including 

diversification requirements on any of 

the activities permitted under section 13 

of the BHC Act if the Agencies 

determine that such additional capital 

and quantitative limitations are 

appropriate to protect the safety and 

soundness of banking entities engaged 

in such activities.2325

The proposed rule implemented the 

capital deduction provided for under 

section 13(d)(4)(B)(iii) of the BHC Act 

by requiring a banking entity to deduct 

the aggregate fair value of its 

investments in covered funds, including 

any attributed profits, from tier 1 

capital. As in the statute, the proposed 

rule applied the capital deduction to 

ownership interests in covered funds 

held as an investment by a banking 

entity pursuant to the provisions of 

section 13(d)(4) of the BHC Act, and not 

to ownership interests acquired under 

other permitted authorities, such as a 

risk-mitigating hedge under section 13 

of the BHC Act. The proposed rule 

required the deduction to be calculated 

consistent with the method for 

calculating other deductions under the 

applicable risk-based capital rules. The 

proposed rule did not otherwise adopt 

additional capital requirements and 

quantitative limitations under section 

13(d)(3) of the BHC Act. 

Some commenters supported the 

proposed dollar-for-dollar deduction 

from tier 1 capital of a banking entity’s 

aggregate investments in covered funds 

and asserted it is consistent with the 

statute.2326 One of these commenters 

urged the Agencies to rely on their 

authority under section 13(d)(3) of the 

BHC Act to apply the capital deduction 

to other permitted ownership interests 

in covered funds to protect the safety 

and soundness of the banking entity.2327

In contrast, other commenters urged the 

Agencies to eliminate the capital 

deduction for investments in covered 

funds and questioned the Agencies’ 

statutory authority to impose the capital 

deduction.2328 These commenters 

argued that the statute does not 

authorize or require the Agencies to 

require banking entities to deduct their 

investments in covered funds for 

purposes of calculating capital pursuant 

to the applicable capital rules. 

According to these commenters, section 

13 only requires deductions for 

purposes of determining compliance 

with applicable capital standards under 

section 13 and argued the Agencies did 

not make the necessary safety and 

soundness findings under section 

13(d)(3) to impose additional capital 

requirements on any activities permitted 

under section 13(d)(1).2329 One 

commenter urged the Agencies to make 

any capital adjustment as part of the 

banking agencies’ broader efforts to 

implement the Basel III capital 

framework.2330 Another commenter 

urged the Agencies to apply the capital 

deduction only for purposes of 

determining a banking entity’s 

compliance with the aggregate funds 

limitation and not for other regulatory 

capital purposes.2331 This commenter 

also argued that a capital deduction is 

normally not required for assets 

reflected on a bank’s consolidated 

balance sheet, and that the Agencies 

should not require a deduction for a 

covered fund investment that is not 

consolidated with the banking entity for 

financial reporting purposes under 

GAAP.2332 Some commenters urged the 

Agencies to apply the capital deduction 

only to a banking entity’s investment in 

a covered fund that the banking entity 

organizes and offers and not to 

ownership interests otherwise permitted 

to be held under section 13 of the BHC 

Act.2333

Several commenters addressed the 

manner for valuing an investment 

subject to the deduction. One 

commenter urged the Agencies to 

permit a banking entity to calculate the 

deduction based on the acquisition cost, 

instead of the fair market value, of the 

banking entity’s ownership interest in 


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2334See SIFMA et al. (Covered Funds) (Feb. 

2012). 

2335 Id. 

2336See IIB/EBF. 

2337See 12 U.S.C. 1851(d)(4)(B)(iii). 

2338See 78 FR 62018, 62072 (Oct. 11, 2013) 

(Board/OCC/FDIC Basel III Final Rule); 78 FR 

55340, 55391 (Sept. 10, 2013) (FDIC Basel III 

interim final rule). 

2339See 12 CFR part 208, subpart D and 

appendixes A, B, E, and F; 12 CFR part 217 (to be 

codified), and 12 CFR part 225, appendixes A, D, 

E, and G; see also 12 CFR 240.15c3–1 (net capital 

requirements for brokers or dealers). 

the covered fund.2334 This commenter 

emphasized that valuing the investment 

at fair market value would penalize a 

banking entity if the covered fund 

performs well by reducing the amount 

of capital available for additional 

covered fund investments but reduce 

the capital charge against troubled 

investments. One commenter argued 

that the Agencies did not perform an 

appropriate cost-benefit analysis of the 

deduction in the proposed rules.2335

Other commenters sought clarification 

on how the capital deduction would 

apply to a foreign banking organization. 

Several commenters argued that the 

capital deduction should not apply to a 

foreign banking entity that calculates its 

tier 1 capital under the standards of its 

home country.2336 These commenters 

argued that imposing a capital 

deduction requirement on foreign banks 

would not be consistent with past 

practices on the application of U.S. riskbased capital requirements to foreign 

banking organizations. 

The Agencies have carefully 

considered the comments in light of the 

statutory provisions requiring a capital 

deduction. The statute requires that the 

aggregate amount of outstanding 

investments by a banking entity, 

including retained earnings, be 

deducted from the assets and tangible 

equity of the banking entity.2337 This 

requirement is independent of the 

minimum regulatory capital 

requirements in the final capital rule 

published by the Federal Banking 

agencies in 2013 (‘‘regulatory capital 

rule’’).2338

The Federal Banking agencies 

recognize that the regulatory capital rule 

imposes risk weights and deductions 

that do not correspond to the deduction 

for covered fund investments imposed 

by section 13 of the BHC Act. The 

Federal Banking agencies intend to 

review the interaction between the 

requirements of this rule and the 

requirements of the regulatory capital 

rule and expect to propose steps to 

reconcile the two rules. 

At the same time, the Agencies 

believe that the dollar-for-dollar 

deduction of the fair market value of a 

banking entity’s investment in a covered 

fund is appropriate to protect the safety 

and soundness of the banking entity, as 

provided in section 13(d) of the BHC 

Act. This approach ensures that a 

banking entity can withstand the failure 

of a covered fund without causing the 

banking entity to breach the minimum 

regulatory capital requirements. 

Consistent with the language and 

purpose of section 13 of the BHC Act, 

this deduction will help provide that a 

banking entity has sufficient capital to 

absorb losses that may occur from 

covered fund investments without 

endangering the safety and soundness of 

the banking entity or the financial 

stability of the United States. 

Accordingly, under the final rule, a 

banking entity must, for purposes of 

determining compliance with applicable 

regulatory capital requirements, deduct 

the greater of (i) the sum of all amounts 

paid or contributed by the banking 

entity in connection with acquiring or 

retaining an ownership interest 

(together with any amounts paid by the 

entity (or employee thereof) in 

connection with obtaining a restricted 

profit interest under § 75.10(b)(6)(ii)), on 

a historical cost basis, including 

earnings or (ii) the fair market value of 

the sum of all amounts paid or 

contributed by the banking entity in 

connection with acquiring or retaining 

an ownership interest (together with any 

amounts paid by the entity (or employee 

thereof) in connection with obtaining a 

restricted profit interest under 

§ 75.10(b)(6)(ii)), if the banking entity 

accounts for the profits (or losses) of the 

fund investment in its financial 

statements.2339 This deduction must be 

made whenever the banking entity 

calculates its tier 1 capital, either 

quarterly or at such other time at which 

the appropriate Federal banking agency 

may request such a calculation. 

Requiring a banking entity to deduct the 

greater of historical cost or fair market 

value of all covered fund investments 

made by a banking entity from the 

entity’s tier 1 capital should result in an 

appropriate deduction that is consistent 

with the manner in which the banking 

entity accounts for its covered fund 

investments. For instance, if a banking 

entity accounts for its investments in 

covered funds using fair market value, 

then any changes in the fair market 

value of the banking entity’s investment 

in a covered fund should similarly be 

reflected in the banking entity’s tier 1 

capital. Thus, this deduction should not 

unduly penalize banking entities for 

making successful investments or allow 

more investments in troubled covered 

funds. 

The final rule does not require a 

foreign banking entity that makes a 

covered fund investment in the United 

States, either directly or through a 

branch or agency, to deduct the 

aggregate value of the investment from 

the foreign bank’s tier 1 capital 

calculated under applicable home 

country standards. However, any U.S. 

subsidiary of a foreign banking entity 

that is required to calculate tier 1 capital 

under U.S. risk based capital regulations 

must deduct the aggregate value of 

investment held through that subsidiary 

from its tier 1 capital. 

While some commenters requested 

that additional capital charges be 

imposed on banking entity’s interests in 

securitizations, the Agencies have 

declined to do so at this time. Under the 

final rule, the banking entity must 

deduct the value of its investment in a 

securitization that is a covered fund 

from its tier 1 capital for purposes of 

determining compliance with the 

applicable regulatory capital 

requirements. This requirement already 

requires the banking entity to adjust its 

capital for the possibility of losses on 

the full amount of its investment. The 

Agencies do not believe that it is 

appropriate to impose additional capital 

charges on these securitizations because 

it would act as a disincentive to retain 

risk in securitizations for which the 

banking entity acts as issuer or sponsor, 

a result that would contradict the 

purpose of section 15G of the Exchange 

Act. Additionally and as noted in the 

proposal, permitting a banking entity to 

retain the minimum level of economic 

interest and risk in a securitization will 

incent banking entities to engage in 

more careful and prudent underwriting 

and evaluation of the risks and 

obligations that may accompany assetbacked securitizations, which would 

promote and protect the safety and 

soundness of banking entities and the 

financial stability of the United States. 

The Agencies have also declined to 

impose additional quantitative 

limitations or diversification 

requirements on covered fund 

investments at this time. The Agencies 

believe that the per-fund and aggregate 

funds limitations, as well as the capital 

deduction required by the rule, acting 

together with the other limitations on 

covered fund activities, establish an 

appropriate framework for ensuring that 

the covered fund investments and 

activities of banking entities are 

conducted in a manner that is safe and 

sound and consistent with financial 

stability. The Agencies will continue to 

monitor these activities and investments 


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6004 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

2340See ABA (Keating); Arnold & Porter; SIFMA 

et al. (Covered Funds) (Feb. 2012); SSgA (Feb. 

2012). 

2341See SIFMA et al. (Covered Funds) (Feb. 

2012); BlackRock; Arnold & Porter. 

2342See ABA (Keating); Arnold & Porter. 

2343See BoA; SIFMA et al. (Covered Funds) (Feb. 

2012); SSgA (Feb. 2012). These commenters argued 

that banking entities traditionally utilize a fund-offunds structure to offer customers the opportunity 

to invest indirectly in a portfolio of other funds 

(including some funds sponsored and managed by 

one or more third parties) and that these structures 

provide customers with certain risk-mitigating 

benefits and allow customers to gain exposure to a 

diverse portfolio without having to satisfy the 

minimum investment requirements of each fund 

directly. They also argued that parallel and feeder 

entities are established for a variety of client-driven 

reasons, including to accommodate tax needs of 

clients and that these entities should be viewed as 

a single investment program in which the master 

fund holds and manages investments in portfolio 

assets and the feeder fund typically makes no 

investments other than in the master fund. 

2344See SIFMA et al. (Covered Funds) (Feb. 

2012); BoA; Arnold & Porter; SSgA (Feb. 2012). 

2345See SIFMA et al. (Covered Funds) (Feb. 

2012). 

2346See Occupy. 

2347The Agencies note that other provisions of 

the BHC Act and Savings and Loan Holding 

Company Act would prohibit a banking entity that 

is a bank holding company or savings and loan 

holding company from acquiring 5 percent or more 

of a covered fund that is itself a bank holding 

company or a savings and loan holding company, 

respectively, without regulatory approval. See 12 

U.S.C. 1842(a); 12 U.S.C. 1467a(e). 

2348See, e.g., First Union Letter. 

2349 Id. See final rule § 75.12(b)(1)(ii). 

to determine whether other limitations 

are appropriate over time. 

f. Attribution of Ownership Interests to 

a Banking Entity 

The proposed rule attributed an 

ownership interest to a banking entity 

based on whether or not the banking 

entity held the interest through a 

controlled entity. The proposed rule 

required that any ownership interest 

held by any entity that is controlled, 

directly or indirectly, by a banking 

entity be included in the amount and 

value of the banking entity’s permitted 

investments in a single covered fund. 

The proposed rule required that the pro 

rata share of any ownership interest 

held by any covered fund that is not 

controlled by the banking entity, but in 

which the banking entity owns, 

controls, or holds with the power to 

vote more than 5 percent of the voting 

shares, be included in the amount and 

value of the banking entity’s permitted 

investments in a single covered fund. 

Many commenters expressed 

concerns regarding the proposed 

attribution requirements.2340 These 

commenters argued that the proposed 

pro rata attribution requirements are not 

required or permitted by the statute, 

have unintended and inconsistent 

consequences for covered fund 

investments, impose heavy compliance 

costs on banking entities, and would 

impede the ability of funds sponsored 

by banking entities to invest in thirdparty funds for the benefit of clients. 

Some commenters argued that the costs 

and complexity of determining whether 

a banking entity ‘‘controls’’ another 

banking entity under the BHC Act and 

the Board’s precedent are high and 

urged the Agencies to adopt a simpler 

test.2341 For example, some commenters 

urged that shares of a company be 

attributed to a banking entity only when 

the banking entity maintains ownership 

of 25 percent or more of voting shares 

of the company.2342

Several commenters maintained that 

applying the attribution requirements to 

fund-of-funds structures and parallel or 

master-feeder structures would be 

unworkable.2343 Commenters contended 

that the proposed attribution rules could 

result in a banking entity calculating the 

per-fund limitation in a way that 

exceeds the banking entity’s actual loss 

exposure if the attribution rule for 

controlled investments is interpreted to 

require that 100 percent of all 

investments made by controlled entities 

be attributed to the banking entity.2344

In addition, several commenters 

argued that the pro rata attribution of 

investments held through noncontrolled structures is not consistent 

with the Board’s rules and practices for 

purposes of the activity and investment 

limits in other sections of the BHC Act. 

Commenters also maintained that this 

pro rata attribution for non-controlled 

entities would be impracticable because 

a banking entity has only a limited 

ability to monitor, direct, or restrain 

investments of a covered fund that it 

does not control.2345

Conversely, one commenter 

supported the pro rata attribution 

requirement in the proposal. This 

commenter argued that this requirement 

reduced opportunities for evasion 

through subsidiaries, affiliates or related 

entities.2346

The final rule has been modified in 

light of the comments. Under the final 

rule, a banking entity must account for 

an investment in a covered fund for 

purposes of the per-fund and aggregate 

funds limitations only if the investment 

is made by the banking entity or another 

entity controlled by the banking entity. 

Accordingly, the final rule does not 

generally require that a banking entity 

include the pro rata share of any 

ownership interest held by any entity 

that is not controlled by the banking 

entity, and thus reduces the potential 

compliance costs of the final rule. The 

Agencies believe that this concept of 

attribution is more consistent with how 

the Board has historically applied the 

concept of ‘‘control’’ under the BHC Act 

for purposes of determining whether a 

company subject to that Act is engaged 

in an activity or whether to attribute an 

investment to that company. 

Furthermore, because a banking entity 

does not control a non-affiliate and 

typically has less access to information 

about the holdings of a non-affiliate, this 

change is unlikely to present 

opportunity for circumvention of the 

per-fund and aggregate funds 

limitations. The Agencies will monitor 

these limitations for practices that 

appear to be attempts to circumvent 

them.2347

Whether a banking entity controls 

another entity under the BHC Act may 

vary depending on the type of entity in 

question. As noted above in Part 

VI.B.1.b.3., the Board’s regulations and 

orders have long recognized that the 

concept of control is different for funds 

than for operating companies.2348 In 

contrast to the proposal, the final rule 

incorporates these different concepts of 

control in part by providing that, for 

purposes of section 13 of the BHC Act 

and the final rule, a registered 

investment company, SEC-regulated 

business development company, and a 

foreign public fund as described in 

§ 75.10(c)(1) of the final rule will not be 

considered to be an affiliate of the 

banking entity if the banking entity 

owns, controls, or holds with the power 

to vote less than 25 percent of the voting 

shares of the company or fund, and 

provides investment advisory, 

commodity trading advisory, 

administrative, and other services to the 

company or fund only in a manner that 

complies with other limitations under 

applicable regulation, order, or other 

authority.2349

In response to commenter concerns 

regarding the workability of the 

proposed rule, the final rule has been 

modified to address how ownership 

interests would be attributed to a 

banking entity when those interests are 

held in a fund-of-funds or multi-tiered 

fund structures. For instance, banking 

entities may use a variety of structures 

to satisfy operational needs or meet the 

investment needs of customers of their 

trust, fiduciary, investment advisory or 

commodity trading advisory services. 

First, except as explained for 

purposes of calculating a banking 

entity’s permitted investment in multitier fund structures, the final rule does 

not generally attribute to a banking 

entity ownership interests held by a 

covered fund so long as the banking 


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2350See final rule § 75.12(b)(1)(iii). 

2351See final rule § 75.12(b)(34). 

2352See 12 U.S.C. 1851(d)(1)(G)(vii); final rule 

§ 75.11(g). 2353See Joint Proposal, 76 FR at 68902. 2354See Ass’n. of Institutional Investors (Feb. 

2012). 2355See Occupy. 2356See Arnold & Porter. 

2357See final rule § 75.12(b)(1)(iv). 

2358See 12 U.S.C. 1851(f)(1). 

2359See 12 U.S.C. 1851(d)(1)(G)(vii). 

entity’s investment in the covered fund 

meets the per-fund limitation in the 

final rule.2350 Absent unusual 

circumstances or structures, a banking 

entity would not control a covered fund 

in which the banking entity has an 

ownership interest that conforms to the 

per-fund and aggregate funds limitations 

contained in the final rule. Thus, the 

interests held by that covered fund 

would not be attributed to the banking 

entity for the reasons discussed above. 

The final rule also explains how the 

investment limitations apply to 

investments of a banking entity in 

multi-tier fund structures. The Agencies 

believe that master-feeder fund 

structures typically constitute a single 

investment program in which the master 

fund holds and manages investments 

and the feeder funds typically make no 

investments other than in the master 

fund and exist as a convenience for 

customers of the trust, fiduciary, 

investment advisory, or commodity 

trading advisory services of the banking 

entity. Similarly, trust, fiduciary, or 

advisory customers of a banking entity 

may desire to obtain diversified 

exposure to a variety of funds or 

investments through investing in a 

fund-of-funds structure that the banking 

entity organizes and offers. 

In order to meet the demands of these 

customers, the final rule provides that if 

the principal investment strategy of a 

covered fund (the ‘‘feeder fund’’) is to 

invest substantially all of its assets in 

another single covered fund (the 

‘‘master fund’’), then for purposes of the 

per-fund limitation the banking entity’s 

permitted investment shall be measured 

only at the master fund. However, in 

order to appropriately capture the 

banking entity’s amount of investment 

in the master fund, a banking entity 

must include in this calculation any 

investment held by the banking entity in 

the master fund, as well as the banking 

entity’s pro-rata share of any ownership 

interest of the master fund that is held 

through the feeder fund.2351

Similarly, regarding fund-of-funds 

structures, the final rule provides that if 

a banking entity organizes and offers a 

covered fund pursuant to § 75.11 for the 

purpose of investing in other covered 

funds (a ‘‘fund of funds’’) and that fund 

of funds itself invests in another 

covered fund that the banking entity 

organizes and offers, then the banking 

entity’s permitted investment in that 

other covered fund shall include any 

investment held by the banking entity in 

that other fund, as well as the banking 

entity’s pro-rata share of any ownership 

interest of the other fund that is held 

through the fund of funds. The banking 

entity’s investment in the fund of funds 

must also meet the investment 

limitations contained in § 75.12. In 

these manners, the final rule permit a 

banking entity to meet the demands of 

customers of their trust, fiduciary, or 

advisory services while also limiting the 

ability of a banking entity to be exposed 

to more than the amount of risk of a 

covered fund contemplated by section 

13. 

As described above in the discussion 

of organizing and offering a covered 

fund, other provisions of section 13 

contemplate investments by employees 

and directors of the banking entity that 

provide qualifying services to a covered 

fund.2352 The Agencies recognized in 

the proposal that employee and director 

investments in a covered fund may 

provide an opportunity for a banking 

entity to evade the limitations regarding 

the amount or value of ownership 

interests a banking entity may acquire in 

a covered fund.2353 In order to address 

this concern, the proposal attributed an 

ownership interest in a covered fund 

acquired or retained by a director or 

employee to the person’s employing 

banking entity if the banking entity 

either extends credit for the purposes of 

allowing the director or employee to 

acquire the ownership interest, 

guaranteed the director or employee’s 

purchase, or guarantees the director or 

employee against loss on the 

investment. 

One commenter supported the way 

the proposal addressed evasion 

concerns by attributing an ownership 

interest in a covered fund acquired or 

retained by a director or employee to a 

banking entity.2354 A different 

commenter urged the Agencies to 

attribute any employee investments in a 

covered fund to the banking entity itself, 

regardless of the source of funds.2355

Another commenter argued that the 

statute prohibits a banking entity from 

guaranteeing an investment by an 

employee or director.2356

After considering the comments and 

the language of the statute, the Agencies 

have determined to retain the 

requirement that all director or 

employee investments in a covered fund 

be attributed to the banking entity for 

purposes of the per-fund limitation and 

the aggregate funds limitation whenever 

the banking entity provides the 

employee or director funding for the 

purpose of acquiring the ownership 

interest. Specifically, under the final 

rule, an investment by a director or 

employee of a banking entity who 

acquires an ownership interest in his or 

her personal capacity in a covered fund 

sponsored by the banking entity will be 

attributed to the banking entity if the 

banking entity, directly or indirectly, 

extends financing for the purpose of 

enabling the director or employee to 

acquire the ownership interest in the 

fund and the financing is used to 

acquire such ownership interest in the 

covered fund.2357 It is also important to 

note that the statute prohibits a banking 

entity from guaranteeing the obligations 

or performance of a covered fund in 

which it acts as investment adviser, 

investment manager or sponsor, or 

organizes and offers.2358

As discussed above in the definition 

of ownership interest, the final rule also 

attributes to the banking entity any 

amounts contributed by an employee or 

director when made in order to receive 

a restricted profit interest, whether or 

not funded or guaranteed by the banking 

entity. This approach ensures that all 

funding provided by the banking 

entity—whether directly or through its 

employees or directors—and all 

exposures of the banking entity— 

whether directly or through a guarantee 

provided to or on behalf of an employee 

or director—is counted against the 

limits on exposure contained in the 

statute and final rule. At the same time, 

this approach recognizes that employees 

and directors may use their own 

resources, not protected by the banking 

entity, to invest in a covered fund. 

Employees of investment advisers in 

particular often invest their own 

resources in covered funds they advise, 

both by choice and as a method to align 

their personal financial interests with 

those of other investors in the covered 

fund. So long as these investments are 

truly with personal resources, and are 

not funded by the banking entity, these 

personal investments would not expose 

the banking entity to loss and would not 

be attributed by the final rule to the 

banking entity. This approach is also 

consistent with the terms of the statute, 

which expressly contemplates 

investments by directors or employees 

of a banking entity in their individual 

capacity.2359

The Agencies intend to monitor 

investments by directors and employees 

of a banking entity to ensure that 

employee ownership interests are not 


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6006 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

2360See 12 U.S.C. 1843(k)(4)(H); 12 CFR 225.170 

et seq. See ABA (Keating); BoA; BOK; SIFMA et al. 

(Covered Funds) (Feb. 2012); SVB. 2361See ABA (Keating). 2362See BOK; SVB; ABA (Keating); BoA; SIFMA 

et al. (Covered Funds) (Feb. 2012). 

2363See BOK. 

2364See Public Citizen; Sens. Merkley & Levin 

(Feb. 2012). 

used to circumvent the per-fund and 

aggregate funds limitations in section 

13. Among the factors the Agencies will 

consider, in addition to financing and 

guarantee arrangements, are whether the 

benefits of the acquisition and retention, 

such as dividends, inure to the benefit 

of the director or employee and not the 

banking entity; the voting or control of 

the ownership interests is subject to the 

direction of, or otherwise controlled by, 

the banking entity; and the employee or 

director, rather than the banking entity, 

determines whether the employee or 

director should make the investment. 

The proposed rule contained a 

provision intended to curb potential 

evasion of the per-fund limitation and 

aggregate limitation through parallel 

investments by banking entities that 

were not otherwise subject to section 13 

of the BHC Act. Specifically, the 

proposed rule provided that, to the 

extent that a banking entity is 

contractually obligated to invest in, or is 

found to be acting in concert through 

knowing participation in a joint activity 

or parallel action toward a common goal 

of investing in, one or more investments 

with a covered fund that is organized 

and offered by the banking entity 

(whether or not pursuant to an express 

agreement), such investment must be 

included in the calculation of a banking 

entity’s per-fund limitation. 

Several commenters objected to this 

requirement and argued that it was not 

consistent with the statute. These 

commenters argued that section 13 of 

the BHC Act restricts a banking entity’s 

investments in covered funds, and not 

direct investments by a banking entity 

in individual companies under other 

authorities, such as the merchant 

banking investment authority in section 

4(k)(4)(H) of the BHC Act.2360 Some 

commenters argued that prohibiting or 

limiting direct investments could cause 

a conflict between a banking entity’s 

fiduciary duty to its clients to manage 

their covered fund investments and the 

banking entity’s duty to its shareholders 

to pursue legitimate merchant banking 

investments.2361 Some commenters 

urged the Agencies not to attribute any 

parallel co-investment alongside a 

covered fund to a banking entity unless 

there is a pattern of evasion, and some 

requested that there be prior notice and 

an opportunity for a hearing to 

determine whether such a pattern has 

occurred.2362 Another commenter 

recommended the Agencies provide a 

safe harbor for situations where a bank 

trustee is acting on behalf of 

customers.2363

In contrast, other commenters 

contended that the risks of direct 

investments, such as those made under 

merchant banking authority, are similar 

to those of many investments in covered 

funds. These commenters urged the 

Agencies to restrict direct investments 

in the underlying holdings or assets of 

a covered fund in the same manner as 

direct investments in covered funds.2364

After carefully considering the 

comments and the language of the 

statute, the Agencies have determined 

not to adopt the proposed prohibition 

on parallel investments in the final rule. 

As illustrated by commenters, banking 

entities rely on a number of investment 

authorities and structures to meet the 

needs of their clients and make 

investments under a variety of 

authorities that are not coordinated with 

investments made by covered funds 

owned or advised by the banking entity. 

The Agencies believe that many 

investments made by banking entities 

are made for the purpose of serving the 

legitimate needs of customers and 

shareholders, and not for the purpose of 

circumventing the per-fund and 

aggregate funds limitations in section 

13. 

Nevertheless, the Agencies continue 

to believe that the potential for evasion 

of these limitations may be present 

where a banking entity coordinates its 

direct investment decisions with the 

investments of covered funds that it 

owns or sponsors. For instance, the 

Agencies understand that it is relatively 

common for the sponsor of a covered 

fund in connection with a privately 

negotiated investment to offer investors 

co-investment opportunities when the 

general partner or investment manager 

for the covered fund determines that the 

covered fund does not have sufficient 

capital available to make the entire 

investment in the target portfolio 

company or determines that it would 

not be suitable for the covered fund to 

take the entire available investment. In 

such circumstances, a banking entity 

that sponsors the covered fund should 

not itself make any additional side by 

side co-investment with the covered 

fund in a privately negotiated 

investment unless the value of such coinvestment is less than 3% of the value 

of the total amount co-invested by other 

investors in such investment. Further, if 

the co-investment is made through a coinvestment vehicle that is itself a 

covered fund (a ‘‘co-investment fund’’), 

the sum of the banking entity’s 

ownership interests in the coinvestment fund and the related covered 

fund should not exceed 3% of the sum 

of the ownership interests held by all 

investors in the co-investment fund and 

related covered fund. Finally, the 

Agencies note that if a banking entity 

makes investments side by side in 

substantially the same positions as the 

covered fund, then the value of such 

investments shall be included for 

purposes of determining the value of the 

banking entity’s investment in the 

covered fund. 

g. Calculation of Tier 1 Capital 

The proposal explained that tier 1 

capital is a banking law concept that, in 

the United States, is calculated and 

reported by certain depository 

institutions and bank holding 

companies in order to determine their 

compliance with regulatory capital 

standards. Accordingly, the proposed 

rule clarified that for purposes of the 

aggregate funds limitation in § 75.12, a 

banking entity that is a bank, a bank 

holding company, a company that 

controls an insured depository 

institution that reports tier 1 capital, or 

uninsured trust company that reports 

tier 1 capital (each a ‘‘reporting banking 

entity’’) needed to use the reporting 

banking entity’s tier 1 capital as of the 

last day of the most recent calendar 

quarter that has ended, as reported to 

the relevant Federal banking agency. 

The proposal also recognizes that not 

all entities subject to section 13 of the 

BHC Act calculate and report tier 1 

capital. In order to provide a measure of 

equality related to the aggregate funds 

limitation contained in section 

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

§ 75.12(c) of the proposed rule, the 

proposed rule clarified how the 

aggregate funds limitation should be 

calculated for entities that are not 

required to calculate and report tier 1 

capital in order to determine 

compliance with regulatory capital 

standards. Under the proposed rule, 

with respect to any banking entity that 

is not affiliated with a reporting banking 

entity and not itself required to report 

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

agency, the banking entity’s tier 1 

capital for purposes of the aggregate 

funds limitation was the total amount of 

shareholders’ equity of the top-tier 

entity within such organization as of the 

last day of the most recent calendar 

quarter that has ended, as determined 

under applicable accounting 


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2365See proposed rule § 75.12(c)(2)(ii)(B)(2). 

2366See proposed rule § 75.12(c)(2)(ii)(A). 

2367See proposed rule § 75.12(c)(1)(B(2)(ii)(B)(1). 

2368See Occupy. 

2369See Credit Suisse (Williams); IIB/EBF. 

2370See Japanese Bankers Ass’n. 

2371See Enhanced Prudential Standards and Early 

Remediation Requirements for Foreign Banking 

Organizations and Foreign Nonbank Financial 

Companies, 77 FR 76628, 76637 (Dec. 28, 2012). 

2372See, e.g., SIFMA et al. (Covered Funds) (Feb. 

2012); SSgA (Feb. 2012); TCW; Credit Suisse 

(Williams). 

2373See, e.g., Occupy; Sens. Merkley & Levin 

(Feb. 2012). 

standards.2365 For a banking entity that 

was not itself required to report tier 1 

capital but was a subsidiary of a 

reporting banking entity that is a 

depository institution (e.g., a subsidiary 

of a national bank), the aggregate funds 

limitation was the amount of tier 1 

capital reported by such depository 

institution.2366 For a banking entity that 

was not itself required to report tier 1 

capital but was a subsidiary of a 

reporting banking entity that is not a 

depository institution (e.g., a nonbank 

subsidiary of a bank holding company), 

the aggregate funds limitation was the 

amount of tier 1 capital reported by the 

top-tier affiliate of such banking entity 

that holds and reports tier 1 capital 

under the proposal.2367

Commenters did not generally object 

to the proposed approach for 

determining the applicable tier 1 capital 

for banking entities. One commenter 

advocated calculating the aggregate 

funds limitation based on the tier 1 

capital of the banking entity making the 

covered fund investment instead of the 

tier 1 capital of the consolidated 

banking entity.2368 In addition, the 

commenter urged the Agencies to 

require banking entities to divest any 

portions of the investment that exceeds 

3 percent of that entity’s tier 1 capital. 

The final rule provides that any 

banking entity that is required to 

calculate and report tier 1 capital (a 

‘‘reporting banking entity’’) must 

calculate the aggregate funds limitation 

using the tier 1 capital amount reported 

by the entity as of the last day of the 

most recent calendar quarter as reported 

to the relevant Federal banking agency. 

A non-depository institution subsidiary 

of a reporting banking entity may rely 

on the consolidated tier 1 capital of the 

reporting banking entity for purposes of 

calculating compliance with the 

aggregate funds limitation. In the case of 

a depository institution that is itself a 

reporting banking entity and that is also 

a subsidiary or affiliate of a reporting 

banking entity, the aggregate of all 

investments in covered funds held by 

the depository institution (including the 

investments by its subsidiaries) may not 

exceed three percent of either the tier 1 

capital of the depository institution or of 

the top-tier reporting banking entity that 

controls such depository institution. 

The final rule also provides that any 

banking entity that is not itself required 

to report tier 1 capital but is a subsidiary 

of a reporting banking entity that is a 

depository institution (e.g., a subsidiary 

of a national bank) may compute 

compliance with the aggregate funds 

limitations using the amount of tier 1 

capital reported by such depository 

institution. 

Several commenters argued that 

foreign banking organizations should be 

permitted to use the consolidated tier 1 

capital at the top-tier foreign banking 

organization level, as calculated under 

applicable home country capital 

standards, to calculate compliance with 

the aggregate funds limitation.2369 One 

commenter noted that the tier 1 capital 

of a banking entity may fluctuate based 

on specific conditions relevant only to 

the banking entity, and urged the 

Agencies to consider an alternative 

measure of capital, although this 

commenter did not suggest any 

alternative.2370

After considering the comments 

received and that purpose and language 

of section 13 of the BHC Act, the 

Agencies have determined that for 

foreign banking organizations, the 

aggregate funds limitation would be 

based on the consolidated tier 1 capital 

of the foreign banking organization, as 

calculated under applicable home 

country standards. However, a U.S. 

bank holding company or U.S. savings 

and loan holding company that is 

controlled by a foreign banking entity 

must separately meet the per-fund and 

aggregate funds limitations for each and 

all (respectively) covered fund 

investments made by the U.S. holding 

company, based on the tier 1 capital of 

the U.S. bank holding company or U.S. 

savings and loan holding company. The 

Federal banking agencies may revisit 

this approach in light of the manner in 

which the Board implements the 

enhanced prudential standards and 

early remediation requirements for 

foreign banking organizations and 

foreign nonbank financial companies, 

including the proposed U.S. 

intermediate holding company 

requirements under that rule.2371

h. Extension of Time To Divest 

Ownership Interest in a Single Fund 

The proposed rule provided that the 

Board may, upon application by a 

banking entity, extend the period of 

time that a banking entity may have to 

conform an investment to the 3 percent 

per-fund limitation. As in the statute, 

the proposed rule permitted the Board 

to grant up to an additional two years 

if the Board finds that an extension 

would be consistent with safety and 

soundness and not detrimental to the 

public interest. The proposal required a 

banking entity to submit an application 

for extension to the Board, and set forth 

the factors that the Board would 

consider in reviewing an application for 

extension, including a requirement that 

the Board consult with the primary 

Federal supervisory agency for the 

banking entity prior to acting on an 

application. 

Some commenters argued that the 

final rule should be modified to extend 

automatically the one-year statutory 

period for complying with the per-fund 

limitation by an additional two years 

without application or approval on a 

case-by-case basis and to apply the 

extended conformance period to the 

aggregate funds limitations.2372 Some of 

these commenters suggested that 

Congress explicitly recognized the need 

for a banking entity to have a sufficient 

seeding period following establishment 

of a fund, and that funds often require 

more than one year to attract enough 

unaffiliated investors to enable the 

sponsoring banking entity to reduce its 

ownership interests in the fund to the 

level required by section 13(d)(4). 

Other commenters argued that the 

amount of a banking entity’s own 

capital involved in seeding a fund is 

typically ‘‘small’’ and suggested that, in 

order to prevent banking entities from 

engaging in prohibited proprietary 

trading through a fund, the Board 

should condition the ability of a 

banking entity to qualify for an 

extension of the one-year statutory 

period on several requirements, 

including a requirement that the 

banking entity not have provided more 

than $10 million in seed capital as part 

of establishing the covered fund.2373

The Agencies have carefully 

considered comments received on the 

proposal and have determined instead 

to adopt the process and standards 

governing requests for extensions of 

time to divest an ownership interest in 

a single covered fund largely as 

proposed. The Agencies believe that this 

approach is consistent with the process 

and standards set out under the statute. 

As under the proposal, the final rule 

requires any banking entity that seeks 

an extension of the conformance period 

provided for the per-funds limitation to 

submit a written request to the Board. 

Any such request must be submitted to 

the Board at least 90 days prior to the 


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2374See ABA (Keating). 

2375See 12 U.S.C. 1851(d)(4)(C). 

2376See 12 U.S.C. 1851(d)(1)(C). 

2377See proposed rule § 75.13(b)(1)(i)(A) and (B). 

2378These requirements were substantially 

similar to the requirements for the risk-mitigating 

hedging exemption for trading activities contained 

in proposed § 75.5. In addition, proposed § 75.13(b) 

also required that: (i) The hedge represent a 

substantially similar offsetting exposure to the same 

covered fund and in the same amount of ownership 

interest in that covered fund arising out of the 

transaction to accommodate a specific customer 

request or directly connected to the banking entity’s 

compensation arrangement with an employee; and 

(ii) the banking entity document, at the time the 

transaction is executed, the hedging rationale for all 

hedging transactions involving an ownership 

interest in a covered fund. 

2379See BoA; Credit Suisse (Williams); Deutsche 

Bank (Fund-Linked Products); ISDA (Feb. 2012); 

SIFMA et al. (Covered Funds) (Feb. 2012). 

2380See AFR et al. (Feb. 2012); Occupy; Public 

Citizen; Sens. Merkley & Levin (Feb. 2012). 

2381See BoA. 

2382See ISDA (Feb. 2012); BoA; Credit Suisse 

(Williams); Deutsche Bank (Fund-Linked Products); 

ISDA (Feb. 2012); SIFMA et al. (Covered Funds) 

(Feb. 2012). 

2383See, e.g., BoA; SIFMA et al. (Covered Funds) 

(Feb. 2012); Deutsche Bank (Fund-Linked 

Products). 

expiration of the applicable time period 

and provide the reasons why the 

banking entity believes the extension 

should be granted. In addition, the 

request must explain the banking 

entity’s plan for reducing the permitted 

investment in a covered fund through 

redemption, sale, dilution or other 

methods to the limits imposed by the 

final rule. To allow the Board to assess 

the factors provided in the statute, the 

final rule provides that any extension 

request by a banking entity must 

address: (i) Whether the investment 

would result, directly or indirectly, in a 

material exposure by the banking entity 

to high-risk assets or high-risk trading 

strategies; (ii) the contractual terms 

governing the banking entity’s interest 

in the covered fund; (iii) the total 

exposure of the covered banking entity 

to the investment and the risks that 

disposing of, or maintaining, the 

investment in the covered fund may 

pose to the banking entity and the 

financial stability of the United States; 

(iv) the cost to the banking entity of 

divesting or disposing of the investment 

within the applicable period; (v) 

whether the investment or the 

divestiture or conformance of the 

investment would involve or result in a 

material conflict of interest between the 

banking entity and unaffiliated parties, 

including clients, customers or 

counterparties to which it owes a duty; 

(vi) the banking entity’s prior efforts to 

reduce through redemption, sale, 

dilution, or other methods its ownership 

interests in the covered fund, including 

activities related to the marketing of 

interests in such covered fund; (vii) 

market conditions; and (viii) any other 

factor that the Board believes 

appropriate. In contrast to the proposal, 

the final rule does not require 

information on whether the extension 

would pose a threat to safety and 

soundness of the covered banking entity 

or to financial stability of the United 

States. The categories of information in 

final rule have been modified in order 

to eliminate redundancies. 

The final rule continues to permit the 

Board to impose conditions on granting 

any extension granted if the Board 

determines conditions are necessary or 

appropriate to protect the safety and 

soundness of banking entities or the 

financial stability of the United States, 

address material conflicts of interest or 

otherwise unsound practices, or to 

otherwise further the purposes of 

section 13 of the BHC Act and the final 

rule. In cases where the banking entity 

is primarily supervised by another 

Agency, the Board will consult with 

such Agency both in connection with its 

review of the application and, if 

applicable, prior to imposing conditions 

in connection with the approval of any 

request by the banking entity for an 

extension of the conformance period. 

While some commenters requested that 

the Board modify the final rule to 

permit a banking entity to have covered 

fund investments in excess of the 

aggregate funds limitation,2374 the final 

rule does not contain such a provision. 

As noted in the release for the proposed 

rule, the statutory grant of authority to 

provide extensions of time to comply 

with the investment limits refers 

specifically and only to the period for 

conforming a seeding investment to the 

per-fund limitation.2375

As noted in the proposed rule, the 

Agencies recognize the potential for 

evasion of the restrictions contained in 

section 13 of the BHC Act through 

misuse of requests for extension of the 

seeding period for covered funds. 

Therefore, the Board and the Agencies 

will monitor requests for extensions of 

the seeding period for activity in 

covered funds that is inconsistent with 

the requirements of section 13 of the 

BHC Act. 

4. Section 75.13: Other Permitted 

Covered Fund Activities 

a. Permitted Risk-Mitigating Hedging 

Activities 

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

provides an exemption for certain riskmitigating hedging activities.2376 In the 

context of covered fund activities, the 

proposed rule implemented this 

authority narrowly and permitted a 

banking entity to acquire or retain an 

ownership interest in a covered fund as 

a risk-mitigating hedge only in two 

situations: (i) When acting as 

intermediary on behalf of a customer 

that is not itself a banking entity to 

facilitate exposure by the customer to 

the profits and losses of the covered 

fund; and (ii) with respect to a 

compensation arrangement with an 

employee of the banking entity that 

directly provides investment advisory or 

other services to that fund.2377 The 

proposed rule imposed specific 

requirements on a banking entity 

seeking to rely on this exemption.2378

The Agencies received a range of 

comments on the proposed riskmitigating hedging exemption for 

ownership interests in covered funds. 

Some commenters objected to the 

limited applicability of the statutory 

risk-mitigating hedging exemption in 

the covered funds context and urged the 

Agencies to allow ownership interests 

in covered funds to be used in any 

appropriate risk-mitigating hedging.2379

In contrast, other commenters urged the 

Agencies to delete one or both of the 

risk-mitigating hedging exemptions as 

the commenters argued they were 

inconsistent with the statute or 

otherwise inappropriate.2380

Commenters also argued that a separate 

risk-mitigating hedging exemption for 

covered funds is unnecessary because 

the statute provides a single riskmitigating hedging exemption.2381

Some commenters argued that the 

proposed rule would impede banking 

entities from offering covered-fund 

linked products to customers, including 

hedging these products, and would, in 

particular, impair the ability of banking 

entities to hedge the risks of fund-linked 

derivatives with fund-linked swaps or 

shares of covered funds referenced in 

fund-linked products.2382 These 

commenters argued this limitation 

would increase risks at banking entities 

and was inconsistent with the purpose 

of the risk-mitigating hedging 

exemption. Commenters also proposed 

modifying the proposal to permit riskmitigating hedging activities that 

facilitate a customer’s exposure to 

profits and/or losses of the covered 

fund, to permit portfolio or dynamic 

hedging strategies involving covered 

fund interests, and to eliminate the 

proposed condition that a customer 

would not itself be a banking entity.2383

Some commenters also urged the 

Agencies to grandfather existing riskmitigating hedging activities with 

respect to any covered-fund linked 

products that comply with the hedging 


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2384See SIFMA et al. (Covered Funds) (Feb. 

2012); BoA. 

2385See Sens. Merkley & Levin (Feb. 2012). 

2386See AFR et al. (Feb. 2012). 

2387See Arnold & Porter. 

2388See BOK. 

2389See Occupy. 

2390See AFR et al. (Feb. 2012); Public Citizen. 

2391See Occupy. 

2392See 12 U.S.C. 1851(d)(2). 

2393See ISDA (Feb. 2012); BoA; Credit Suisse 

(Williams); Deutsche Bank (Fund-Linked Products); 

SIFMA et al. (Covered Funds) (Feb. 2012). 

2394See SIFMA et al. (Covered Funds) (Feb. 

2012); Credit Suisse (Williams). 2395See final rule § 75.13(a)(2). 

requirements for proprietary trading 

under § 75.5 of the proposed rule.2384

In contrast, other commenters 

objected to the exemption for hedging 

covered fund-linked products sold to 

customers. These commenters asserted 

that this activity would authorize 

investment in covered funds in a 

manner that would not be subject to the 

three percent per-fund limitation; 2385 or 

would be inconsistent with the statutory 

requirement that a banking entity 

actively seek additional investors for a 

fund.2386

Some commenters urged the Agencies 

to expand the hedging exemption to 

allow banking entities to invest in 

covered funds in order to hedge 

obligations relating to deferred 

compensation plans for employees who 

do not directly provide services to the 

covered fund for which the hedge 

relates.2387 Another commenter argued 

that banking entities should be 

permitted to hedge compensation 

investment accounts for executive 

officers who are not involved in the 

management of the investment 

accounts.2388 In contrast, other 

commenters objected to the hedging 

exemption for compensation 

arrangements, arguing that it may 

increase risk to banking entities,2389 is 

unnecessary,2390 or may provide 

banking entities with an opportunity to 

evade the limitations on the amount of 

ownership interests they may have as an 

investment in a covered fund.2391

After review of the comments, the 

Agencies believe at this time that 

permitting only limited risk-mitigating 

hedging activities involving ownership 

interests in covered funds is consistent 

with the safe and sound conduct of 

banking entities, and that increased use 

of ownership interests in covered funds 

could result in exposure to higher 

risks.2392

In particular, the Agencies have 

determined that transactions by a 

banking entity to act as principal in 

providing exposure to the profits and 

losses of a covered fund for a customer, 

even if hedged by the entity with 

ownership interests of the covered fund, 

is a high risk strategy that could 

threaten the safety and soundness of the 

banking entity. These transactions 

expose the banking entity to the risk 

that the customer will fail to perform, 

thereby effectively exposing the banking 

entity to the risks of the covered fund. 

Furthermore, a customer’s failure to 

perform may be concurrent with a 

decline in value of the covered fund, 

which could expose the banking entity 

to additional losses. Accordingly, the 

Agencies believe that these transactions 

pose a significant potential to expose 

banking entities to the same or similar 

economic risks that section 13 of the 

BHC Act sought to eliminate, and have 

not adopted the proposed exemption for 

using ownership interests in covered 

funds to hedge these types of 

transactions in the final rule. 

As argued by some commenters, 

modifying the proposal to eliminate the 

exemption for permitting banking 

entities to acquire covered fund 

interests in connection with customer 

facilitation may impact banking entities 

ability to hedge the risks of fund-linked 

derivatives through the use of fundlinked swaps or shares of covered funds 

referenced by fund-linked products.2393

Some commenters on the proposal 

argued that innovation of financial 

products may potentially be reduced if 

the final rule does not permit this type 

of activity related to fund-linked 

products.2394 The Agencies recognize 

that U.S. banking entities may no longer 

be able to participate in offering certain 

customer facilitation products relating 

to covered funds, but believe it is 

consistent with the purposes of section 

13 to restrict these activities. 

The final rule maintains the proposed 

exemption for hedging employee 

compensation arrangements with 

several changes. To ensure that exempt 

hedging activities are designed to 

reduce one or more specific risks, as 

required by section 13(d)(1)(C) of the 

BHC Act, the proposed rule required 

that permitted hedging activity be 

designed to reduce the specific risks to 

the banking entity in connection with 

and related to its obligations or 

liabilities. The final rule permits a 

banking entity to acquire or retain an 

ownership interest in a covered fund 

provided that the ownership interest is 

designed to demonstrably reduce or 

otherwise significantly mitigate the 

specific, identifiable risks to the banking 

entity in connection with a 

compensation arrangement with an 

employee who directly provides 

investment advisory or other services to 

the covered fund. Under the final rule, 

a banking entity may not use as a hedge 

ownership interests of a covered fund 

for which the employee does not 

provide services. The requirement 

under the final rule that the hedging 

activity be designed to demonstrably 

reduce or otherwise significantly 

mitigate the specific, identifiable risks 

to the banking entity is consistent with 

the requirement in § 75.5 of the final 

rule, as discussed above in Part VI.A.4. 

The final rule permits a banking entity 

to hedge its exposures to price and other 

risks based on fund performance that 

arise from restricted profit interest and 

other performance based compensation 

arrangements with its investment 

managers. 

Section 13(a)(2) of the final rule 

describes the criteria a banking entity 

must meet in order to rely on the riskmitigating hedging exemption for 

covered funds. These requirements, 

which are based on the requirements for 

the risk-mitigating hedging exemption 

for trading activities under § 75.5 of the 

final rule and which are discussed in 

detail above in Part VI.A.4, have been 

modified from the proposal to reflect the 

more limited scope of this section.2395

In particular, the final rule permits a 

banking entity to engage in riskmitigating hedging activities involving 

ownership interests in a covered fund 

only if the banking entity has 

established and implements, maintains 

and enforces an internal compliance 

program that is reasonably designed to 

ensure the covered banking entity’s 

compliance with the requirements of the 

hedging exemption, including 

reasonably designed written policies 

and procedures and internal controls 

and ongoing monitoring and 

authorization procedures, and has 

acquired or retained the ownership 

interest in accordance with these 

written policies, procedures and 

internal controls. Furthermore, the 

acquisition or retention of an ownership 

interest must demonstrably reduce or 

otherwise significantly mitigate, at the 

inception of the hedge, one or more 

specific, identifiable risks arising in 

connection with the compensation 

arrangement with an employee that 

directly provides investment advisory or 

other services to the covered fund. The 

acquisition or retention also may not, at 

the inception of the hedge, result in any 

significant new or additional risk that is 

not itself hedged contemporaneously in 

accordance with the hedging exemption, 

and the hedge must be subject to 

continuing review, monitoring and 

management by the banking entity. 


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2396See final rule § 75.13(a)(2)(iii). 

2397Section 13(d)(1)(I) of the BHC Act permits a 

banking entity to acquire or retain an ownership 

interest in, or have certain relationships with, a 

covered fund notwithstanding the restrictions on 

investments in, and relationships with, a covered 

fund, if: (i) Such activity or investment is 

conducted by a banking entity pursuant to 

paragraph (9) or (13) of section 4(c) of the BHC Act; 

(ii) the activity occurs solely outside of the United 

States; (iii) no ownership interest in such fund is 

offered for sale or sold to a resident of the United 

States; and (iv) the banking entity is not directly or 

indirectly controlled by a banking entity that is 

organized under the laws of the United States or of 

one or more States. See 12 U.S.C. 1851(d)(1)(I). 

2398This section’s discussion of the concept 

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

solely for purposes of the final rule’s 

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

Act, and does not affect a banking entity’s 

obligation to comply with additional or different 

requirements under applicable securities, banking, 

or other laws. 

2399See 156 Cong. Rec. S5897 (daily ed. July 15, 

2010) (statement of Sen. Merkley) (‘‘Subparagraphs 

(H) and (I) recognize rules of international 

regulatory comity by permitting foreign banks, 

regulated and backed by foreign taxpayers, in the 

course of operating outside of the United States to 

engage in activities permitted under relevant 

foreign law. However, these subparagraphs are not 

intended to permit a U.S. banking entity to avoid 

the restrictions on proprietary trading simply by 

setting up an offshore subsidiary or reincorporating 

offshore, and regulators should enforce them 

accordingly. In addition, the subparagraphs seek to 

maintain a level playing field by prohibiting a 

foreign bank from improperly offering its hedge 

fund and private equity fund services to U.S. 

persons when such offering could not be made in 

the United States.’’). 

2400See, e.g., IIB/EBF; SIFMA et al. (Covered 

Funds) (Feb. 2012); see also Occupy. 

2401See Ass’n. of German Banks; BVI; Allen & 

Overy (on behalf of Canadian Banks); EFAMA; F&C; 

HSBC; IIB/EBF; ICSA; PEGCC; Socie ́te ́ Ge ́ne ́rale; 

Union Asset; Ass’n. of Banks in Malaysia; EBF; 

Credit Suisse (Williams); Cadwalader (on behalf of 

Thai Banks). 

2402See IIB/EBF; EBF; Allen & Overy (on behalf 

of Canadian Banks); Credit Suisse (Williams); 

Katten (on behalf of Int’l Clients). 

2403See Credit Suisse (Williams); PEGCC; see also 

Commissioner Barnier. 

2404See e.g., Norinchukin; Cadwalader (on behalf 

of Thai Banks); Barclays; EBF; Ass’n. of German 

Banks; Socie ́te ́ Ge ́ne ́rale; Chamber (Feb. 2012). 

2405See BaFin/Deutsche Bundesbank; 

Norinchukin; IIF; Allen & Overy (on behalf of 

Canadian Banks); ICFR; BoA. As discussed below 

in Part VI.C.1, other parts of the final rule address 

commenters’ concerns regarding the compliance 

burden on foreign banking entities. 

2406See AFG; Ass’n. of German Banks; BVI; 

Comm. on Capital Markets Regulation; IIB/EBF; 

Japanese Bankers Ass’n.; Norinchukin; Union Asset. 

As discussed in greater detail below in Part VI.C.1, 

activities and investments of a foreign bank that are 

conducted under the foreign funds exemption are 

generally not subject to the specific requirements of 

§ 75.20 and Appendices A and B. The U.S. 

operations of foreign banking entities are expected 

to have policies and procedures in place to ensure 

that they conduct activities under this part in full 

compliance with this part. 

2407See Australian Bankers Ass’n.; AFMA; Allen 

& Overy (on behalf of Foreign Bank Group); British 

Bankers’ Ass’n.; F&C; French Banking Fed’n.; IIB/ 

EBF; Japanese Bankers Ass’n; Katten (on behalf of 

Int’l Clients); Union Asset. See also infra Part 

VI.B.5. 

2408See BVI; Credit Suisse (Williams); EFAMA; 

IIB/EBF; PEGCC; Union Asset. See supra Part II for 

a discussion regarding the conformance period. 

The final rule also permits a banking 

entity to engage in risk-mitigating 

hedging activities in connection with a 

compensation arrangement, subject to 

the conditions noted above, only if the 

compensation arrangement relates 

solely to the covered fund in which the 

banking entity or any affiliate thereof 

has acquired an ownership interest and 

the losses on such ownership interest 

are offset by corresponding decreases in 

the amounts payable in connection with 

the related employee compensation 

arrangement.2396

b. Permitted Covered Fund Activities 

and Investments Outside of the United 

States 

Section 13(d)(1)(I) of the BHC Act 2397

permits foreign banking entities to 

acquire or retain an ownership interest 

in, or act as sponsor to, covered funds, 

so long as those activities and 

investments occur solely outside the 

United States and certain other 

conditions are met (the ‘‘foreign fund 

exemption’’).2398 As described in the 

proposal, the purpose of this statutory 

exemption appears to be to limit the 

extraterritorial application of the 

statutory restrictions on covered fund 

activities and investments, while 

preserving national treatment and 

competitive equality among U.S. and 

foreign banking entities within the 

United States.2399 The statute does not 

explicitly define what is meant by 

‘‘solely outside of the United States.’’ 

The proposed rule allowed foreign 

banking entities that met certain 

qualifications to engage in covered fund 

activities, including owning, organizing 

and offering, and sponsoring funds 

outside the United States. The proposed 

rule defined both the type of foreign 

banking entity that is eligible for the 

exemption and when an activity or 

investment would occur ‘‘solely outside 

of the United States.’’ The proposed rule 

allowed a qualifying foreign banking 

entity to acquire or retain an ownership 

interest in, or act as sponsor to, a 

covered fund under the exemption only 

if no subsidiary, affiliate or employee of 

the banking entity that’s incorporated or 

physically located in the United States 

engaged in offering or selling the 

covered fund. The proposed rule also 

implemented the statutory requirement 

that prohibited an ownership interest in 

the covered fund from being offered for 

sale or sold to a resident of the United 

States. 

Commenters generally expressed 

support for an exemption to allow 

foreign banking entities to conduct 

foreign covered fund activities and 

make investments outside the United 

States.2400 A number of commenters 

also expressed concerns that the 

proposed foreign fund exemption was 

too narrow and would not be effective 

in permitting foreign banking entities to 

engage in covered fund activities and 

investments outside of the United 

States. For instance, many commenters 

argued that several of the proposal’s 

restrictions on the exemption were not 

required by statute and were 

inconsistent with congressional intent 

to limit the extraterritorial impact of 

section 13 of the BHC Act.2401 These 

commenters argued that the foreign 

funds exemption should focus on 

whether a prohibited activity, such as 

sponsoring or investing in a covered 

fund, involves principal risk taken or 

held by the foreign banking entity that 

poses risk to U.S. banking entities or the 

financial stability of the United 

States.2402 Commenters also argued that 

a broader exemption would better 

recognize the regulation and 

supervision of the home country 

supervisor of the foreign banking entity 

and of its covered fund activities.2403

Some commenters contended that the 

proposal represented an improper 

extraterritorial application of U.S. law 

that could be found to violate 

international treaty obligations of the 

United States, such as those under the 

North American Free Trade Agreement, 

and might result in retaliation by foreign 

countries in their treatment of U.S. 

banking entities abroad.2404

Commenters also alleged that the 

proposal would impose significant 

compliance costs on the foreign 

operations of foreign banking entities 

conducting activity pursuant to this 

exemption.2405 These commenters 

argued that foreign banking entities 

relying on the foreign fund exemption 

should not be subject to the compliance 

program requirements contained in 

Appendix C with respect to their nonU.S. operations.2406

Several commenters argued that the 

restrictions of section 13(f), which limits 

transactions between a banking entity 

and certain covered funds, would not 

apply to activities and investments 

made in reliance on the foreign fund 

exemption.2407 Some commenters 

argued that the Agencies should 

grandfather all existing foreign covered 

funds and argued that failure to provide 

relief for existing relationships could 

cause substantial disruption to foreign 

covered funds and significantly harm 

investors in existing funds without 

producing a clear offsetting benefit.2408


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2409For instance, many commenters raised 

concerns regarding the treatment of foreign public 

funds such as UCITS. As discussed in greater detail 

above in Part VI.B.1, the definition of covered fund 

under the final rule has been modified from the 

proposal and tailored to include only the types of 

foreign funds that the Agencies believe are intended 

to be the focus of the statute (e.g., certain foreign 

funds that are established by U.S. banking entities). 

Foreign public funds are also excluded from the 

definition of covered fund under the final rule. The 

modifications in the final rule in part address 

commenters’ request that foreign funds be 

grandfathered. To the extent that an entity qualifies 

for one or more of the exclusions from the 

definition of covered fund, that entity would not be 

a covered fund under the final rule. Moreover, any 

entity that would be a covered fund would still be 

able to rely on the conformance period in order to 

come into compliance with the requirements of 

section 13 and the final rule. 

2410The final rule clarifies the eligibility 

requirements for banking entities seeking to rely on 

the foreign fund exemption. Section 13(d)(1)(I) of 

the BHC Act and § 75.13(c)(1)(i) of the proposal 

require that a banking entity seeking to rely on the 

foreign fund exemption not be directly or indirectly 

controlled by a banking entity that is organized 

under the laws of the United States or of one or 

more states. For clarification purposes, in addition 

to the eligibility requirement in Section 13(d)(1)(I) 

of the BHC Act and the proposal, the final rule also 

expressly requires that the banking entity not itself 

be organized under the laws of the United States. 

2411See 12 U.S.C. 1851(d)(1)(I). 

2412Section 75.13(b)(2) only addresses when a 

transaction will be considered to have been 

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

Act. Although the statute also references section 

4(c)(13) of the BHC Act, the Board has to date 

applied the general authority contained in that 

section solely to the foreign activities of U.S. 

banking organizations which, by the express terms 

of section 13(d)(1)(I) of the BHC Act, are unable to 

rely on the foreign funds exemption. 

2413See 12 U.S.C. 1843(c)(9). 

2414See 12 CFR 211.20 et seq. 

2415Some commenters argued that the Board’s 

Regulation K contains a number of limitations that 

may not be appropriate to include as part of the 

requirements of the foreign fund exemption. For 

example, subpart B of the Board’s Regulation K 

includes various approval requirements and 

interstate office location restrictions. See Allen & 

Overy (on behalf of Foreign Bank Group); HSBC 

Life. The final rule does not retain the proposal’s 

requirement that the activity be conducted in 

compliance with all of subpart B of the Board’s 

Regulation K (12 CFR 211.20 through 211.30). 

However, the foreign fund exemption in section 

13(d)(1)(I) of the BHC Act and the final rule 

operates as an exemption and is not a separate grant 

of authority to engage in an otherwise 

impermissible activity. To the extent a banking 

entity is a foreign banking organization, it remains 

subject to the Board’s Regulation K and must, as a 

separate matter, comply with any and all applicable 

rules and requirements of that regulation. 

2416See 12 CFR 211.23(a), (c), and (e). The 

proposed rule only referenced the qualifying test 

under section 211.23(a) of the Board’s Regulation K; 

however, because there are two other methods by 

which a foreign banking organization may meet the 

requirements to be considered a qualified foreign 

banking organization, the final rule incorporates a 

reference to those provisions as well. 

2417This modification to the definition of foreign 

banking organization from the proposed definition 

is necessary because, under the International 

Banking Act and the Board’s Regulation K, 

depository institutions that are located in, or 

organized under the laws of a commonwealth, 

territory, or possession of the United States, are 

foreign banking organizations. However, for 

purposes of the Federal securities laws and certain 

banking statutes, such as section 2(c)(1) of the BHC 

Act and section 3 of the FDI Act, these same entities 

are defined to be and treated as domestic entities. 

For instance, these entities act as domestic brokerdealers under U.S. securities laws and their 

deposits are insured by the FDIC. Because one of 

the purposes of section 13 is to protect insured 

depository institutions and the U.S. financial 

system from the perceived risks of proprietary 

trading and covered fund activities, the Agencies 

believe that these entities should be considered to 

be located within the United States for purposes of 

section 13. The final rule includes within the 

definition of State any State, the District of 

Columbia, the Commonwealth of Puerto Rico, 

Guam, American Samoa, the United States Virgin 

Islands, and the Commonwealth of the Northern 

Mariana Islands. 

In response to comments received on 

the proposal, the final rule contains a 

number of modifications to more 

effectively implement the foreign fund 

exemption in light of the language and 

purpose of the statute. Importantly, as 

explained in the section defining 

covered funds, the Agencies also believe 

that the more circumscribed definition 

of covered fund, including the exclusion 

for foreign public funds, should 

alleviate many of the concerns raised 

and potential burdens identified by 

commenters with respect to the funds 

activities of foreign banking entities.2409

1. Foreign Banking Entities Eligible for 

the Exemption 

The statutory language of section 

13(d)(1)(I) provides that, in order to be 

eligible for the foreign funds exemption, 

the banking entity must not be directly 

or indirectly controlled by a banking 

entity that is organized under the laws 

of the United States or of one or more 

States. Consistent with this statutory 

language, the proposed rule limited the 

scope of the exemption to banking 

entities that are organized under foreign 

law and, as applicable, controlled only 

by entities organized under foreign law. 

The Agencies did not receive 

substantive comment on this aspect of 

the proposal related to the foreign fund 

exemption, though some commenters 

offered suggestions to clarify various 

parts of the wording of the scope of the 

definition of banking entities that may 

qualify for the exemption. The final rule 

makes only minor, technical changes to 

more fully carry out the purposes of the 

statute. 

Consistent with the statutory language 

and purpose of section 13(d)(1)(I) of the 

BHC Act, the final rule provides that the 

exemption is available only if the 

banking entity is not organized 

under 2410 or directly or indirectly 

controlled by a banking entity that is 

organized under the laws of the United 

States or of one or more States. As noted 

above, section 13(d)(1)(I) of the BHC Act 

specifically provides that its exemption 

is available only to a banking entity that 

is not ‘‘directly or indirectly’’ controlled 

by a banking entity that is organized 

under the laws of the United States or 

of one or more States.2411 Because of 

this express statutory requirement, a 

foreign subsidiary controlled, directly or 

indirectly, by a banking entity organized 

under the laws of the United States or 

one of its States, and a foreign branch 

office of a banking entity organized 

under the laws of the United States or 

one of the States, may not take 

advantage of this exemption. 

Like the proposal, the final rule 

incorporates the statutory requirement 

that the banking entity conduct its 

sponsorship or investment activities 

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

the BHC Act. The final rule retains the 

tests in the proposed rule for 

determining when a banking entity 

would meet that requirement. The final 

rule also provides qualifying criteria for 

both a banking entity that is a qualifying 

foreign banking organization under the 

Board’s Regulation K and a banking 

entity that is not a foreign banking 

organization for purposes of Regulation 

K.2412

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

to any company organized under the 

laws of a foreign country the greater part 

of whose business is conducted outside 

the United States, if the Board by 

regulation or order determines that the 

exemption would not be substantially at 

variance with the purposes of the BHC 

Act and would be in the public 

interest.2413 The Board has 

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

subpart B of the Board’s Regulation 

K,2414 which specifies a number of 

conditions and requirements that a 

foreign banking organization must meet 

in order to act pursuant to that 

authority.2415 The qualifying conditions 

and requirements include, for example, 

that the foreign banking organization 

demonstrate that more than half of its 

worldwide business is banking and that 

more than half of its banking business 

is outside the United States.2416 Under 

the final rule a banking entity that is a 

qualifying foreign banking organization 

for purposes of the Board’s Regulation 

K, other than a foreign bank as defined 

in section 1(b)(7) of the International 

Banking Act of 1978 that is organized 

under the laws of any commonwealth, 

territory, or possession of the United 

States, will qualify for the foreign fund 

exemption.2417

Section 13 of the BHC Act also 

applies to foreign companies that 

control a U.S. insured depository 

institution but that are not subject to the 


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2418This 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. 

2419For clarification purposes, the final rule has 

been modified from the proposal to provide that the 

requirements for this provision must be met on a 

fully-consolidated basis. 

2420See final rule § 75.13(b)(2)(ii)(B). For 

purposes of determining whether, on a fully 

consolidated basis, it meets the requirements under 

§ 75.13(b)(2)(ii)(B), a foreign banking entity that is 

not a foreign banking organization should base its 

calculation on the consolidated global assets, 

revenues, and income of the top-tier affiliate within 

the foreign banking entity’s structure. 

2421See 12 U.S.C. 1843(c)(9); 12 CFR 211.23(a), 

(c), and (e); final rule § 75.13(b)(2)(ii)(B). 

2422See Credit Suisse (Williams); IIB/EBF; Katten 

(on behalf of Int’l Clients). 

2423See Allen & Overy (on behalf of Foreign Bank 

Group); Ass’n. of German Banks; Credit Suisse 

(Williams); IIB/EBF; Socie ́te ́ Ge ́ne ́rale; Union Asset. 

2424See Allen & Overy (on behalf of Foreign Bank 

Group); Ass’n. of German Banks; Credit Suisse 

(Williams); IIB/EBF; Katten (on behalf of Int’l 

Clients); TCW; Union Asset. 

2425See IIB/EBF; Socie ́te ́ Ge ́ne ́rale; TCW; Union 

Asset; Credit Suisse (Williams); see also Katten (on 

behalf of Int’l Clients) (recommending that, similar 

to the SEC’s Regulation S (17 CFR 230.901 through 

230.905), the final rule provide that involvement of 

persons located in the United States in the 

distribution of a non-U.S. covered fund’s securities 

to potential purchasers outside of the United States 

not affect the analysis of whether a non-U.S. 

banking entity’s investment or sponsorship occurs 

outside the United States). 

2426See Allen & Overy (on behalf of Foreign Bank 

Group). 

2427See BaFin/Deutsche Bundesbank; ICSA; IIB/ 

EBF; EBF; Allen & Overy (on behalf of Canadian 

Banks); Credit Suisse (Williams); George Osborne. 

2428See IIB/EBF. 

2429See IIB/EBF. 

BHC Act generally or to the Board’s 

Regulation K—for example, because the 

foreign company controls a savings 

association or an FDIC-insured 

industrial loan company. Accordingly, 

the final rule also provides that a foreign 

banking entity that is not a foreign 

banking organization would be 

considered to be conducting activities 

‘‘pursuant to section 4(c)(9)’’ for 

purposes of the foreign fund 

exemption 2418 if the entity, on a fullyconsolidated basis,2419 meets at least 

two of three requirements that evaluate 

the extent to which the foreign banking 

entity’s business is conducted outside 

the United States, as measured by 

assets, revenues, and income.2420 This 

test largely mirrors the qualifying 

foreign banking organization test that is 

made applicable under section 4(c)(9) of 

the BHC Act and § 211.23(a), (c), or (e) 

of the Board’s Regulation K, except that 

the test does not require the foreign 

entity to demonstrate that more than 

half of its banking business is outside 

the United States.2421 This difference 

reflects the fact that foreign entities 

subject to section 13 of the BHC Act, but 

not the BHC Act generally, are likely to 

be, in many cases, predominantly 

commercial firms. A requirement that 

such firms also demonstrate that more 

than half of their banking business is 

outside the United States would likely 

make the exemption unavailable to such 

firms and subject their global activities 

to the restrictions on covered fund 

activities and investments, a result that 

the Agencies do not believe was 

intended. 

2. Activities or Investments Solely 

Outside of the United States 

As noted above, the proposed rule 

adopted a transaction-based approach to 

implementing the foreign fund 

exemption and focused on the extent to 

which the foreign fund transactions 

occur within, or are carried out by 

personnel, subsidiaries or affiliates 

within, the United States. In particular, 

§ 75.13(c)(3) of the proposed rule 

provided that a transaction or activity be 

considered to have occurred solely 

outside of the United States only if: (i) 

The transaction or activity is conducted 

by a banking entity that is not organized 

under the laws of the United States or 

of one or more States; (ii) no subsidiary, 

affiliate, or employee of the banking 

entity that is involved in the offer or 

sale of an ownership interest in the 

covered fund is incorporated or 

physically located in the United States; 

and (iii) no ownership interest in such 

covered fund is offered for sale or sold 

to a resident of the United States. 

Commenters suggested that, like the 

foreign trading exemption, the foreign 

fund exemption should focus on the 

location of activities that a banking 

entity engages in as principal.2422 These 

commenters argued that the location of 

sales activities of a fund should not 

determine whether a banking entity has 

sponsored or acquired an ownership 

interest in a covered fund solely outside 

of the United States. Commenters also 

argued that foreign banking entities 

typically locate marketing and sales 

personnel for foreign funds in the 

United States in order to serve 

customers, including those that are not 

residents of the United States, and that 

the proposal would needlessly force all 

covered fund sales activities to shift 

outside of the United States. These 

commenters alleged that the restrictions 

under the proposal would cause foreign 

banking entities to relocate their 

personnel from the United States to 

overseas, diminishing U.S. jobs with no 

concomitant benefit.2423

Many commenters requested removal 

of the proposal’s prohibition on a U.S. 

subsidiary, affiliate, or employee of the 

foreign banking entity offering or selling 

fund interests in order to qualify for the 

foreign fund exemption.2424

Commenters argued that this limitation 

was not included in the statute and that 

the limited involvement of persons 

located in the U.S. in the distribution of 

ownership interests in a foreign covered 

fund should not, by itself, disqualify the 

banking entity from relying on the 

foreign fund exemption so long as the 

fund is offered only outside the United 

States.2425 These commenters argued 

that organizing and offering a fund is 

not a prohibited activity so long as it is 

not accompanied by ownership or 

sponsorship of the covered fund. One 

commenter urged that the final rule 

permit U.S. personnel of a foreign 

banking entity to engage in non-selling 

activities related to a covered fund, 

including acting as investment advisor, 

establishing fund vehicles, conducting 

back-office functions such as day-to-day 

management and deal sourcing tax 

structuring, obtaining licenses, 

interfacing with regulators, and other 

related activities that do not involve 

U.S. sales activity.2426

Instead of the proposal’s transactionbased approach to implementing the 

foreign fund exemption, many 

commenters suggested the final rule 

adopt a risk-based approach.2427 These 

commenters argued that a risk-based 

approach would prohibit or 

significantly limit the amount of 

financial risk from such activities that 

could be transferred to the United States 

by the foreign activity of foreign banking 

entities in line with the purpose of the 

statue.2428 Commenters also contended 

that foreign activities of most foreign 

banking entities are already subject to 

activities limitations, capital 

requirements, and other prudential 

requirements of their home-country 

supervisor(s).2429

In response to commenters’ concerns 

and in order to more effectively 

implement both the statutory 

prohibition as well as the foreign fund 

exemption, the final rule has been 

modified to better reflect the purpose of 

the statute by ensuring that the 

principal risks of covered fund 

investments and sponsorship by foreign 

banking entities permitted under the 

foreign funds exemption occur and 

remain solely outside of the United 

States. One of the principal purposes of 

section 13 is to limit the risks that 

covered fund investments and activities 

pose to the safety and soundness of U.S. 

banking entities and the U.S. financial 


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2430See final rule § 75.13(b)(4). 2431See final rule § 75.13(b)(5). 

2432See final rule § 75.10(a)(2). 

2433See proposed rule § 75.13(c)(1)(iii). 

2434See 17 CFR 230.901–905. 

2435See IIB/EBF; EFAMA; ICI Global. 

2436See Cadwalader (on behalf of Thai Banks); 

Grosvenor; SIFMA et al. (Covered Funds) (Feb. 

2012). 

2437See Ass’n. of German Banks; BAROC; 

Cadwalader (on behalf of Thai Banks); Comm. on 

Capital Markets Regulation; Credit Suisse 

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

Katten (on behalf of Int’l Clients); PEGCC. 

system. Another purpose of the foreign 

fund exemption was to limit the 

extraterritorial application of section 13 

as it applies to foreign banking entities 

subject to section 13. 

To accomplish these purposes in light 

of the structure and purpose of the 

statute and in response to commenters, 

the final rule adopts a risk-based 

approach rather than a transaction 

approach to the foreign fund exemption. 

In order to ensure these risks remain 

solely outside of the United States, the 

final rule also includes several 

conditions on the availability of the 

foreign fund exemption. Specifically, 

the final rule provides that an activity 

or investment occurs solely outside the 

United States for purposes of the foreign 

fund exemption only if: 

• The banking entity acting as 

sponsor, or engaging as principal in the 

acquisition or retention of an ownership 

interest in the covered fund, is not itself, 

and it not controlled directly or 

indirectly by, a banking entity that is 

located in the United States or 

established under the laws of the United 

States or of any State; 

• The banking entity (including 

relevant personnel) that makes the 

decision to acquire or retain the 

ownership interest or act as sponsor to 

the covered fund is not located in the 

United States or organized under the 

laws of the United States or of any State; 

• The investment or sponsorship, 

including any transaction arising from 

risk-mitigating hedging related to an 

ownership interest, is not accounted for 

as principal directly or indirectly on a 

consolidated basis by any branch or 

affiliate that is located in the United 

States or organized under the laws of 

the United States or of any State; and 

• No financing for the banking 

entity’s ownership or sponsorship is 

provided, directly or indirectly, by any 

branch or affiliate that is located in the 

United States or organized under the 

laws of the United States or of any 

State.2430

These requirements are designed to 

ensure that any foreign banking entity 

engaging in activity under the foreign 

fund exemption does so in a manner 

that ensures the risk and sponsorship of 

the activity or investment occurs and 

resides solely outside of the United 

States. 

The final rule has been modified from 

the proposal to specifically recognize 

that, for purposes of the foreign fund 

exemption, a U.S. branch, agency, or 

subsidiary of a foreign bank, is located 

in the United States; however, a foreign 

bank that operates or controls that 

branch, agency, or subsidiary is not 

considered to be located in the United 

States solely by virtue of operation of 

the U.S. branch, agency, or 

subsidiary.2431 A subsidiary (wherever 

located) of a U.S. branch, agency, or 

subsidiary of a foreign bank is also 

considered itself to be located in the 

United States. This provision helps give 

effect to the statutory language limiting 

the foreign fund exemption to activities 

of foreign banking entities that occur 

‘‘solely outside of the United States’’ by 

clarifying that the U.S. operations of 

foreign banking entities may not 

sponsor or acquire or retain an 

ownership interest in a covered fund as 

principal based on this exemption. 

Because so-called ‘‘back office’’ 

activities do not involve sponsoring or 

acquiring or retaining an ownership 

interest in a covered fund, the final rule 

does not impose restrictions on U.S. 

personnel of a foreign banking entity 

engaging in these activities in 

connection with one or more covered 

funds. This allows providing 

administrative services or similar 

functions to the covered fund as an 

incident to the activity conducted under 

the foreign fund exemption (such as 

clearing and settlement, maintaining 

and preserving records of the fund, 

furnishing statistical and research data, 

or providing clerical support for the 

fund). 

The foreign fund exemption in the 

final rule also permits the U.S. 

personnel and operations of a foreign 

banking entity to act as investment 

adviser to a covered fund in certain 

circumstances. For instance, the U.S. 

personnel of a foreign banking entity 

may provide investment advice and 

recommend investment selections to the 

manager or general partner of a covered 

fund so long as that investment advisory 

activity in the United States does not 

result in the U.S. personnel 

participating in the control of the 

covered fund or offering or selling an 

ownership interest to a resident of the 

United States. As explained above, the 

final rule also explicitly provides that 

acquiring or retaining an ownership 

interest does not include acquiring or 

retaining an ownership interest in a 

covered fund by a banking entity acting 

solely as agent, broker, or custodian, 

subject to certain conditions, or acting 

on behalf of customers as a trustee, or 

in a similar fiduciary capacity for a 

customer that is not a covered fund, so 

long as the activity is conducted for the 

account of the customer and the banking 

entity and its affiliates do not have or 

retain beneficial ownership of the 

ownership interest.2432 The final rule 

would thus allow a foreign bank to 

engage in any of these capacities in the 

U.S. without the need to rely on the 

foreign fund exemption. 

3. Offered for Sale or Sold to a Resident 

of the United States 

The proposed rule provided that no 

ownership interest in the covered fund 

be offered for sale or sold to a resident 

of the United States, a requirement of 

the statute.2433 Numerous commenters 

focused on the definition of ‘‘resident of 

the United States’’ in the proposed rule 

and the manner in which the restriction 

on offers and sales to such persons 

would interrelate with Regulation S 

under the Securities Act of 1933. 

Commenters asserted that, since market 

participants have long conducted 

offerings of foreign funds in reliance on 

Regulation S 2434 in order to comply 

with U.S. securities law obligations, 

these same securities law principles 

should be applied to determine whether 

a person is a resident of the United 

States for purposes of section 13 and the 

final rule to determine whether an offer 

or sale is made to residents of the 

United States.2435

Certain commenters argued that 

because of the way the restriction in the 

statute and proposed rule was written, 

it was unclear whether the restriction on 

offering for sale to a resident of the 

United States applied to the foreign 

banking entity or to any third party that 

establishes a fund.2436 Commenters 

argued the prohibition against offers or 

sales of ownership interests to residents 

of the United States should apply only 

to offers and sales of covered funds 

organized and offered by the foreign 

banking entity but not to covered funds 

established by unaffiliated third 

parties.2437 These commenters reasoned 

that a foreign banking entity should be 

permitted to make a passive investment 

in a covered fund sponsored and 

controlled by an unaffiliated third party 

that has U.S. investors as long as the 

foreign banking entity does not itself 

offer or sell ownership interest in the 

covered fund to residents of the United 


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2438See Grosvenor; IIB/EBF; Japanese Bankers 

Ass’n.; Katten (on behalf of Int’l Clients); Sens. 

Merkley & Levin (Feb.2012); Norinchukin; SIFMA 

et al. (Covered Funds) (Feb. 2012). 

2439See BAROC; Credit Suisse (Williams); 

Grosvenor; IIB/EBF. 

2440See Comm. on Capital Markets Regulation; 

Credit Suisse (Williams); PEGCC. 

2441See SIFMA et al. (Covered Funds) (Feb. 

2012); see also Grosvenor; PEGCC. 

2442See AFG; BAROC; Cadwalader (on behalf of 

Thai Banks); Japanese Bankers Ass’n. 

2443See 156 Cong. Rec. S5897 (daily ed. July 15, 

2010) (statement of Sen. Merkley). 

2444See IIB/EBF; Katten (on behalf of Int’l 

Clients); Union Asset. 

2445See IFIC; see also Allen & Overy (on behalf 

of Canadian Banks). 

2446See Ass’n. of German Banks; Credit Suisse 

(Williams); IIB/EBF; Katten (on behalf of Int’l 

Clients). 

2447See Credit Suisse (Williams). 

2448See BVI; EFAMA; Union Asset. 

2449See AFG; Union Asset; see also BVI; Allen & 

Overy (on behalf of Canadian Banks); Katten (on 

behalf of Int’l Clients). 

2450See Japanese Bankers Ass’n. 

2451See final rule § 75.13(b)(1)(iii). 

2452See final rule § 75.13(b)(3). 

2453See Statement of the Commission Regarding 

Use of Internet Web sites to Offer Securities, Solicit 

Securities Transactions or Advertise Investment 

Services Offshore, Securities Act Release No. 7516 

(Mar. 23, 1998). Reliance on these principles only 

applies with respect to whether an ownership 

interest in a covered fund is offered for sale or sold 

to a resident of the United States for purposes of 

States.2438 Commenters contended that 

this interpretation would be consistent 

with section 13’s purpose to prevent 

foreign banks from using the foreign 

fund exemption to market and sell 

covered funds to U.S. investors, while 

simultaneously limiting the 

extraterritorial impact of section 13.2439

Commenters argued that the proposal’s 

foreign fund exemption would 

negatively impact U.S. asset managers 

unaffiliated with any banking entity 

because they would either be forced to 

exclude foreign banking entities from 

investing in their funds or would need 

to ensure that no residents of the United 

States hold ownership interests in funds 

offered to these entities.2440

Commenters also contended that foreign 

banking entities, including sovereign 

wealth funds that own or control foreign 

banking organizations, invest tens of 

billions of dollars in U.S. covered funds 

and that if these types of investments 

were not permitted under the foreign 

fund exemption an important source of 

foreign investment in the U.S. could be 

eliminated.2441

Commenters argued that an 

investment by a foreign banking entity 

in a third-party unaffiliated fund does 

not pose any risk to a U.S. banking 

entity or to the U.S. financial system. 

Moreover, commenters argued that a 

foreign banking entity that has invested 

in a fund sponsored and advised by a 

third party has no control over 

whether—and may have no 

knowledge—that the third party has 

determined to offer or sell the fund to 

U.S. residents.2442

As noted above, one of the purposes 

of section 13 is to limit the risk to 

banking entities and the financial 

system of the United States. Another 

purpose of the statute appears to be to 

permit foreign banking entities to 

engage in foreign activities without 

being subject to the restrictions of 

section 13 while also ensuring that these 

foreign entities do not receive a 

competitive advantage over U.S. 

banking entities with respect to offering 

and selling their covered fund services 

in the United States.2443 As such, the 

final rule does not prohibit a foreign 

banking entity from making an 

investment in or sponsoring a foreign 

fund. However, a foreign banking entity 

would not be permitted under the 

foreign fund exemption to invest in, or 

engage in the sponsorship of, a U.S. or 

foreign covered fund that offers 

ownership interests to residents in the 

United States unless it does so pursuant 

to and subject to the limitations of the 

permitted activity exemption for 

organizing and offering a covered fund, 

for example, which has the same effect 

for U.S. banking entities. The final rule 

ensures that the risk of the sponsoring 

and investing in non-U.S. covered funds 

by foreign banking entities remains 

outside of the United States and that the 

foreign fund exemption does not 

advantage foreign banking entities 

relative to U.S. banking entities with 

respect to providing their covered fund 

services in the United States by 

prohibiting the offer or sale of 

ownership interests in related covered 

funds to residents of the United States. 

Commenters also argued that foreign 

investors in a foreign covered fund 

should not be treated as residents of the 

United States for purposes of the final 

rule if, after purchasing their interest in 

the covered fund, they relocate to the 

U.S.,2444 or travel to the U.S. on a 

temporary basis.2445 Commenters also 

argued that non-U.S. investors in a fund 

offered by a foreign banking entity 

should not be prohibited from 

transferring their interests to residents 

of the United States in the secondary 

market.2446 One commenter alleged that, 

notwithstanding the reasonable efforts 

of foreign banking entities to prevent 

residents of the United States from 

investing in their foreign covered funds, 

investors may find ways to circumvent 

and invest in covered funds without 

knowledge or assistance from the 

foreign banking entity.2447

Certain commenters argued that there 

was a substantial risk that foreign funds 

offered by foreign banking entities 

would not be able to rely on the 

exemption due to the presence of a 

limited number of investors who are 

residents of the United States.2448 A few 

commenters suggested that the final rule 

should require that, for both related and 

unrelated covered funds, a banking 

entity need only have a reasonable 

belief that an ownership interest in a 

covered fund is not offered or sold to 

residents of the United States in order 

to qualify for the foreign fund 

exemption. Commenters argued that 

only active targeting or marketing 

towards a resident of the United States 

by the foreign banking entity should be 

prohibited by the final rule, and that the 

incidental presence of a limited number 

of investors that are residents of the 

United States in a foreign covered fund 

offered by a foreign banking entity 

should not prohibit the foreign banking 

entity from relying on the foreign fund 

exemption.2449 One commenter argued 

that, for certain complex fund structures 

(e.g., a structure with a master fund and 

multiple feeder funds that investors 

invest in or a parallel fund structure 

both managed by the same fund 

manager), eligibility for the foreign fund 

exemption should not be precluded for 

a fund with no ownership interests 

offered for sale or sold to U.S. residents 

even if a related covered fund is offered 

to residents of the United States.2450

After considering comments received 

on the proposal, the final rule retains 

the statutory requirement that no 

ownership interest in the covered fund 

be offered for sale to a resident of the 

United States.2451 The final rule 

provides that an ownership interest in a 

covered fund is offered for sale or sold 

to a resident of the United States for 

purposes of the foreign fund exemption 

only if it is sold or has been sold 

pursuant to an offering that targets 

residents of the United States.2452

Absent circumstances otherwise 

indicating a nexus with residents of the 

United States, the sponsor of a foreign 

fund would not be viewed as targeting 

U.S. residents for purposes of the 

foreign fund exemption if it conducts an 

offering directed to residents of one or 

more countries other than the United 

States; includes in the offering materials 

a prominent disclaimer that the 

securities are not being offered in the 

United States or to residents of the 

United States; and includes other 

reasonable procedures to restrict access 

to offering and subscription materials to 

persons that are not residents of the 

United States.2453 If ownership interests 


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section 13 of the BHC Act. In addition, reliance 

would not be appropriate if a foreign fund engages 

in a private placement of ownership interests in the 

United States in reliance on Section 4(a)(2) of the 

Securities Act of 1933 or Regulation D (17 CFR 

230.501–230.506). 

2454An offer or sale is made in an ‘‘offshore 

transaction’’ under Regulation S if, among other 

conditions, the transaction is executed in, on or 

through the facilities of a ‘‘designated offshore 

securities market’’ as described in Regulation S, 

which includes a number of foreign stock 

exchanges and markets and any others the SEC 

designates. See Securities Act rule 902(h). 

2455See Securities Act rule 902(k)(2). 

2456See final rule § 75.10(d)(8). 2457See 12 U.S.C. 1851(d)(1)(F). 2458See 12 U.S.C. 1851(d)(1)(D). 2459See proposed rule §§ 75.6(b)(2)(iii); 75.6(c). 2460See, e.g., Sutherland (on behalf of Comm. of 

Annuity Insurers); ACLI (Jan. 2012); Country Fin. et 

al.; Nationwide; NAMIC; Fin. Services Roundtable 

(Feb. 3, 2012) (citing FSOC study at 71); HSBC Life; 

Chamber (Feb. 2012); Country Fin. et al.; Mutual of 

Omaha; see also Rep. McCarthy et al.; Sen. Nelson; 

Sen. Hagan; Sens. Brown & Harkin. 

2461See, e.g., Fin. Services Roundtable (Feb. 3, 

2012); TIAA–CREF (Feb. 13, 2012); Sutherland (on 

behalf of Comm. of Annuity Insurers); USAA (citing 

FSOC study at 71); HSBC Life; ACLI; NAMIC; 

Nationwide. 

2462See Sutherland (on behalf of Comm. of 

Annuity Insurers); Nationwide; see also Rep. 

McCarthy et al.; Sens. Brown & Harkin. 

2463See, e.g., Fin. Services Roundtable (Feb. 3, 

2012); USAA; HSBC Life; Country Fin. et al.; 

Sutherland (on behalf of Comm. of Annuity 

Insurers); Nationwide (discussing the exemption for 

the general account of an insurance company); 

ACLI; Nationwide (discussing the exemption for 

separate accounts). 

2464See, e.g., Sutherland (on behalf of Comm. of 

Annuity Insurers). 

that are issued in a foreign offering are 

listed on a foreign exchange, secondary 

market transactions could be 

undertaken by the banking entity 

outside the United States in accordance 

with Regulation S under the foreign 

fund exemption.2454 Foreign banking 

entities should use precautions not to 

send offering materials into the United 

States or conduct discussions with 

persons located in the United States 

(other than to or with a person known 

to be a dealer or other professional 

fiduciary acting on behalf of a 

discretionary account or similar account 

for a person who is not a resident of the 

United States).2455 In order to comply 

with the rule as adopted, sponsors of 

covered funds established outside of the 

United States must examine the facts 

and circumstances of their particular 

offerings and confirm that the offering 

does not target residents of the United 

States. 

With respect to the treatment of multitiered fund structures under the foreign 

fund exemption, the Agencies expect 

that activities related to certain complex 

fund structures should be integrated in 

order to determine whether an 

ownership interest in a covered fund is 

offered for sale to a resident of the 

United States. For example, a banking 

entity may not be able to rely on the 

foreign fund exemption to sponsor or 

invest in an initial covered fund (that is 

offered for sale only overseas and not to 

residents of the United States) that is 

itself organized or operated for the 

purpose of investing in another covered 

fund (that is sold pursuant to an offering 

that targets U.S. residents) and that is 

either organized and offered or is 

advised by that banking entity. 

4. Definition of ‘‘Resident of the United 

States’’ 

As discussed in greater detail above in 

Part VI.B.1, section 13(d)(1)(I) of the 

BHC Act provides that a foreign banking 

entity may acquire or retain an 

ownership interest in or act as sponsor 

to a covered fund, but only if that 

activity is conducted according to the 

requirements of the statute, including 

that no ownership interest in the 

covered fund is offered for sale or sold 

to a ‘‘resident of the United States.’’ As 

noted above in Part VI.B.1.f describing 

the definition of ‘‘resident of the United 

States,’’ the statute does not define this 

term. 

After carefully considering comments 

received, the Agencies have defined the 

term ‘‘resident of the United States’’ in 

the final rule to mean a ‘‘U.S. person’’ 

as defined in the SEC’s Regulation S.2456

The Agencies note, however, that it 

would not be permissible under the 

foreign fund exemption for a foreign 

banking entity to facilitate or participate 

in the formation of a non-U.S. 

investment vehicle for a person or entity 

that is itself a U.S. person for the 

specific purpose of investing in a 

foreign fund. The Agencies believe that 

this type of activity would constitute an 

evasion of the requirements of section 

13 of the BHC Act. 

c. Permitted Covered Fund Interests and 

Activities by a Regulated Insurance 

Company 

As discussed above, section 

13(d)(1)(F) of the BHC Act permits a 

banking entity that is a regulated 

insurance company acting for its general 

account, or an affiliate of an insurance 

company acting for the insurance 

company’s general account, to purchase 

or sell a financial instrument subject to 

certain conditions.2457 Section 

13(d)(1)(D) of the Act permits a banking 

entity to purchase or sell a financial 

instrument on behalf of customers.2458

The proposal implemented these 

exemptions with respect to the 

proprietary trading activities of 

insurance companies by permitting a 

banking entity that is an insurance 

company to purchase or sell a financial 

instrument for the general account of 

the insurance company or for a separate 

account, in each case subject to certain 

restrictions.2459 The proposal did not 

apply these exemptions to covered fund 

activities or investments. 

A number of commenters argued that 

section 13 was designed to 

accommodate the business of insurance 

by exempting both the proprietary 

trading and covered fund activities of 

insurance companies.2460 These 

commenters argued that providing an 

exemption for covered fund activities 

and investments through both the 

general account and separate accounts 

of an insurance company was integral to 

the business of insurance and that, 

absent an exemption from the covered 

fund provisions, insurance companies 

would lack an effective means to 

diversify their holdings and obtain 

adequate rates of return in order to 

maintain affordable premiums for 

customers.2461

Some commenters argued that section 

13 of the BHC Act specifically provides 

exemptions from both the covered fund 

prohibition of section 13(a)(1), and the 

prohibition on proprietary trading.2462

Commenters contended that the 

exemptions in section 13(d)(1)(F) 

(referencing activity in general accounts 

of insurance companies) and 13(d)(1)(D) 

(referencing activities on behalf of 

customers) cross-reference the 

instruments described in section 

13(h)(4) and not activity described in 

section 13(h)(4). On this basis, 

commenters argued the statute exempts 

both proprietary trading in these 

instruments described in section 

13(h)(4) and investments in those 

instruments (including when those 

instruments are ownership interests in 

covered funds).2463

Alternatively, commenters argued that 

the Agencies should use their authority 

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

provide an exemption for the covered 

fund activities and investments of 

insurance companies.2464 These 

commenters argued that exempting 

covered funds activities and 

investments of insurance companies 

would promote and protect the safety 

and soundness of the banking entity and 

financial stability of the United States 

and provide certain benefits to the U.S. 

financial system by allowing insurance 

companies to access important asset 

classes (for better investment diversity 

and returns), provide more diverse 

product offerings to customers, better 

manage their investment risks through 

diversification and more closely 

matching the maturity of their assets 


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2465See Fin. Services Roundtable (Feb. 3, 2012); 

TIAA–CREF (Feb. 13, 2012); USAA; HSBC Life; 

ACLI (Jan. 2012); NAMIC; Nationwide. 2466See, e.g., Nationwide. 2467See, e.g., ACLI (Jan. 2012); Fin. Services 

Roundtable (Feb. 3, 2012); USAA; Chamber (Feb. 

2012); Country Fin. et al.; Mutual of Omaha; 

NAMIC; Nationwide; Rep. McCarthy et al. See also 

156 Cong. Reg. S. 5896 (daily ed. July 15, 2010) 

(statement of Sen. Merkley) (arguing that activities 

of insurance companies ‘‘are heavily regulated by 

State insurance regulators, and in most cases do not 

pose the same level of risk as other proprietary 

trading’’). 

2468Some commenters urged the Agencies to 

provide that an affiliate or subsidiary of an 

insurance company could purchase covered funds 

for the insurance company’s general account or a 

separate account. See e.g., Fin. Services Roundtable 

(Feb. 3, 2012); TIAA–CREF (Feb. 13, 2012). The 

Agencies note that the final rule provides (as does 

the statute) an exemption that permits an insurance 

company or its affiliate to acquire and retain an 

ownership interest in a covered fund solely for the 

insurance’s company general account (or one or 

more of its separate account); such an affiliate or 

subsidiary also may be a wholly-owned subsidiary, 

as defined in the final rule. 

2469The final rule defines the terms ‘‘general 

account’’ and ‘‘separate account’’ largely as 

proposed, and includes the new defined term 

‘‘insurance company,’’ defined as a company that 

is organized as an insurance company, primarily 

and predominantly engaged in writing insurance or 

reinsuring risks underwritten by insurance 

companies, subject to supervision as such by a state 

insurance regulator or a foreign insurance regulator, 

and not operated for the purpose of evading the 

provisions of section 13 of the BHC Act. Cf. section 

2(a)(17) of the Investment Company Act (defining 

the term insurance company). 

2470See final rule § 75.13(c). 2471See 12 U.S.C. 1851(d)(1)(D), (F). 

2472See 12 U.S.C. 1851(b)(1)(F). See also 156 

Cong. Reg. S. 5896 (daily ed. July 15, 2010) 

(statement of Sen. Merkley) (arguing that ‘‘section 

13 of the BHC Act] was never meant to affect the 

ordinary business of insurance’’). 

2473See 12 U.S.C. 1851(b)(1)(F). See also 156 

Cong. Reg. S. 5896 (daily ed. July 15, 2010) 

(statement of Sen. Merkley) (arguing that ‘‘section 

13 of the BHC Act] was never meant to affect the 

ordinary business of insurance’’). 

2474 12 U.S.C. 371c. The Agencies note that this 

does not alter the applicability of section 23A of the 

FR Act and the Board’s Regulation W to covered 

transactions between insured depository 

institutions and their affiliates. 

2475 12 U.S.C. 371c–1. 

2476See proposed rule § 75.16. 

and liabilities, contribute liquidity to 

capital markets, and support economic 

growth through the provision of capital 

to entrepreneurs and businesses.2465

Commenters also argued that an 

exemption for insurance companies 

from the covered fund prohibitions was 

necessary to permit insurance 

companies that are banking entities to 

effectively compete with insurance 

companies not affiliated with an insured 

depository institution.2466 Commenters 

alleged that insurance companies are 

already subject to extensive regulation 

under state insurance laws that 

specifically include provisions designed 

to diversify risk among investment 

categories, limit exposure to particular 

types of asset classes including covered 

fund investments, and protect the safety 

and soundness of the insurance 

company.2467

After careful review of the comments 

in light of the statutory provisions, the 

final rule has been modified to permit 

an insurance company or its affiliate 2468

to acquire or retain an ownership 

interest in, or act as sponsor to, a 

covered fund for either the general 

account of the insurance company or 

one or more separate accounts 

established by the insurance 

company.2469

These activities are only permitted 

under the final rule so long as: (1) The 

insurance company or its affiliate 

acquires and retains the ownership 

interest solely for the general account of 

the insurance company or for one or 

more separate accounts established by 

the insurance company; (2) the 

acquisition and retention of the 

ownership interest is conducted in 

compliance with, and subject to, the 

insurance company investment laws, 

regulations, and written guidance of the 

State or jurisdiction in which the 

insurance company is domiciled; and 

(3) the appropriate Federal banking 

agencies, after consultation with the 

Financial Stability Oversight Council 

and the relevant insurance 

commissioners of the States and 

relevant foreign jurisdictions, as 

appropriate, have not jointly 

determined, after notice and comment, 

that a particular law, regulation, or 

written guidance described in 

§ 75.13(c)(2) of the final rule is 

insufficient to protect the safety and 

soundness of the banking entity, or the 

financial stability of the United 

States.2470

The Agencies believe that exempting 

insurance activities and investments 

from the covered fund restrictions is 

supported by the language of sections 

13(d)(1)(D) and (F) of the BHC Act,2471

and more fully carries out Congressional 

intent and the statutory purpose of 

appropriately accommodating the 

business of insurance within an 

insurance company.2472 Section 

13(d)(1)(F) of the statute specifically 

exempts general accounts of insurance 

companies, and, as explained above in 

Part VI.A.7, separate accounts are 

managed and maintained on behalf of 

customers, an activity exempt under 

section 13(d)(1)(D) of the statute. By 

their terms, these are statutory 

exemptions from the prohibitions in 

section 13(a), which includes both the 

prohibition on proprietary trading and 

the prohibition on covered fund 

investments and sponsorship. Moreover, 

the statutory language of sections 

13(d)(1)(D) and 13(d)(1)(F), both crossreference the instruments described in 

section 13(h)(4) and not activity 

described in section 13(h)(4). These 

instruments are ‘‘any security, any 

derivative, any contract of sale of a 

commodity for future delivery, any 

option on any such security, derivative 

or contract or any other security or 

financial instrument that [the Agencies 

determine by rule.]’’ This reference 

covers an ownership interest in a 

covered fund. The Agencies believe 

these exemptions as modified more 

fully carry out Congressional intent and 

the statutory purpose of appropriately 

accommodating the business of 

insurance within an insurance 

company.2473 Insurance companies are 

already subject to a robust regulatory 

regime including limitations on their 

investment activities. 

5. Section 75.14: Limitations on 

Relationships With a Covered Fund 

Section 13(f) of the BHC Act generally 

prohibits a banking entity that, directly 

or indirectly, serves as investment 

manager, investment adviser, or sponsor 

to a covered fund (or that organizes and 

offers a covered fund pursuant to 

section 13(d)(1)(G) of the BHC Act) from 

entering into a transaction with a 

covered fund that would be a covered 

transaction as defined in section 23A of 

the Federal Reserve Act (‘‘FR Act’’).2474

The statute also provides an exemption 

for prime brokerage transactions 

between a banking entity and a covered 

fund in which a covered fund managed, 

sponsored, or advised by that banking 

entity has taken an ownership interest. 

Section 13(f) subjects any transaction 

permitted under section 13(f) of the 

BHC Act (including a permitted prime 

brokerage transaction) between the 

banking entity and covered fund to 

section 23B of the FR Act.2475 In 

general, section 23B of the FR Act 

requires that the transaction be on 

market terms or on terms at least as 

favorable to the banking entity as a 

comparable transaction by the banking 

entity with an unaffiliated third party. 

Section 75.16 of the proposed rule 

implemented these provisions.2476

a. Scope of Application 

Section 13(f) of the BHC Act and the 

related provisions of the proposal were 

among the most commented upon 

aspects of the covered funds section. 

The majority of commenters argued that 

the broad definition of ‘‘covered fund’’ 

under the proposal made the proposed 

implementation of section 13(f) 

unworkable and disruptive to existing 

market practices because it would 


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2477See, e.g., Allen & Overy (on behalf of Foreign 

Bank Group); BoA; Barclays; Credit Suisse 

(Williams); Deutsche Bank (Fund-Linked Products); 

GE (Feb. 2012); Goldman Sachs (Covered Funds); 

ICI Global; ISDA (Feb. 2012); RMA; SIFMA et al. 

(Covered Funds) (Feb. 2012). 

2478See SunTrust; AHIC; SBIA. 

2479See SIFMA et al. (Covered Funds) (Feb. 

2012). 

2480See final rule § 75.10(b). See supra Part 

VI.B.1. 

2481See IIB/EBF; Katten (on behalf of Int’l 

Clients); EBF; EFAMA; French Banking Fed’n.; 

Japanese Bankers Ass’n. 

2482See AIMA. 

2483See final rule § 75.10(b)(1)(ii) and (c)(1). See 

supra Part VI.B.1. 

2484Section 75.11(b) of the final rule provides 

that for purposes of securitizations, organizing and 

offering includes acting as the securitizer. As 

discussed in greater detail above in Part VI.B.2.b, 

a banking entity that continues to hold interests in 

a securitization in reliance on this exemption must 

comply with certain requirements, including the 

requirements of § 75.14. Accordingly, § 75.14 of the 

final rule has also been modified from the proposal 

to prohibit a banking entity that continues to hold 

an ownership interest in accordance with 

§ 75.11(b), and its affiliates, from entering into a 

covered transaction with a covered fund, subject to 

certain exceptions. 

2485See AFME et al.: ASF (Feb. 2012); Ashurst; 

BoA; Barclays; Cadwalader (Municipal Securities); 

Credit Suisse (Williams); Commercial Real Estate 

Fin. Council; Deutsche Bank (Fund-Linked 

Products); Fidelity; GE (Feb. 2012); Goldman Sachs 

(Covered Funds); ICI (Feb. 2012); IIB/EBF; ISDA 

(Feb. 2012); JPMC; PNC et al.; PNC; RBC; SIFMA 

et al. (Covered Funds) (Feb. 2012); SIFMA 

(Securitization) (Feb. 2012); Chamber (Feb. 2012). 

These comments are addressed above in Part II 

regarding availability of the conformance period 

provisions of section 13 of the BHC Act. 

2486See Katten (on behalf of Int’l Clients). 

2487The 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. 

2488See 12 U.S.C. 371c(d); 12 CFR 223.42; ABA 

(Keating); Ass’n. of Institutional Investors (Feb. 

2012); BoA; BNY Mellon et al.; Credit Suisse 

(Williams); SIFMA et al. (Covered Funds) (Feb. 

2012); see also Allen & Overy (on behalf of Foreign 

Bank Group). 

2489See ABA (Keating); Ass’n. of Institutional 

Investors (Feb. 2012); BoA; BNY Mellon et al.; 

SIFMA et al. (Covered Funds) (Feb. 2012). 

prohibit corporate funding transactions 

with ordinary corporate entities that do 

not engage in hedge fund or private 

equity activities.2477 Commenters also 

argued that activities that the proposal 

appeared to permit as a permitted 

activity exemption (e.g., investments in 

public welfare funds) would be 

prohibited by the restrictions in 

13(f) 2478 and that the Agencies should 

construe section 13(d)(1)(J) of the BHC 

Act as allowing them to permit banking 

entities to enter into covered 

transactions with a covered fund, if 

those activities would promote and 

protect the safety and soundness of 

banking entities and the financial 

stability of the United States.2479

However, many of the comments 

discussed above and some of the 

economic burdens noted by these 

commenters have been addressed by 

revisions discussed above in Part VI.B.1 

to the definition of covered fund.2480 A 

number of these and related comments 

are also addressed by portions of the 

final rule that provide that the 

prohibitions of section 13 do not apply 

to interests acquired, for example, as 

agent, broker, custodian, in satisfaction 

of a debt previously contracted, through 

a pension fund, or as trustee or fiduciary 

(all within the limits defined in the final 

rule). 

Several commenters argued that 

applying the restrictions in section 13(f) 

to foreign activities of foreign banking 

entities would be inconsistent with the 

presumption against extraterritorial 

application of U.S. law and principles of 

international comity, including 

deference to home-country 

regulation.2481 For example, one 

commenter expressed concern that rules 

being developed around custody 

obligations in the European Union may 

require a prime broker or custodian to 

indirectly guarantee assets of a fund, 

which would directly conflict with the 

prohibition on guarantees in section 

13(f) of the BHC Act.2482 As explained 

above, the final rule has been modified 

to more narrowly focus the scope of the 

definition of covered fund as it applies 

to foreign funds.2483 These changes 

substantially address the issues raised 

by commenters regarding the 

applicability of section 13(f) of the BHC 

Act to foreign funds. 

Commenters also raised a number of 

other issues. For instance, some 

commenters argued that applying 

section 13(f) to securitization entities 

would in some instances run counter to 

the rule of construction contained in 

section 13(g)(2) regarding the sale and 

securitization of loans.2484 These 

commenters recommended that the final 

rule, at a minimum, grandfather preexisting relationships between banking 

entities and existing securitization 

vehicles to reduce the potential effects 

of the final rule on agreements and 

positions entered into before the 

enactment of the statute.2485

One commenter argued that a banking 

entity that delegates its responsibility 

for acting as sponsor, investment 

manager, or investment adviser to an 

unaffiliated entity should no longer be 

subject to the restrictions of section 

13(f).2486 By its terms, section 13(f) of 

the BHC Act applies to a banking entity 

that, directly or indirectly, serves as 

investment manager, investment 

adviser, or sponsor to a covered fund (or 

that relies on section 13(d)(1)(G) of the 

BHC Act in connection with organizing 

and offering a covered fund). The 

Agencies believe that a banking entity 

that delegates its responsibility to act as 

sponsor, investment manager, or 

investment adviser to an unaffiliated 

party would still be subject to the 

limitations of section 13(f) if the 

banking entity retains the ability to 

select, remove, direct, or otherwise exert 

control over the sponsor, investment 

manager, or investment adviser 

designee. In addition, the unaffiliated 

party designated as sponsor, investment 

manager, or investment adviser would 

be subject to the restrictions of section 

13(f) if the third party is a banking 

entity. 

b. Transactions That Would Be a 

‘‘Covered Transaction’’ 

Section 13(f) of the BHC Act prohibits 

covered transactions as defined in 

section 23A of the FR Act between a 

banking entity that serves as investment 

manager, investment advisor or sponsor 

to a covered fund or that relies on the 

exemption in section 13(d)(1)(G) and a 

covered fund.2487 A number of 

commenters contended that the 

definition of ‘‘covered transaction’’ in 

section 13(f) of the BHC Act should 

incorporate the exemptions available 

under section 23A and the Board’s 

Regulation W.2488 These commenters 

alleged that the statute’s general 

reference to section 23A suggests that 

the term ‘‘covered transaction’’ should 

be construed in light of section 23A as 

a whole, including the exemptions in 

subsection (d) of that Act and as 

implemented in the Board’s Regulation 

W.2489 These commenters also argued 

that the Board’s authority to interpret 

and issue rules pursuant to section 23A 

of the FR Act and section 5(b) of the 

BHC Act, the general rule-making 

authority contained in section 13(b) of 

the BHC Act, and the exemptive 

authority in section 13(d)(1)(J) all 


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2490See BNY Mellon et al.; SIFMA et al. (Covered 

Funds) (Feb. 2012); see also Credit Suisse 

(Williams). 2491See ABA (Keating); AFG; Ass’n. of 

Institutional Investors (Feb. 2012); BoA; BNY 

Mellon et al.; Credit Suisse (Williams); EFAMA; 

French Treasury et al.; JPMC; IMA; RMA; SIFMA 

et al. (Covered Funds) (Feb. 2012); State Street (Feb. 

2012); SSgA (Feb. 2012); Vanguard. 2492See BoA; Credit Suisse (Williams); SIFMA et 

al. (Covered Funds) (Feb. 2012). 

2493See Credit Suisse (Williams). 2494See, e.g., Credit Suisse (Williams). 

2495See BoA; Credit Suisse (Williams); SIFMA et 

al. (Covered Funds) (Feb. 2012). 

2496See State Street (Feb. 2012); RMA. 

2497See BoA; SIFMA et al. (Covered Funds) (Feb. 

2012); see also Katten (on behalf of Int’l Clients). 

2498See Occupy. 

2499See 12 U.S.C. 371c(b)(7); see also 12 U.S.C. 

371c–1(a)(2)(B) (including the sale of securities or 

other assets to an affiliate as a transaction subject 

to section 23B). 

2500See 12 U.S.C. 371c(d). 

2501See proposed rule § 75.16(a)(2)(i). 

2502See, e.g., SIFMA et al. (Covered Funds) (Feb. 

2012). 

2503The final rule modifies the proposal to clarify 

that a banking entity may acquire and retain an 

ownership interest in a covered fund by express 

reference to the permitted activities described in 

§§ 75.11, 75.12 and 75.13. 

provide a basis for providing such 

exemptions.2490

In particular, commenters argued that 

intraday extensions of credit; 2491

transactions fully secured by cash or 

U.S. government securities; 2492

purchases of liquid assets and 

marketable securities from covered 

funds; 2493 and riskless principal 

transactions with covered funds all 

should be exempt from the restrictions 

in section 13(f) of the BHC Act.2494

These commenters argued that 

providing an exemption for intraday 

extensions of credit in particular was 

necessary to allow a banking entity to 

continue to provide affiliated covered 

funds with standard custody, clearing, 

and settlement services that include 

intra-day or overnight overdrafts 

necessary to facilitate securities 

settlement, contractual settlement, predetermined income, or similar custodyrelated transactions. Some commenters 

argued that transactions fully secured by 

cash or U.S. government securities do 

not expose banking entities to 

inappropriate risks, are permitted in 

unlimited amounts under section 23A, 

and should not be entirely prohibited 

under the rule.2495 A few commenters 

argued that the proposal would prohibit 

securities lending transactions and 

argued that borrower default 

indemnifications by a banking entity in 

agency securities lending arrangements 

should not be prohibited under section 

13(f).2496 Some commenters argued that 

a banking entity should be allowed to 

accept the shares of a sponsored covered 

fund as collateral for a loan to any 

person or entity, in particular where the 

loan is not for the purpose of purchasing 

interests in the covered fund.2497

One commenter argued that no 

exceptions should be granted to the 

definition of covered transaction, and 

financing of covered funds would relate 

to greater fund risk.2498 In addition, that 

commenter contended that the Agencies 

should prohibit a sale of securities by a 

banking entity to a covered fund even 

though these transactions are not within 

the definition of covered transaction for 

purposes of section 23A of the FR 

Act.2499

The final rule continues to apply the 

same definition of covered transaction 

as the proposal. Section 13(f) refers to a 

covered transaction, as defined in 

section 23A of the FR Act. Section 13(f) 

of the BHC Act does not incorporate or 

reference the exemptions contained in 

section 23A of the FR Act or the Board’s 

Regulation W. Indeed, the exemptions 

for these transactions are not included 

in the definition of covered transactions 

in section 23A; the exemptions are 

instead in a different subsection of 

section 23A and provide an exemption 

from only some (but not all) of the 

provisions of section 23A governing 

covered transactions.2500 Therefore, the 

final rule does not incorporate the 

exemptions in section 23A. 

Similarly, the final rule incorporates 

the statutory restriction as written, 

which provides that a banking entity 

that serves in certain specified roles 

may not enter into a transaction with a 

covered fund that would be a covered 

transaction as defined in section 23A of 

the FR Act as if the banking entity were 

a member bank and the covered fund 

were an affiliate thereof. There are 

certain occasions when the restrictions 

of section 23A apply to transactions that 

involve a third party other than an 

affiliate of a member bank. For example, 

section 23A would apply to an 

extension of credit by a member bank to 

a customer where the extension of credit 

is secured by shares of an affiliate. The 

Agencies believe that these transactions 

between a banking entity and a third 

party that is not a covered fund are not 

covered by the terms of section 13(f), 

which (as discussed above) make 

specific reference to transactions by the 

banking entity with the covered fund. A 

contrary reading would prohibit 

securities margin lending, which 

Congress has specifically addressed 

(and permitted) in other statutes. There 

is no indication in the legislative history 

that Congress intended section 13(f) to 

prohibit margin lending that occurs in 

accordance with other specific statutes. 

Thus, section 13(f) does not prohibit a 

banking entity from extending credit to 

a customer secured by shares of a 

covered fund (as well as, perhaps, other 

securities) held in a margin account. 

However, the Agencies expect banking 

entities not to structure transactions 

with third parties in an attempt to evade 

the restrictions on transactions with 

covered funds, and the Agencies will 

use their supervisory authority to 

monitor and restrict transactions that 

appear to be evasions of section 13(f). 

c. Certain Transactions and 

Relationships Permitted 

While section 13(f)(1) of the BHC Act 

generally prohibits a banking entity 

from entering into a transaction with a 

related covered fund that would be a 

covered transaction as defined under 

section 23A of the FR Act, other specific 

portions of the statute permit a banking 

entity to engage in certain transactions 

or relationships with such funds. 

1. Permitted Investments and 

Ownerships Interests 

The proposed rule permitted a 

banking entity to acquire or retain an 

ownership interest in a covered fund in 

accordance with the requirements of 

section 13.2501 This was consistent with 

the text of section 13(f), which by its 

terms is triggered by the presence of 

certain ownership interests. This view 

also resolved an apparent conflict 

between the text of section 13(f) and the 

reference in section 13(f) prohibiting 

covered transactions under section 23A 

of the FR Act, which includes acquiring 

or retaining an interest in securities 

issued by an affiliate. 

Several commenters supported this 

aspect of the proposal.2502 There is no 

evidence that Congress intended section 

13(f)(1) of the BHC Act to override the 

other provisions of section 13 with 

regard to the acquisition or retention of 

ownership interests specifically 

permitted by the section. Moreover, a 

contrary reading would make these 

more specific sections that permit 

covered transactions between a banking 

entity and a covered fund mere 

surplusage. Therefore, the final rule 

adopts this provision as proposed.2503

2. Prime Brokerage Transactions 

Section 13(f) provides an exception 

from the prohibition on covered 

transactions with a covered fund for any 

prime brokerage transaction with a 

covered fund in which a covered fund 

managed, sponsored, or advised by a 

banking entity has taken an ownership 

interest (a ‘‘second-tier fund’’). 

However, the statute does not define 


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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 6019 

2504See proposed rule § 75.10(b)(4). 

2505See, e.g., Occupy; Public Citizen. 

2506See SIFMA et al. (Mar. 2012). 

2507See RMA. 

2508See RMA. 

2509See Katten (on behalf of Int’l Clients). 

2510See final rule § 75.10(d)(5). 

2511See RMA; Katten (on behalf of Int’l Clients); 

EFAMA; see also Hong Kong Inv. Funds Ass’n.; 

IMA; Union Asset. 2512See Sens. Merkley & Levin (Feb. 2012); 

Occupy. 2513See 12 U.S.C. 1851(f)(3). 

prime brokerage transaction. The 

proposed rule defined prime brokerage 

transaction to include providing one or 

more products or services, such as 

custody, clearance, securities borrowing 

or lending services, trade execution, or 

financing, data, operational, and 

portfolio management support.2504

A few commenters argued that the 

proposed definition of prime brokerage 

transaction was overly broad and should 

not permit securities lending or 

borrowing services. These commenters 

argued that securities lending and 

borrowing (and certain other services) 

could increase leverage by covered 

funds and the risk that a banking entity 

would bailout these funds.2505

Other commenters argued that the 

proposed definition of prime brokerage 

transaction was confusing because it 

included transactions (such as data or 

portfolio management support) that 

were not ‘‘covered transactions’’ under 

section 23A of the FR Act and thus not 

prohibited as an initial matter by section 

13(f). These commenters argued that 

including otherwise permissible 

transactions within the definition of 

prime brokerage transaction created 

uncertainty about the permissibility of 

other transactions or services that are 

not expressly covered transactions 

under section 23A of the FR Act and 

thus not prohibited under section 13(f). 

One commenter proposed defining 

prime brokerage transaction as any 

‘‘covered transaction’’ entered into by a 

banking entity with a covered fund ‘‘for 

purposes of custody, clearance, 

securities borrowing or lending services, 

trade execution and settlement, 

financing and related hedging, 

intermediation, or a similar 

purpose.’’ 2506

A few commenters supported 

expanding the definition of prime 

brokerage transaction to include any 

service or transaction ‘‘related to’’ a 

specific list of permissible transactions. 

For instance, one commenter argued 

that acting as agent in providing 

contractual income and settlement 

services and intraday and overnight 

overdraft protection should expressly be 

included within the definition of prime 

brokerage transaction.2507 This 

commenter also urged that borrower 

default indemnification should be 

included as a prime brokerage 

transaction to the extent it would be a 

covered transaction that is prohibited by 

section 13(f).2508 Another commenter 

recommended that the definition of 

prime brokerage transaction expressly 

include transactions in commodities, 

futures and foreign exchange, as well as 

securities, and transactions effected 

through OTC derivatives, including, 

without limitation, contracts for 

differences, various swaps and securitybased swaps, foreign exchange swaps 

and forwards and ‘‘FX prime 

brokerage’’.2509

Based on review of the comments, the 

definition of prime brokerage 

transaction has been modified in several 

ways. For purposes of the final rule, 

prime brokerage transaction is defined 

to mean any transaction that would be 

a covered transaction, as defined in 

section 23A(b)(7) of the FR Act (12 

U.S.C. 371c(b)(7)), that is provided in 

connection with custody, clearance and 

settlement, securities borrowing or 

lending services, trade execution, 

financing, or data, operational, and 

administrative support. The definition 

of prime brokerage transaction under 

the final rule generally recognizes the 

same relationships that were considered 

when defining prime brokerage 

transaction under the proposal,2510

without certain of the modifications 

suggested by some commenters that are 

discussed above. The Agencies carefully 

considered comments received on the 

definition of prime brokerage 

transaction. As noted above, certain 

commenters requested that various 

types of transactions be included in or 

omitted from the definition. The 

Agencies believe it appropriate to 

include within the definition of prime 

brokerage transaction those transactions 

that the Agencies believe generally 

constitute the typical type of prime 

brokerage transactions provided in the 

market. Including this list of 

relationships provides clarity and 

certainty for transactions that are 

commonly considered to be prime 

brokerage transactions. 

The final rule incorporates within the 

definition of prime brokerage 

transaction a reference to covered 

transactions under section 23A(b)(7) of 

the FR Act. This change aligns the final 

rules with section 13(f) of the BHC Act 

and is designed to eliminate confusion 

and provide certainty regarding both the 

breath of the prohibition on covered 

transactions in section 13(f) and the 

scope of the exception for prime 

brokerage transactions. Thus, a 

transaction or relationship that is not a 

covered transaction under section 13(f) 

of the BHC Act is not prohibited in the 

first instance (unless prohibited 

elsewhere in section 13). Within the 

category of transactions prohibited by 

section 13(f), transactions within the 

definition of prime brokerage 

transaction are permitted. 

Some commenters argued that the 

Agencies should provide an exemption 

for prime brokerage transactions with a 

broader array of funds than the proposal 

permitted. For instance, some 

commenters argued that the Agencies 

should permit a banking entity to enter 

into a prime brokerage transaction with 

any covered fund or fund structure that 

the banking entity organizes and offers 

or for which it directly serves as 

investment manager, investment 

adviser, or sponsor, and should not 

limit the exception for prime brokerage 

transactions to only a second-tier 

covered fund.2511 Conversely, a few 

commenters argued that the prime 

brokerage exemption should only 

permit a banking entity to provide these 

services to a third-party fund in order to 

ensure that the provision of prime 

brokerage services does not give rise to 

the same risks that section 13 was 

designed more generally to limit.2512

The Agencies note that the statute by 

its terms does not restrict prime 

brokerage transactions generally. As 

noted above, section 13(f)(3)(A) of the 

BHC Act provides that a banking entity 

may enter into any prime brokerage 

transaction with a second-tier fund. The 

statute by its terms permits a banking 

entity with a relationship to a covered 

fund described in section 13(f) to engage 

in prime brokerage transactions (that are 

covered transactions) only with secondtier funds and does not extend to 

covered funds more generally. Neither 

the statute nor the final rule limit 

covered transactions between a banking 

entity and a covered fund for which the 

banking entity does not serve as 

investment manager, investment 

adviser, or sponsor (as defined in 

section 13 of the BHC Act) or have an 

interest in reliance on section 

13(d)(1)(G) of the BHC Act. Under the 

statute, the exemption for prime 

brokerage transactions is available only 

so long as certain enumerated 

conditions are satisfied.2513 The 

conditions are that (i) the chief 

executive officer (or equivalent officer) 

of the banking entity certifies in writing 

annually that the banking entity does 

not, directly or indirectly, guarantee, 

assume, or otherwise insure the 

obligations or performance of the 


emcdonald on DSK67QTVN1PROD with RULES3
6020 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

2514See proposed rule § 75.16(a)(2)(ii); IIB/EBF; 

Credit Suisse (Williams). 

2515See 12 U.S.C. 1851(f)(3)(A)(ii). 

2516 12 U.S.C. 371c–1. 

2517See proposed rule § 75.16(b). 

2518 12 U.S.C. 371c–1(a); 12 CFR 223.51. 

2519See final rule § 75.14(b). As discussed above, 

§ 75.11(b) of the final rule provides that for 

purposes of securitizations, organizing and offering 

includes acting as the securitizer. A banking entity 

that continues to own interests in a securitization 

in reliance on this exemption must comply, among 

other things, with the requirements of § 75.14. 

Accordingly, § 75.14(b) of the final rule has been 

modified to require that a banking entity that 

continues to hold an ownership interest in 

accordance with § 75.11(b) is subject to section 23B 

of the Federal Reserve Act, as if such banking entity 

were a member bank and the covered fund were an 

affiliate. 

2520See EBF; Ass’n. of German Banks. 

2521For Commission registrants that are swap 

dealers and to which this rule applies, it is noted 

that the compliance requirements of subpart D are 

included in the Commission’s regulations that are 

to be addressed as part of the chief compliance 

officer duties and requirements under CFTC 

regulation 3.3. 

covered fund or of any covered fund in 

which such covered fund invests, and 

(ii) the Board has not determined that 

such transaction is inconsistent with the 

safe and sound operation and condition 

of the banking entity. The proposed rule 

incorporated each of these provisions. 

The final rule provides that this 

certification be made to the appropriate 

Federal supervisor for the banking 

entity. 

A few commenters argued that the 

proposal did not adequately address 

how the CEO attestation requirement in 

section 13(f) would apply to foreign 

banking organizations. They argued that 

a senior officer with authority for the 

U.S. operations of the foreign bank 

should be permitted to make the 

required attestation.2514

The statute allows the attestation for 

purposes of the prime brokerage 

exception in section 13(f) of the BHC 

Act to be from the chief executive 

officer or ‘‘equivalent officer.’’ 2515 In 

the case of the U.S. operations of foreign 

banking entities, the senior officer of the 

foreign banking entity’s U.S. operations 

or the chief executive officer of the U.S. 

banking entity may provide the required 

attestation. 

d. Restrictions on Transactions With 

Any Permitted Covered Fund 

Sections 13(f)(2) and 13(f)(3)(B) of the 

BHC Act apply section 23B of the FR 

Act 2516 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.2517 Section 23B provides that 

transactions between a member bank 

and an affiliate must be on terms and 

under circumstances, including credit 

standards, that are substantially the 

same or at least as favorable to the 

banking entity as those prevailing at the 

time for comparable transactions with or 

involving unaffiliated companies or, in 

the absence of comparable transactions, 

on terms and under circumstances, 

including credit standards, that in good 

faith would be offered to, or would 

apply to, non-affiliated companies.2518

Mirroring the statute, the proposal 

applied this requirement to transactions 

between a banking entity that serves as 

investment manager, investment 

adviser, or sponsor to a covered fund 

and that fund and any other fund 

controlled by that fund. It also applied 

this condition to a permissible prime 

brokerage transaction in which a 

banking entity may engage under the 

proposal. 

Commenters generally did not raise 

any issues regarding the proposal’s 

implementation of section 13(f)(2) and 

13(f)(3)(B). The final rule generally 

implements these requirements in the 

same manner as the proposal.2519

6. Section 75.15: Other Limitations on 

Permitted Covered Fund Activities 

Like § 75.8, § 75.17 of the proposed 

rule implemented section 13(d)(2) of the 

BHC Act, which places certain 

limitations on the permitted covered 

fund activities and investments in 

which a banking entity may engage. 

Consistent with the statute and § 75.8 of 

the proposed rule, § 75.17 provided that 

no transaction, class of transactions, or 

activity was permissible under §§ 75.11 

through 75.14 and § 75.16 of the 

proposed rule if the transaction, class of 

transactions, or activity would: (i) 

Involve or result in a material conflict 

of interest between the banking entity 

and its clients, customers, or 

counterparties; (ii) result, directly or 

indirectly, in a material exposure by the 

banking entity to a high-risk asset or a 

high-risk trading strategy; or (iii) pose a 

threat to the safety and soundness of the 

banking entity or the financial stability 

of the United States. 

Section 75.17 of the proposed rule 

defined ‘‘material conflict of interest,’’ 

‘‘high-risk assets,’’ and ‘‘high-risk 

trading strategies’’ for these purposes in 

a fashion identical to the definitions of 

the same terms for purposes of § 75.8 of 

the proposed rule related to proprietary 

trading. In the final rule, other than the 

permitted activities to which §§ 75.7 

and 75.15 apply, §§ 75.7 and 75.15 are 

also identical. Comments received on 

the definitions in these sections, as well 

as the treatment of these concepts under 

the final rule, are described in detail in 

Part VI.A.9 above. 

The Agencies also note that some 

concerns identified by commenters 

regarding the rule’s extraterritorial 

application are addressed by 

modifications in the final rule to the 

definition of a covered fund under 

§ 75.10. As noted above, commenters 

requested that the Agencies clarify that 

the limitations in §§ 75.8 or 75.17 of the 

proposed rule apply only to a foreign 

banking entity’s U.S. activities and 

affiliates.2520 As discussed in greater 

detail above in Part VI.B.1, the final rule 

has been modified to more narrowly 

focus the scope of the definition of 

covered fund as it applies to foreign 

funds. Pursuant to the definition of a 

covered fund in § 75.10(b)(1), a foreign 

fund may be a covered fund with 

respect to the U.S. banking entity that 

sponsors the fund, but not be a covered 

fund with respect to a foreign bank that 

invests in the fund solely outside the 

United States. Foreign public funds, as 

defined in § 75.10(c)(1) of the final rule, 

are also excluded from the definition of 

a covered fund. By excluding foreign 

public funds from the definition of 

covered fund and by narrowing the 

scope of the definition of a covered fund 

with respect to foreign funds, the 

Agencies have addressed some 

commenters’ concerns regarding the 

burdens imposed by proposed rule 

§ 75.17. 

C. Subpart D and Appendices A and B— 

Compliance Program, Reporting, and 

Violations 

Subpart D of the proposed rule 

implemented section 13(e)(1) of the 

BHC Act and required certain banking 

entities to develop and provide for the 

continued administration of a program 

reasonably designed to ensure and 

monitor compliance with the 

prohibitions and restrictions on 

activities and investments set forth in 

section 13 and the proposed rule.2521

As explained in detail below, in 

response to comments on the 

compliance program requirements and 

Appendix C (Minimum Standards for 

Programmatic Compliance) and to 

conform to modifications to other 

sections of the proposed rule, the 

Agencies are adopting a variety of 

modifications to Subpart D of the 

proposed rule, which requires certain 

banking entities to develop and provide 

for the continued administration of a 

program reasonably designed to ensure 

and monitor compliance with the 

prohibitions and restrictions on 

proprietary trading activities and 


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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 6021 

2522See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); Citigroup (Feb. 2012); Wells Fargo (Prop. 

Trading); see also Barclays; BlackRock; Chamber 

(Dec. 2011); Comm. on Capital Markets Regulation; 

Credit Suisse (Williams); FIA; Goldman (Covered 

Funds); Investure; NYSE Euronext; RBC; STANY; 

Wedbush; see also Northern Trust; Chamber (Feb. 

2012). 

2523See Citigroup (Feb. 2012). 

2524See ABA (Abernathy); IIB/EBF; ICFR. While 

the Agencies recognize these issues, the Agencies 

believe the final rule’s modifications to the 

proposal—for example, providing for simplified 

programs for smaller, less active banking entities 

and increasing the asset threshold that triggers 

enhanced compliance requirements—helps balance 

enforceability and consistency concerns with 

implementing a program that helps to ensure 

compliance consistent with section 13(e)(1) of the 

BHC Act. See 12 U.S.C. 1851(e)(1). 

2525See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); RBC; STANY; see also Barclays. 

2526See AFR (Nov. 2012); Occupy; Sens. Merkley 

& Levin (Feb. 2012) 

2527See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Wells Fargo (Prop. Trading); see also M&T Bank; 

Credit Suisse (Seidel); State Street (Feb. 2012); see 

also NYSE Euronext; Stephen Roach. 

2528See Citigroup (Feb. 2012); SIFMA et al. (Prop. 

Trading) (Feb. 2012); see also ABA (Abernathy); 

Paul Volcker. 

2529See Citigroup (Feb. 2012); see also SIFMA et 

al. (Prop. Trading) (Feb. 2012). 

2530See Citigroup (Feb. 2012). 

2531See Occupy. 

2532See, e.g., Credit Suisse (Williams); GE (Feb. 

2012); see also NAIB et al.; Chamber (Feb. 2012). 

2533See GE (Feb. 2012). Under the BHC Act, an 

entity would generally be considered an affiliate of 

a banking entity, and therefore a banking entity 

itself, if it controls, is controlled by, or is under 

common control with an insured depository 

institution. Pursuant to the BHC Act, a company 

controls another company if, for instance, the 

company directly or indirectly or acting through 

one or more other persons owns, controls, or has 

power to vote 25 per cent or more of any class of 

voting securities of the company. See 12 U.S.C. 

1841(a)(2). The compliance program requirement 

applies to all banking entities in order to ensure 

their compliance with the final rule. 

2534See Part VI.B.4.c. 

covered fund activities and investments 

set forth in section 13 of the BHC Act 

and the final rule. As described above, 

this compliance program requirement 

forms a key part of the multi-faceted 

approach to implementing section 13 of 

the BHC Act, and is intended to ensure 

that banking entities establish, maintain 

and enforce compliance procedures and 

controls to prevent violation or evasion 

of the prohibitions and restrictions on 

proprietary trading activities and 

covered fund activities and investments. 

The proposal adopted a tiered 

approach to implementing the 

compliance program mandate, requiring 

a banking entity engaged in proprietary 

trading activities or covered fund 

activities and investments to establish a 

compliance program that contained 

specific elements and, if the banking 

entity’s activities were significant, meet 

a number of more detailed minimum 

standards. If a banking entity did not 

engage in proprietary trading activities 

and covered fund activities and 

investments, it was required to ensure 

that its existing compliance policies and 

procedures included measures that were 

designed to prevent the banking entity 

from becoming engaged in such 

activities and making such investments 

and to develop and provide for the 

required program under § 75.20(a) of the 

proposed rule prior to engaging in such 

activities or making such investments, 

but was not otherwise required to meet 

the requirements of subpart D of the 

proposed rule. 

1. Section 75.20: Compliance Program 

Mandate 

a. Program Requirement 

A number of commenters argued that 

the compliance program requirements of 

the proposal were overly specific, too 

prescriptive and complex to be 

workable, and not justified by the costs 

and benefits of having a compliance 

program.2522 For instance, one 

commenter expressed concern that the 

complexity of the proposed compliance 

regime would undermine compliance 

efforts because the requirements were 

overlapping, imprecise, and did not 

provide sufficient clarity to traders or 

banking entities as to what types or 

levels of activities would be viewed as 

permissible trading.2523 Some 

commenters argued that the compliance 

program would be challenging to 

enforce or administer with any 

consistency across different banking 

entities and jurisdictions.2524 A few 

commenters objected to any attempt to 

identify every possible instance of 

prohibited proprietary trading in 

otherwise permitted activity.2525 By 

contrast, some commenters supported 

the proposed compliance program as 

effective and consistent with the statute 

but also suggested a number of ways 

that the proposal’s compliance program 

could be improved.2526

A few commenters argued that the 

proposed compliance program should 

be replaced with a more principlesbased framework that provides banking 

entities the discretion and flexibility to 

customize compliance programs tailored 

to the structure and activities of their 

organizations.2527 A few commenters 

argued that building on compliance 

regimes that already exist at banking 

entities, including risk limits, risk 

management systems, board-level 

governance protocols, and the level at 

which compliance is monitored, would 

reduce the costs and complexity of the 

proposal while also enabling a robust 

compliance mechanism for section 

13.2528

Another commenter suggested that 

the focus of the compliance program be 

on the key goal of reducing risk at 

banking entities by requiring each 

banking entity to establish a risk 

architecture that prescribes a customerfocused business model for market 

making-related activities including a 

comprehensive set of risk limits that 

focuses on servicing customers and 

ensuring safety and soundness.2529 This 

commenter suggested the proposal’s 

compliance requirements be replaced by 

a simpler compliance framework that 

could be harmonized with the broader 

systemic capital and risk management 

framework under the Basel accord. This 

commenter argued such a framework 

would increase transparency as well as 

reduce overall complexity and costs of 

regulation, and that information 

relevant to the compliance 

infrastructure, including customer 

orientation policies and procedures, 

target customer and product lists, trade 

histories, and risk limit calibration 

methodology and analyses, should all be 

made available to examiners.2530

Another commenter urged that the 

compliance program could be generally 

improved by having a greater focus on 

the compensation incentives within the 

compliance program of banking 

entities.2531

A number of other commenters 

requested certain types of banking 

entities be specifically excluded from 

having to implement the requirements 

of the compliance program. For 

example, some commenters urged that 

the details required in proposed 

Appendix C apply only to those banking 

entities and business lines within a 

banking group that have ‘‘significant’’ 

covered funds or trading activities and 

not apply to an affiliate of a banking 

entity that does not engage in the types 

of activities section 13 is designed to 

address (e.g., an industrial affiliate that 

manufactures machinery).2532 One 

commenter argued that the final rule 

should not impose a compliance 

program requirement on a banking 

entity that owns 50 percent or less of 

another banking entity in order to 

ensure the compliance program did not 

discourage joint ventures or other 

arrangements where a banking entity 

does not have actual control over an 

affiliate.2533 As discussed in Part 

VI.B.4.c. above,2534 other commenters 

argued that the reporting and 

recordkeeping and compliance 

requirements of the rule should not 

apply to permitted insurance company 

investment activities because insurance 

companies are already subject to 

comprehensive regulation of the kinds 


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6022 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

2535See, e.g., ACLI (Jan. 2012); Country Fin. et al.; 

NAMIC. 2536See Sens. Merkley & Levin (Feb. 2012). As 

noted above, the compliance program requirement 

applies to all banking entities, including insurance 

companies that are considered banking entities, in 

order to ensure their compliance with the final rule. 2537See ASF (Feb. 2012); AFME et al.; SIFMA 

(Securitization) (Feb. 2012); Commercial Real Estate 

Fin. Council. 2538See Occupy. 

2539See, e.g., Socie ́te ́ Ge ́ne ́rale; IIB/EBF; 

Australian Bankers Ass’n. (Feb. 2012); Banco de 

Me ́xico; Norinchukin; Cadwalader (on behalf of 

Thai Banks); Cadwalader (on behalf of Singapore 

Banks); Allen & Overy (on behalf of Canadian 

Banks); BAROC; Comm. on Capital Markets 

Regulation; Credit Suisse (Williams); EFAMA; Hong 

Kong Inv. Funds Ass’n.; HSBC; IIAC; IMA; Katten 

(on behalf of Int’l Clients); Ass’n. of Banks in 

Malaysia; RBC; Sumitomo Trust; see also AFME et 

al.; British Bankers’ Ass’n.; EBF; Commissioner 

Barnier; French Banking Fed’n.; UBS; Union Asset. 

2540See, e.g., AFME et al.; IIB/EBF; BaFin/

Deutsche Bundesbank; Credit Suisse (Williams); 

HSBC. 

2541See Australian Bankers Ass’n. (Feb. 2012); 

see also RBC. 

2542See IIB/EBF. 

2543See IIB/EBF. 

2544See Occupy. 

2545See Alfred Brock. 

2546See Wells Fargo (Prop. Trading); PNC et al.; 

Australian Bankers Ass’n. (Feb. 2012); SIFMA et al. 

(Prop. Trading) (Feb. 2012); ABA (Keating); AFME 

et al.; BoA; Barclays; SIFMA et al. (Covered Funds) 

(Feb. 2012); SIFMA et al. (Mar. 2012); Comm. on 

Capital Markets Regulation; Credit Suisse 

(Williams); T. Rowe Price; see also Citigroup (Feb. 

2012); Socie ́te ́ Ge ́ne ́rale; IIB/EBF; Am. Express; 

Arnold & Porter; BDA (Mar. 2012). 

2547See Wells Fargo (Prop. Trading); PNC et al.; 

Australian Bankers Ass’n. (Feb. 2012); BoA; 

Barclays; SIFMA et al. (Covered Funds) (Feb. 2012); 

SIFMA et al. (Mar. 2012); Credit Suisse (Seidel); see 

also BDA (Mar. 2012). 

2548See SIFMA et al. (Prop. Trading) (Feb. 2012); 

ABA (Keating); AFME et al.; GE; Credit Suisse 

(Williams); Goldman (Prop. Trading); Morgan 

Stanley; RBC; SVB. 

2549See Morgan Stanley. 

2550The Agencies believe these modifications, 

such as increasing the threshold that triggers 

enhanced compliance standards and allowing 

smaller banking entities to customize their 

compliance programs, help address concerns that 

the proposed requirement was too complex and 

unworkable. See, e.g., SIFMA et al. (Prop. Trading) 

(Feb. 2012); Citigroup (Feb. 2012); Wells Fargo 

(Prop. Trading). 

2551Some commenters argued that the 

requirement should build on banking entities’ 

existing compliance regimes. See Citigroup (Feb. 

2012); SIFMA et al. (Prop. Trading) (Feb. 2012); see 

also ABA (Abernathy); Paul Volcker. 

2552See final rule § 75.20(f)(2). 

2553See final rule § 75.20(f)(1). In response to a 

few commenters, the final rule, unlike § 75.20(d) of 

the proposed rule, no longer requires a banking 

entity include measures that are designed to 

prevent such entity from becoming engaged in 

covered trading activities or covered fund 

investments and activities. 

2554Under the proposal, each banking entity was 

required to have a compliance program that 

addressed the elements described in the rule, unless 

the banking entity did not engage in prohibited 

activities or investments, in which case it need only 

have existing policies and procedures requiring the 

banking entity to develop a compliance program 

and amounts of investments they can 

make under State or foreign insurance 

laws and regulations.2535 However, 

another commenter suggested that 

insurance company affiliates of banking 

entities expressly be made subject to 

data collection and reporting 

requirements to prevent possible 

evasion of the restrictions of section 13 

and the final rule using their insurance 

affiliates.2536

A few commenters argued that 

requiring securitization vehicles to 

establish even the minimal 

requirements set forth in § 75.20(d) 

would impose unnecessary costs and 

burdens on these entities.2537 By 

contrast, another commenter argued 

that, because of the perceived risks of 

these entities, securitization vehicles 

related to a banking entity should be 

required to comply fully with the 

proposed rule regardless of how such 

compliance procedures are funded by 

the banking entity.2538

Several commenters urged that 

foreign activities of foreign banking 

entities, which are already subject to 

their own prudential regulation under 

applicable home country regulation, be 

excluded from the compliance program 

and argued that to do otherwise would 

be an extraterritorial expansion of U.S. 

law.2539 These commenters contended 

that the compliance program 

requirements for foreign banking 

entities should, in any event, be 

narrowly circumscribed.2540 One 

commenter proposed that the foreign 

activity of foreign banking entities be 

excluded from compliance, reporting 

and other obligations where the risk of 

the activity is outside of the United 

States because those risks do not pose 

a threat to U.S. taxpayers.2541 Another 

commenter argued that only U.S. 

affiliates of foreign banking entities 

engaged in proprietary trading and 

covered fund activities as principal in 

the United States should be required to 

institute the compliance and reporting 

systems required in the proposal, and 

that all foreign affiliates only be 

required to have policies and 

procedures designed to prevent the 

banking entity from engaging in relevant 

trading and covered fund activities in 

the United States.2542 This commenter 

also expressed concern that the 

reporting and recordkeeping 

requirements could be interpreted to 

apply to an entire trading unit, even 

trading activities with no U.S. nexus, if 

any portion of a trading unit’s activities, 

even a single trade, would be required 

to rely on the market-making, hedging, 

underwriting or U.S. government 

security exemptions.2543

Commenters also offered thoughts on 

the timeframe within which banking 

entities must establish a compliance 

program. One commenter urged that 

reporting begin immediately,2544 while 

another commenter contended that the 

effective date provided banking entities 

with sufficient time to implement the 

proposal’s compliance program.2545

Other commenters, however, argued 

that banking entities should have 

additional time to establish compliance 

programs.2546 Some commenters argued 

banking entities should have one-year 

from the date of publication of the final 

rule to implement their compliance 

programs,2547 while others urged that 

banking entities have a two-year period 

to build compliance systems.2548 One 

commenter suggested the Board amend 

its conformance rule to provide U.S. 

banking entities with an additional year 

for implementing the compliance 

requirements with respect to their 

foreign operations.2549

After considering comments on the 

proposal, the final rule retains the 

compliance program requirement with a 

variety of modifications. In particular, 

the modifications are designed to make 

the compliance program requirements 

clearer and more tailored to the size, 

complexity and type of activity 

conducted by each banking entity.2550

The Agencies also believe that the 

revisions build on the limits, procedures 

and elements of risk management 

programs that many banking entities 

have already developed to monitor and 

control the risk of existing trading and 

investment activities.2551

The final rule builds on the proposed 

rule’s tiered approach by adjusting asset 

thresholds and by adding a new 

provision allowing a banking entity 

with modest covered activities to 

customize its compliance program. 

Specifically, the final rule allows 

banking entities with total assets below 

$10 billion to fold compliance measures 

into their existing compliance program 

in a manner that addresses the types 

and amounts of activities the entity 

conducts.2552 The proposal did not 

contain such a provision. Similar to the 

proposal, the final rule requires that a 

banking entity that conducts no activity 

subject to section 13 of the BHC Act is 

not required to develop any compliance 

program until it begins conducting 

activities subject to section 13.2553 The 

final rule further modifies the proposal 

by requiring that a banking entity with 

total assets greater than $10 billion but 

less than $50 billion is generally 

required to establish a compliance 

program suited to its activities which 

includes the six elements described in 

the final rule.2554 Additionally, the final 


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before engaging in such activities. Further, a 

banking entity that has trading assets and liabilities 

equal to or greater than $1 billion, or equal to 10% 

or more of total assets, would have been subject to 

additional standards under the proposed rule. See 

proposed rule § 75.20(a), (c), (d). 

2555Because the Agencies have determined not to 

retain proposed Appendix B in the final rule, 

proposed Appendix C is now Appendix B under the 

final rule. 

2556See, e.g., Socie ́te ́ Ge ́ne ́rale; IIB/EBF; 

Australian Bankers Ass’n. (Feb. 2012); Banco de 

Me ́xico; Norinchukin; Cadwalader (on behalf of 

Thai Banks); Cadwalader (on behalf of Singapore 

Banks); Allen & Overy (on behalf of Canadian 

Banks); BAROC; Comm. on Capital Markets 

Regulation; Credit Suisse (Williams); EFAMA; Hong 

Kong Inv. Funds Ass’n.; HSBC; IIAC; IMA; Katten 

(on behalf of Int’l Clients); Ass’n. of Banks in 

Malaysia; RBC; Sumitomo Trust; see also AFME et 

al.; British Bankers’ Ass’n.; EBF; Commissioner 

Barnier; French Banking Fed’n.; UBS; Union Asset. 

2557As discussed in Part II., the Board is 

extending the conformance period by one year. 

Extension of the conformance period will, among 

other things, provide banking entities with 

additional time to establish the required 

compliance program. The Agencies believe the 

extension of the conformance period, as well as the 

phased-in approach to implementing the enhanced 

compliance program in Appendix B, address certain 

commenters’ requests for additional time to 

establish a compliance program. See Wells Fargo 

(Prop. Trading); PNC et al.; Australian Bankers 

Ass’n. (Feb. 2012); SIFMA et al. (Prop. Trading) 

(Feb. 2012); ABA (Keating); AFME et al.; BoA; 

Barclays; SIFMA et al. (Covered Funds) (Feb. 2012); 

SIFMA et al. (Mar. 2012); Comm. on Capital 

Markets Regulation; Credit Suisse (Williams); T. 

Rowe Price; see also Citigroup (Feb. 2012); Socie ́te ́

Ge ́ne ́rale; IIB/EBF; Am. Express; Arnold & Porter; 

BDA (Mar. 2012); Morgan Stanley. 

2558Commenters provided a wide range of 

feedback regarding the timeframe for establishing a 

compliance program, from requesting that reporting 

begin immediately to requesting two years from the 

date of publication of the final rule. See, e.g., 

Occupy; Alfred Brock; Wells Fargo (Prop. Trading); 

PNC et al.; SIFMA et al. (Prop. Trading) (Feb. 2012). 

The Agencies believe that the final rule’s approach 

appropriately balances the desire for effective 

regulation with requests for additional time to 

establish a compliance program. 

2559This requirement is substantially the same as 

the proposed written policies and procedures 

requirement. See proposed rule § 75.20(b)(1). 

2560This requirement is substantially the same as 

the proposed internal controls requirement. See 

proposed rule § 75.20(b)(2). 

2561The final rule modifies the proposed 

management framework requirement by adding that 

the management framework element must include 

appropriate management review of trading limits, 

strategies, hedging activities, incentive 

compensation, and other matters. See final rule 

§ 75.20(b)(3). See also proposed rule § 75.20(b)(3). 

One commenter suggested that the compliance 

program requirement have a greater focus on 

compensation incentives. See Citigroup (Feb. 2012). 

2562The final rule modifies the proposed 

independent testing requirement by specifying that 

such testing must be done ‘‘periodically.’’ See final 

rule § 75.20(b)(4). See also proposed rule 

§ 75.20(b)(4). The meaning of ‘‘independent testing’’ 

is discussed in more detail below in Part VI.C.2.e. 

The reference to ‘‘audit’’ does not mean that the 

independent testing must be performed by a 

designated auditor, whether internal or external. 

rule requires that the largest and most 

active banking entities, with total assets 

above $50 billion, or that are subject to 

the quantitative measurements 

requirement due to the size of their 

trading assets and liabilities, adopt an 

enhanced compliance program that 

addresses the six elements described in 

the rule plus a number of more detailed 

requirements described in Appendix 

B.2555

In response to commenters’ concerns 

regarding compliance program burdens 

in connection with covered fund 

activities and investments, the final rule 

is further modified with respect to 

thresholds for covered fund activities 

and investments. As noted above, this 

and the other modifications are 

designed to make the compliance 

program requirement clearer and more 

tailored to the size, complexity and type 

of activity conducted by each banking 

entity. The final rule, unlike the 

proposal, does not require a banking 

entity to adopt the enhanced 

compliance program if the banking 

entity, together with its affiliates and 

subsidiaries, invests in the aggregate 

more than $1 billion in covered funds 

or if they sponsor or advise covered 

funds, the average total assets of which 

are equal to or greater than $1 billion. 

Banking entities would look to the total 

asset thresholds discussed above, 

instead of the amount of covered fund 

investments and activities, in 

determining whether they would be 

subject to the enhanced compliance 

program requirements. The Agencies 

have also modified the compliance 

program reporting obligations of foreign 

banking entities with respect to their 

covered trading and covered fund 

activities that are conducted pursuant to 

the exemptions contained in §§ 75.6(e) 

and 75.13(b).2556

The final rule also responds to 

commenters’ concerns regarding the 

timeframe within which a banking 

entity must establish and implement the 

compliance program required for that 

entity under § 75.20. Under the final 

rule, each banking entity must establish 

the compliance program required for 

that entity under § 75.20 as soon as 

practicable and in no case later than the 

end of the conformance period.2557 The 

Agencies expect that during this period 

a banking entity will develop and 

implement the compliance program 

requirements of the final rule as part of 

its good-faith efforts to fully conform its 

activities and investments to the 

requirements of section 13 and the final 

rule. As explained below in the 

discussion of the enhanced minimum 

standards for compliance programs 

under Appendix B, the final rule also 

requires larger and more active banking 

entities to report certain data regarding 

their trading activities. These 

requirements have been phased-in to 

provide banking entities an opportunity 

to develop the necessary systems to 

capture and report the relevant data.2558

In addition, as explained below, the 

Agencies will consider, after a period to 

gain experience with the data, revisiting 

these data collections to determine their 

usefulness in monitoring the risk and 

types of activities conducted by banking 

entities. 

b. Compliance Program Elements 

Section 75.20 of the final rule 

specifies six elements that each 

compliance program required under that 

section must at a minimum contain. 

With some minor modifications, these 

are the same six elements that were 

included in the proposed rule. The 

changes reflect modifications made in 

requirements and limits in the other 

provisions of the rule and, in particular, 

acknowledge the importance of trading 

and hedging limits, appropriate setting, 

monitoring and management review of 

trading and hedging limits, strategies, 

and activities and investments, 

incentive compensation and other 

matters. 

The six elements specified in 

§ 75.20(b) are: 

• Written policies and procedures 

reasonably designed to document, 

describe, monitor and limit trading 

activities and covered fund activities 

and investments conducted by the 

banking entity to ensure that all 

activities and investments that are 

subject to section 13 of the BHC Act and 

the rule comply with section 13 of the 

BHC Act and the rule; 2559

• A system of internal controls 

reasonably designed to monitor 

compliance with section 13 of the BHC 

Act and the rule and to prevent the 

occurrence of activities or investments 

that are prohibited by section 13 of the 

BHC Act and the rule; 2560

• A management framework that 

clearly delineates responsibility and 

accountability for compliance with 

section 13 of the BHC Act and the rule 

and includes appropriate management 

review of trading limits, strategies, 

hedging activities, investments, 

incentive compensation and other 

matters identified in the rule or by 

management as requiring attention; 2561

• Independent testing and audit of 

the effectiveness of the compliance 

program conducted periodically by 

qualified personnel of the banking 

entity or by a qualified outside 

party; 2562

• Training for trading personnel and 

managers, as well as other appropriate 

personnel, to effectively implement and 


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2563The final rule retains the proposed training 

requirement. See final rule § 75.20(b)(5). See also 

proposed rule § 75.20(b)(5). 

2564One of these commenters suggested the 

Agencies adopt a simpler compliance framework 

that could be harmonized with the Basel accord. 

See Citigroup (Feb. 2012). The Agencies believe the 

final framework described above helps address 

concerns about streamlining the compliance 

program requirement while meeting the statutory 

requirement to issue regulations ‘‘in order to insure 

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

2565One commenter stated that the proposed rule 

did not provide sufficient clarity as to what types 

or levels of activities would be permissible. See 

Citigroup (Feb. 2012). 

2566Some commenters requested a more 

principles-based framework that allows banking 

entities to customize compliance programs to the 

structure and activities of their organizations. See 

SIFMA et al. (Prop. Trading) (Feb. 2012); Wells 

Fargo (Prop. Trading); see also M&T Bank; Credit 

Suisse (Seidel); State Street (Feb. 2012); NYSE 

Euronext; Stephen Roach. 

2567See final rule § 75.20(e)(1). As discussed 

under § 75.10 regarding entities excluded from the 

definition of covered fund, the Agencies recognize 

that the final rule’s definition of covered fund does 

not include certain pooled investment vehicles. The 

Agencies expect that the types of pooled investment 

vehicles sponsored by the financial services 

industry will continue to evolve, including in 

response to the final rule, and the Agencies will be 

monitoring this evolution to determine whether 

excluding these and other types of entities remains 

appropriate. The Agencies will also monitor use of 

the exclusions for attempts to evade the 

requirements of section 13 and intend to use their 

authority where appropriate to prevent evasions of 

the rule. The Agencies are adopting this additional 

documentation requirement to facilitate such 

monitoring activities. 

2568See final rule § 75.20(e)(2). The Agencies are 

adopting this additional documentation 

requirement for the same reasons discussed above 

with respect to § 75.20(e)(1). 

2569See final rule § 75.20(e)(3). The rationale for 

this additional documentation requirement is 

provided under the discussion regarding registered 

investment companies and business development 

companies in § 75.10. 

2570See final rule § 75.20(e)(4). The rationale for 

this additional documentation requirement is 

provided under the discussion regarding foreign 

public funds in § 75.10. For purposes of this 

requirement, a U.S. branch, agency, or subsidiary of 

a foreign banking entity is located in the United 

States; however, the foreign bank that operates or 

controls that branch, agency, or subsidiary is not 

considered to be located in the United States solely 

by virtue of operating or controlling the U.S. 

branch, agency, or subsidiary. See final rule 

§ 75.20(e)(5). 

enforce the compliance program; 2563

and 

• Making and keeping records 

sufficient to demonstrate compliance 

with section 13 of the BHC Act and the 

rule, which a banking entity must 

promptly provide to the relevant 

supervisory Agency upon request and 

retain for a period of no less than 5 

years. 

Under the final rule, these six 

elements must be part of the compliance 

program of each banking entity with 

total consolidated assets greater than 

$10 billion that engages in activities 

covered by section 13 of the BHC Act. 

As discussed above, the Agencies 

have moved particular elements with 

respect to the required compliance 

program for the exemptions contained 

in § 75.4(a), § 75.4(b), and § 75.5 into the 

specific requirements of these 

exemptions. The Agencies believe this 

structure more effectively conveys that 

satisfying the requirements of these 

exemptions involves specific 

compliance measures or, with respect to 

underwriting and market making, a 

customer-focused business model, as 

requested by some commenters.2564

In addition to the generally required 

compliance program elements specified 

in § 75.20(b), a banking entity relying on 

any of these exemptions should employ 

the specific compliance tools specified 

within the relevant section of this rule 

to facilitate compliance with the 

applicable exemption and should 

appropriately tailor the required 

compliance program elements to the 

individual trading activities and 

strategies of each trading desk on an 

ongoing basis. By specifying particular 

compliance program-related 

requirements in the exemptions, the 

Agencies have sought to provide 

additional guidance and clarity as to 

how a compliance program should be 

structured,2565 while at the same time 

providing the banking entity with 

sufficient discretion to consider the 

type, size, scope and complexity of its 

activities and business structure in 

designing a compliance program to meet 

the requirements set forth in 

§ 75.20(b).2566

For a banking entity with more than 

$10 billion in total consolidated assets, 

the compliance program requires 

additional documentation with respect 

to funds. For example, the banking 

entity is required to maintain records 

that include documentation of 

exclusions or exemptions other than 

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

Investment Company Act of 1940 relied 

on by each fund sponsored by the 

banking entity (including all 

subsidiaries and affiliate) in 

determining that such fund is not a 

covered fund.2567 The banking entity is 

also required to maintain, with respect 

to each fund sponsored by the banking 

entity (including all subsidiaries and 

affiliates) for which the banking entity 

relies on one or more of the exclusions 

provided by §§ 75.10(c)(1), 75.10(c)(5), 

75.10(c)(8), 75.10(c)(9), or 75.10(c)(10) 

of subpart C, documentation supporting 

the banking entity’s determination that 

the fund is not a covered fund pursuant 

to one or more of those exclusions.2568

If the banking entity operates a seeding 

vehicle described in §§ 75.10(c)(12)(i) or 

75.10(c)(12)(iii) of subpart C that will 

become a registered investment 

company or SEC-regulated business 

development company, the compliance 

program must also include a written 

plan documenting the banking entity’s 

determination that the seeding vehicle 

will become a registered investment 

company or SEC-regulated business 

development company; the period of 

time during which the vehicle will 

operate as a seeding vehicle; and the 

banking entity’s plan to market the 

vehicle to third-party investors and 

convert it into a registered investment 

company or SEC-regulated business 

development company within the time 

period specified in § 75.12(a)(2)(i)(B) of 

subpart C.2569 Furthermore, for any 

banking entity that is, or is controlled 

directly or indirectly by a banking entity 

that is, located in or organized under the 

laws of the United States or of any State, 

if the aggregate amount of ownership 

interest in foreign public funds as 

described in § 75.10(c)(1) of subpart C 

owned by such banking entity 

(including ownership interests owned 

by any affiliate that is controlled 

directly or indirectly by a banking entity 

that is located in or organized under the 

laws of the United States or of any State) 

exceeds $50 million at the end of two 

or more consecutive calendar quarters, 

beginning with the next succeeding 

calendar quarter, such banking entity 

must include in its compliance program 

documentation the value of the 

ownership interests owned by the 

banking entity (and such affiliates) in 

each foreign public fund and each 

jurisdiction in which any such foreign 

public fund is organized. Such 

calculation must be done at the end of 

each calendar quarter and must 

continue until the banking entity’s 

aggregate amount of ownership interests 

in foreign public funds is below $50 

million for two consecutive calendar 

quarters.2570

c. Simplified Programs for Less Active 

Banking Entities 

The proposed rule provided that the 

six elements of the compliance program 

required by § 75.20 would apply to all 

banking entities engaged in covered 

trading activities or covered fund 

activities and investments and that the 

minimum detailed standards of 

Appendix C would apply to only those 

banking entities above specified 

thresholds. The application of detailed 

minimum standards was intended to 

reflect the heightened compliance risks 

of significant covered trading and 


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2571See, e.g., ICBA; ABA (Keating); Conf. of State 

Bank Supervisors; NAIB; Ryan Kamphuis; 

Wisconsin Bankers Ass’n. 

2572See, e.g., ICBA; ABA (Keating). 

2573See Sens. Merkley & Levin (Feb. 2012); Conf. 

of State Bank Supervisors; Ryan Kamphuis; SVB. 

2574See Sens. Merkley & Levin (Feb. 2012). 

2575See ICBA. 

2576Some commenters asked the Agencies to 

consider the burden of the compliance program 

requirement on smaller institutions and 

recommended that small banks be given the benefit 

of the doubt regarding compliance. See Sens. 

Merkley & Levin (Feb. 2012); Conf. of State Bank 

Supervisors; Ryan Kamphuis; SVB. The Agencies 

decline to follow the approach suggested by another 

commenter to allow banking entities with assets of 

$10 billion or less be permitted to engage in certain 

limited activities without having to establish a 

compliance program. See ICBA. The Agencies 

believe that requiring a banking entity engaged in 

covered trading or covered fund activity to establish 

a compliance program is a fundamental part of the 

multi-faceted approach to implementing section 13 

of the BHC Act, which requires the Agencies to 

implement rules ‘‘to insure compliance with this 

section.’’ 12 U.S.C. 1851(e)(1). Further, the Agencies 

believe that the final rule’s modification of the 

proposal to allow banking entities with total assets 

under $10 billion to customize their compliance 

programs helps ease the burden of this requirement 

on smaller institutions. 

2577See, e.g., Sens. Merkley & Levin (Feb. 2012); 

PNC et al. 

2578See ABA (Keating); M&T Bank; PNC et al. 

2579See PNC et al.; M&T Bank; see also ABA 

(Abernathy). 

significant covered fund activities and 

investments. 

The proposed rule provided that a 

banking entity with no covered 

activities or investments could satisfy 

the requirements of § 75.20 if its existing 

compliance policies and procedures 

were amended to include measures that 

were designed to prevent the banking 

entity from becoming engaged in such 

activities or making such investments 

and required the banking entity to 

develop and provide for the required 

compliance program prior to engaging 

in covered activities or making covered 

investments. 

Several commenters expressed 

concern over the requirement in 

§ 75.20(d) of the proposed rule that a 

banking entity that did not engage in 

any covered trading activities or covered 

fund activities or investments must 

ensure that its existing compliance 

policies and procedures include 

measures designed to prevent the 

banking entity from becoming engaged 

in such activities and making such 

investments.2571 In particular, some 

commenters expressed concern that the 

proposal would have a burdensome 

impact on community banks and force 

community banks to hire specialists to 

amend their policies and procedures to 

ensure compliance with section 13 and 

the final regulations. These commenters 

argued that a banking entity should not 

be required to amend its compliance 

policies and procedures and set up a 

monitoring program if the banking 

entity does not engage in prohibited 

activities.2572

A few commenters argued that the 

Agencies should more carefully 

consider the burden of the compliance 

program on smaller institutions that 

engage in a modest level of permissible 

trading or covered fund activity.2573

One commenter recommended that 

smaller banks be given the benefit of the 

doubt regarding compliance.2574 For 

instance, one commenter recommended 

that banking entities with consolidated 

assets of $10 billion or less be permitted 

to engage in a limited amount of interest 

rate swaps and certain other traditional 

banking activities without being 

required to establish a compliance 

program.2575

The Agencies have considered 

carefully the comments received and, as 

noted above, have modified the rule in 

order to limit the implementation, 

operational or other burdens or 

expenses associated with the 

compliance requirements for a banking 

entity that engages in no covered 

activities or investments. The final rule 

permits banking entities that have no 

covered activities or investments (other 

than covered transactions in obligations 

of or guaranteed by the United States or 

an agency of the United States and 

municipal securities) to satisfy the 

compliance program requirements by 

establishing the required compliance 

program prior to becoming engaged in 

such activities or making such 

investments. This eliminates the burden 

on banking entities that do not engage 

in covered activities or investments. 

Similarly, § 75.20(f)(2) of the final rule 

provides that a banking entity with total 

consolidated assets of $10 billion or less 

as measured on December 31 of the 

previous two years that does engage in 

covered activities and investments may 

satisfy the requirements of § 75.20 by 

including in its existing compliance 

policies and procedures references to 

the requirements of section 13 and 

subpart D as appropriate given the 

activities, size, scope and complexity of 

the banking entity.2576 This could 

include appropriate references to the 

limits on trading activities permitted in 

reliance upon any of the exemptions 

contained in § 75.4(a), § 75.4(b) or 

§ 75.5. 

d. Threshold for Application of 

Enhanced Minimum Standards 

Under the proposed rule, banking 

entities with significant covered trading 

activities or covered fund activities and 

investments were required to establish 

an enhanced compliance program in 

accordance with Appendix C, which 

contained detailed compliance program 

requirements. The proposed rule 

required a banking entity to implement 

the enhanced compliance program 

under Appendix C if the banking entity 

engaged in covered activities and 

investments and either: (i) Has, on a 

consolidated basis, trading assets and 

liabilities the average gross sum of 

which (on a worldwide consolidated 

basis), as measured as of the last day of 

each of the four prior calendar quarters, 

is equal to or greater than $1 billion or 

equals 10 percent or more of its total 

assets; or (ii) has, on a consolidated 

basis, aggregate investments in covered 

funds the average value of which (on a 

worldwide consolidated basis), as 

measured as of the last day of each of 

the four prior calendar quarters, is equal 

to or greater than $1 billion, or sponsors 

and advises one or more covered funds 

the total assets of which are, as 

measured as of the last day of each of 

the four prior calendar quarters, equal to 

or greater than $1 billion. 

In general, commenters argued that 

the activities and investments subject to 

section 13 are conducted by only a 

small number of the nation’s largest 

financial firms and that the compliance 

program requirements should be 

tailored to target these firms.2577 Some 

commenters urged the Agencies to raise 

substantially the proposed $1 billion 

threshold for trading assets and 

liabilities in § 75.20(c)(2) of the proposal 

to $10 billion or higher due to the high 

costs of implementing the enhanced 

compliance program. A few commenters 

argued that even if the threshold were 

raised to $10 billion, an overwhelming 

percentage of trading assets and 

liabilities in the banking industry 

(approximately 98 percent) would still 

remain subject to heightened 

compliance requirements included in 

Appendix C.2578 Some of these 

commenters recommended the 

threshold for trading assets for 

compliance should be increased to no 

less than $10 billion to mitigate the 

costs and impact on regional banking 

organizations that do not engage 

proprietary trading subject to the 

prohibition of section 13. These 

commenters argued that the compliance 

requirements of § 75.20(a)–(b) are 

sufficient to ensure that regional 

banking organizations have appropriate 

compliance programs.2579 One 

commenter suggested the threshold for 

the enhanced compliance requirement 

be increased to $50 billion in combined 


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2580See State Street (Feb. 2012). 

2581See ABA (Keating). 

2582See PNC et al. 

2583See PNC et al. 

2584See Northern Trust. 

2585See Occupy. 

2586See ABA (Keating); PNC et al. 

2587See PNC et al. 

2588See ASF (Feb. 2012). 

2589See PNC et al.; SIFMA et al. (Covered Funds) 

(Feb. 2012). 

2590See proposed rule § 75.20(c)(2)(iii); final rule 

§ 75.20(c)(3). 

2591 Issues related to the threshold for reporting 

quantitative measurements are discussed in detail 

in Part VI.C.3., below. 

trading assets and liabilities.2580 One 

commenter also argued that banking 

entities required to establish enhanced 

compliance programs should no longer 

be required to do so if they fall below 

the threshold.2581

Commenters also offered a number of 

suggestions for modifying the activity 

that would be considered in meeting the 

thresholds for determining which 

compliance program requirements apply 

to a banking entity. Several commenters 

argued that certain types of trading 

assets or fund investments should not 

be included for purposes of determining 

whether the relevant dollar threshold 

triggering the enhanced compliance was 

met, particularly those that are not 

prohibited activities or investments. For 

instance, some commenters urged that 

trading in U.S. government obligations 

should not count toward the calculation 

of whether a banking organization meets 

the trading threshold triggering 

Appendix C.2582 These commenters also 

argued that other positions or 

transactions that do not involve 

financial instruments and that may 

constitute trading assets and liabilities, 

such as loans, should be excluded from 

the thresholds because exempt activities 

should not determine the type of 

compliance program a banking entity 

must implement.2583 One commenter 

urged that foreign exchange swaps and 

forwards be excluded from the 

definition of a ‘‘derivative’’ and not be 

subject to compliance requirements as a 

result.2584 Conversely, one commenter 

urged that all assets and liabilities 

defined as trading assets for purposes of 

the Market Risk Capital Rule should be 

included in the $1 billion standard for 

becoming subject to any reporting and 

recordkeeping requirements under the 

final rule.2585

A few commenters argued that the $1 

billion threshold for establishing an 

enhanced compliance program should 

not include the amount of investments 

in, or assets of, funds that are SBICs or 

similar funds that contain, SBICs or 

other investments specified under 

section 13(d)(1)(E) of the BHC Act, such 

as investments in and funds that qualify 

for low-income housing tax credits, or 

New Markets Tax Credits or that qualify 

for Federal historic tax credits or similar 

state programs.2586 These commenters 

argued that each of these types of funds 

is expressly permitted by the statute and 

that including these investments and 

funds in the dollar thresholds that 

trigger the programmatic compliance 

requirements of Appendix C would 

provide a disincentive to banking 

entities investing in or sponsoring these 

funds, a result inconsistent with 

permitting these types of investments. 

Similarly, one commenter urged that 

investments by a banking entity in, and 

assets held by, loan securitizations not 

be included in these thresholds because 

these activities and investments are 

expressly excluded from coverage under 

the rule of construction contained in 

section 13(g)(2) of the BHC Act 

regarding the securitization of loans.2587

Another commenter urged that this 

threshold not include investments in, or 

assets of, any securitization vehicle that 

would be considered a covered fund 

because many smaller and regional 

banking entities that were not intended 

to be subject to Appendix C likely 

would exceed the $1 billion threshold if 

these assets are included.2588 A few 

commenters also argued that, during the 

conformance period, investments in, 

and relationships with, a covered fund 

that a banking entity is required to 

terminate or otherwise divest in order to 

comply with section 13 should not be 

included for purposes of calculating the 

compliance thresholds.2589

After considering comments received 

on the proposal and in order to 

implement a compliance program 

requirement that is consistent with the 

purpose and language of the statute and 

rule while at the same time 

appropriately calibrating the associated 

resource burden on banking entities, the 

final rule applies the enhanced 

minimum standards contained in 

Appendix B to only those banking 

entities with the most significant 

covered trading activities or those that 

meet a specified threshold of total 

consolidated assets. The final rule, 

unlike the proposal, does not require a 

banking entity to adopt the enhanced 

compliance program if the banking 

entity, together with its affiliates and 

subsidiaries, invest in the aggregate 

more than $1 billion in covered funds 

or if they sponsor or advise covered 

funds, the average total assets of which 

are equal to or greater than $1 billion. 

Banking entities would look to the total 

consolidated asset thresholds, instead of 

the amount of covered fund investments 

and activities, in determining whether 

they would be subject to the enhanced 

compliance program requirements. The 

Agencies believe that commenters’ 

concerns about whether certain types of 

covered fund investments or activities 

(e.g., amounts or relationships held 

during the conformance period) are 

included for purposes of calculating the 

enhanced compliance thresholds are 

addressed because under the final rule, 

the enhanced compliance thresholds are 

based on total consolidated assets and 

not the amount of covered fund 

investments and activities. Similar to 

the proposed rule, which provided that 

a banking entity could be subject to the 

enhanced compliance program if the 

Agency deemed it appropriate, the final 

rule’s enhanced compliance program 

also could apply if the Agency notifies 

the banking entity in writing that it 

must satisfy the requirements.2590

Section 75.20 provides that three 

categories of banking entities will be 

subject to the enhanced minimum 

standards contained in Appendix B. The 

first category is any banking entity that 

engages in proprietary trading and is 

required to report metrics regarding its 

trading activities to its primary Federal 

supervisory agency under the final 

rule.2591 This category includes a 

banking entity that has, together with its 

affiliates and subsidiaries, trading assets 

and liabilities that equal or exceed $50 

billion based on the average gross sum 

of trading assets and liabilities (on a 

worldwide consolidated basis and after 

excluding trading assets and liabilities 

involving obligations of or guaranteed 

by the United States or any agency of 

the United States) over the previous 

consecutive four quarters, as measured 

as of the last day of each of the four 

prior calendar quarters. A foreign 

banking entity with U.S. operations is 

required to adopt an enhanced 

compliance program if its total trading 

assets and liabilities across all its U.S. 

operations equal or exceed $50 billion 

(after excluding trading assets and 

liabilities involving obligations of or 

guaranteed by the U.S. or any agency of 

the U.S.). While these banking entities 

will be required to begin to report and 

record quantitative measurements by 

June 30, 2014, they will not be required 

to implement an enhanced compliance 

program by this date. Instead, as 

discussed above, a banking entity must 

establish a compliance program as soon 

as practicable and in no event later than 

the end of the conformance period. As 

explained more fully in Part VI.C.3., this 

category expands over time to include 


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2592Some commenters requested raising this 

dollar threshold to at least $10 billion. See PNC et 

al.; PNC; ABA (Keating). One commenter suggested 

the threshold be increased to $50 billion. See State 

Street (Feb. 2012). 

2593See PNC et al.; M&T Bank; see also ABA 

(Abernathy); ABA (Keating). The Agencies 

recognize that, at the $10 billion threshold, a 

significant percentage of the trading assets and 

liabilities in the banking industry will remain 

subject to the enhanced compliance program 

requirement. See PNC. 

2594See PNC et al. 

2595See, e.g., ABA (Keating) (suggesting the 

threshold should not include the amount of 

investments in or assets of SBICs, or those that 

qualify for low-income housing tax credits (LIHTC) 

New Markets Tax Credits (NMTC), or Federal 

historic tax credits (HTC)); PNC et al. (loans); 

Northern Trust. 

2596Several commenters requested that foreign 

activities of foreign banking entities be excluded 

from the compliance program requirement. See, 

e.g., Socie ́te ́ Ge ́ne ́rale; IIB/EBF; Australian Bankers 

Ass’n. (Feb. 2012); Banco de Mexico; Norinchukin. 

One commenter stated the only U.S. affiliates of 

foreign banking entities should be required to 

institute the proposed reporting and compliance 

requirements. See IIB/EBF. 

2597See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012). 

2598This is generally consistent with the 

proposed rule’s compliance program requirement. 

See proposed rule § 75.20(a) (requiring that the 

banking entity’s compliance program be appropriate 

for the size, scope and complexity of activities and 

business structure of the banking entity). 

any banking entity with trading assets 

and liabilities that equal or exceed $10 

billion (as measured in the manner 

described above). For banking entities 

below the $50 billion threshold that 

become subject to the quantitative 

measurements requirement through the 

phased-in approach, they will not 

become subject to the enhanced 

compliance program until the date they 

are required to comply with the 

quantitative measurements requirement. 

However, these banking entities will be 

required to have a compliance program 

that meets the requirements of § 75.20(b) 

by the end of the conformance period. 

Thus, banking entities with between $25 

billion and $50 billion trading assets 

and liabilities (as described in 

§ 75.20(d)) will be required to 

implement an enhanced compliance 

program under Appendix B by April 30, 

2016. Similarly, banking entities with 

between $10 billion and $25 billion 

trading assets and liabilities will be 

subject to the requirements of Appendix 

B by December 31, 2016. 

After considering comments, the 

Agencies have increased the trading 

asset and liability thresholds triggering 

the enhanced compliance program 

requirements. The Agencies believe that 

banking entities with a significant 

amount of trading assets should have 

the most detailed programs for ensuring 

compliance with the trading and other 

requirements of section 13 of the BHC 

Act and the final rule. Specifically, 

consistent with the thresholds for 

reporting and recording quantitative 

measurements, the threshold will 

initially be $50 billion trading assets 

and liabilities and, over time, will be 

reduced to $10 billion.2592 As noted by 

commenters, these thresholds will 

continue to capture a significant 

percentage of the total trading assets and 

liabilities in the banking system, but 

will reduce the burdens to smaller, less 

complex banking entities.2593 With 

respect to this first category, the 

Agencies determined, in response to 

comments,2594 that the threshold for 

proprietary trading should not include 

trading assets and liabilities involving 

obligations of or guaranteed by the 

United States or any agency of the 

United States. This approach reduces 

the burdens associated with the 

enhanced minimum compliance 

program on banking entities whose 

trading operations consist primarily of 

trading U.S. government or agency 

obligations, which are generally exempt 

from the proprietary trading prohibition 

under § 75.6(a)(1)(i). While some 

commenters argued that additional 

assets or liabilities, such as 

securitizations or investments in SBICs, 

should be excluded from the 

calculation,2595 the Agencies believe 

that trading in other assets involves 

more complex trading activity and 

warrants being included in the 

threshold calculation for applying the 

enhanced compliance program 

requirement. 

To balance the increased trading asset 

and liability threshold with the goal of 

requiring appropriate specificity and 

rigor for large and complex banking 

organizations’ compliance programs, the 

Agencies have determined to also 

require an enhanced compliance 

program for any banking entity that has 

reported total consolidated assets, as of 

the previous calendar year-end, of $50 

billion or more. Banking entities with 

total assets of $50 billion or more are 

among the most complex banking 

entities and have been found by 

Congress to pose sufficient risk to the 

financial stability of the United States to 

warrant being generally subject to 

enhanced prudential standards under 

section 165 of the Dodd-Frank Act. With 

respect to foreign banking entities, this 

threshold is calculated by reference 

solely to the aggregate assets of the 

foreign banking entity’s U.S. operations, 

including its U.S. branches and 

agencies. This approach is consistent 

with the statute’s focus on the risks 

posed by covered trading activities and 

investments within the United States 

and also responds to commenters’ 

concerns regarding the level of burden 

placed on foreign banking entities with 

respect to their foreign operations.2596

The third category includes any 

banking entity that is notified by its 

primary Federal supervisory Agency in 

writing that it must satisfy the 

requirements and other standards 

contained in Appendix B. By retaining 

the flexibility to impose enhanced 

compliance requirements on a given 

banking entity upon specific notice to 

the firm, the Agencies have the ability 

to apply additional standards to any 

banking entity with a mix, level, 

complexity or risk of activities that, in 

the judgment of the relevant supervisory 

Agency, indicates that the firm should 

appropriately have in place an 

enhanced compliance program. 

Some commenters argued that the 

final rule should not require a banking 

entity to establish the type of detailed 

compliance regime dictated by 

Appendix C for both trading and 

covered fund activities and investments 

simply because the banking entity 

engages in one but not the other 

activity.2597

To comply with the applicable 

compliance program requirements 

under § 75.20 and Appendix B of the 

final rule, banking entities should 

appropriately take into account the type, 

size, scope and complexity of their 

activities and business structure in 

determining the terms, scope and detail 

of the compliance program to be 

instituted.2598 For example, if all of a 

banking entity’s activities subject to the 

rule involve covered fund activities or 

investments, it would be expected that 

the banking entity would have an 

appropriate compliance program 

governing those activities (including an 

enhanced compliance program if 

applicable) and it would not be 

expected that the banking entity would 

construct the same detailed compliance 

program under the proprietary trading 

provision of the rule. Similarly, if a 

banking entity engages only in activities 

that are subject to the proprietary 

trading provisions of the rule and does 

not engage in any covered fund 

activities or investments, it would not 

be expected that the banking entity 

would implement the same detailed 

compliance program under the covered 

funds section as would be required for 

its proprietary trading activities. In each 

of these situations, the banking entity 

would be expected to put in place 

sufficient controls to ensure that an 

appropriate compliance program is 

established before the banking entity 

commences a new covered activity. The 


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2599See Joint Proposal, 76 FR at 68963. 

Agencies believe that this treatment is 

consistent with the statutory language 

regarding internal controls and 

recordkeeping to ensure compliance 

with section 13 and also reduces 

unnecessary costs and burdens 

associated with requiring banking 

entities to implement compliance 

requirements that are not appropriate to 

the size, scope and risk of their relevant 

activities. 

2. Appendix B: Enhanced Minimum 

Standards for Compliance Programs 

The proposed rule contained an 

appendix (Appendix C) which specified 

a variety of minimum standards 

applicable to the compliance program of 

a banking entity with significant 

covered trading activities or covered 

fund activities and investments. The 

Agencies proposed to include these 

minimum standards as part of the 

regulation itself, rather than as 

accompanying guidance, reflecting the 

compliance program’s importance 

within the general implementation 

framework for the rule. 

As explained above, the Agencies 

continue to believe that the inclusion of 

specified minimum standards for the 

compliance program within the 

regulation itself rather than as 

accompanying guidance serves to 

reinforce the importance of the 

compliance program in the 

implementation framework for section 

13 of the BHC Act. As explained above, 

the Agencies believe that large banking 

entities and banking entities engaged in 

significant trading activities should 

establish, maintain and enforce an 

enhanced compliance program. The 

requirements for an enhanced 

compliance program have been 

consolidated in Appendix B of the final 

rule. 

Similar to the proposed rule, section 

I of Appendix B provides that the 

enhanced compliance program must: 

• Be reasonably designed to identify, 

document, monitor and report the 

covered trading and covered fund 

activities and investments of the 

banking entity; identify, monitor and 

promptly address the risks of these 

covered activities and investments and 

potential areas of noncompliance; and 

prevent activities or investments 

prohibited by, or that do not comply 

with, section 13 of the BHC Act and the 

rule; 

• Establish and enforce appropriate 

limits on the covered activities and 

investments of the banking entity, 

including limits on the size, scope, 

complexity, and risks of the individual 

activities or investments consistent with 

the requirements of section 13 of the 

BHC Act and the rule; 

• Subject the effectiveness of the 

compliance program to periodic 

independent review and testing, and 

ensure that the entity’s internal audit, 

corporate compliance and internal 

control functions involved in review 

and testing are effective and 

independent; 

• Make senior management, and 

others as appropriate, accountable for 

the effective implementation of the 

compliance program, and ensure that 

the board of directors and CEO (or 

equivalent) of the banking entity review 

the effectiveness of the compliance 

program; and 

• Facilitate supervision and 

examination by the Agencies of the 

banking entity’s covered trading and 

covered fund activities and investments. 

The proposed rule included several 

definitions within the appendix. In the 

final rule, all definitions have been 

moved to other sections of the rule or 

into Appendix A (governing metrics). 

Any banking entity subject to the 

enhanced minimum standards 

contained in Appendix B may 

incorporate existing policies, 

procedures and internal controls into 

the compliance program required by 

Appendix B to the extent that such 

existing policies, procedures and 

internal controls assist in satisfying the 

requirements of Appendix B. 

Section II of Appendix B contains two 

parts: One that sets forth the enhanced 

minimum compliance program 

standards applicable to covered trading 

activities of a banking entity and one 

that sets forth the corresponding 

enhanced minimum compliance 

program standards with respect to 

covered fund activities and investments. 

As noted above, if all of a banking 

entity’s activities subject to the final 

rule involve only covered trading 

activities (or only covered fund 

activities and investments), it would be 

expected that the banking entity would 

have an appropriate compliance 

program governing those activities 

(including an enhanced compliance 

program if applicable) and it would not 

be expected that the banking entity 

would construct the same detailed 

compliance program under the covered 

funds (or proprietary trading) provisions 

of the rule. As discussed below, the 

Agencies have determined not to 

include the provisions regarding 

enterprise-wide compliance programs. 

a. Proprietary Trading Activities 

Like the proposed compliance 

appendix, section II.a of Appendix B 

requires a banking entity subject to the 

enhanced minimum standards 

contained in Appendix B to establish, 

maintain and enforce a compliance 

program that includes written policies 

and procedures that are appropriate for 

the types, size, and complexity of, and 

risks associated with, its permitted 

trading activities.2599 This portion of 

Appendix B requires a banking entity to 

devote adequate resources and use 

knowledgeable personnel in conducting, 

supervising and managing its covered 

trading activities, and to promote 

consistency, independence and rigor in 

implementing its risk controls and 

compliance efforts. The compliance 

program must be updated with a 

frequency sufficient to account for 

changes in the activities of the banking 

entity, results of independent testing of 

the program, identification of 

weaknesses in the program and changes 

in legal, regulatory or other 

requirements. 

Similar to the proposed rule, section 

II.a of Appendix B requires a banking 

entity subject to the Appendix to: (i) 

Have written policies and procedures 

governing each trading desk that 

include a description of certain 

information specific to each trading 

desk that will delineate its processes, 

mission and strategy, risks, limits, types 

of clients, customers and counterparties 

and its compensation arrangements; (ii) 

include a comprehensive description of 

the risk management program for the 

trading activity of the banking entity, as 

well as a description of the governance, 

approval, reporting, escalation, review 

and other processes that the banking 

entity will use to reasonably ensure that 

trading activity is conducted in 

compliance with section 13 of the BHC 

Act and subpart B; (iii) implement and 

enforce limits and internal controls for 

each trading desk that are reasonably 

designed to ensure that trading activity 

is conducted in conformance with 

section 13 of the BHC Act and subpart 

B and with the banking entity’s policies 

and procedures, and establish and 

enforce risk limits appropriate for the 

activity of each trading desk; and (iv) for 

any hedging activities that are 

conducted in reliance on the exemption 

contained in § 75.5, establish, maintain 

and enforce policies and procedures 

regarding the use of risk-mitigating 

hedging instruments and strategies that 

describe the positions, techniques and 

strategies that each trading desk may 

use, the manner in which the banking 

entity will determine that the risks 

generated by each trading desk have 

been properly and effectively hedged, 

the level of the organization at which 


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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 6029 

2600This is consistent with proposed Appendix C, 

except that the term ‘‘trading unit’’ from the 

proposal has been replaced with the term ‘‘trading 

desk.’’ See Joint Proposal, 76 FR at 68965. 2601See Joint Proposal, 76 FR at 68965. 

2602See AFME et al.; IIB/EBF; BaFin/Deutsche 

Bundesbank; Credit Suisse (Seidel); HSBC. 

hedging activity and management will 

occur, the management in which such 

hedging strategies will be monitored 

and the personnel responsible for such 

monitoring, the risk management 

processes used to control unhedged or 

residual risks, and a description of the 

process for developing, documenting, 

testing, approving and reviewing all 

hedging positions, techniques and 

strategies permitted for each trading 

desk and for the banking entity in 

reliance on § 75.5. 

To the extent that any of the standards 

contained in Appendix B may be 

appropriately met by policies and 

procedures, internal controls and other 

requirements that are common to more 

than one trading desk, a banking entity 

may satisfy the requirements for the 

enhanced minimum standards of the 

compliance program by implementing 

such common requirements with 

respect to any such desks as to which 

they are appropriately applicable.2600

To the extent the required elements of 

the compliance program apply 

differently to different trading desks that 

conduct trading in the same financial 

instruments, a banking entity must 

document the differences and adopt 

policies and procedures and implement 

internal controls specific to each of the 

different trading desks. Overall, the 

policies and procedures should provide 

the Agencies with a clear, 

comprehensive picture of a banking 

entity’s covered trading activities that 

can be effectively reviewed. 

Appendix B also requires that the 

banking entity perform robust analysis 

and quantitative measurement of its 

covered trading activities that is 

reasonably designed to ensure that the 

trading activity of each trading desk is 

consistent with the banking entity’s 

compliance program; monitor and assist 

in the identification of potential and 

actual prohibited proprietary trading 

activity; and prevent the occurrence of 

prohibited proprietary trading. In 

particular, the banking entity must 

incorporate into its compliance program 

any quantitative measure reported by 

the banking entity pursuant to 

Appendix A where applicable, and 

include at a minimum: (i) Internal 

controls and written policies and 

procedures reasonably designed to 

ensure the accuracy and integrity of the 

quantitative measures employed; (ii) 

ongoing timely monitoring and review 

of calculated quantitative 

measurements; (iii) the establishment of 

thresholds and trading measures for 

each trading desk and heightened 

review of any trading activity that is 

inconsistent with those thresholds; and 

(iv) review, investigation and escalation 

with respect to matters that suggest a 

reasonable likelihood that a trading desk 

has violated any part of section 13 of the 

BHC Act or the rule.2601

Where a banking entity is subject to 

the reporting requirements of Appendix 

A, any additional quantitative 

measurements developed and 

implemented by the banking entity 

under the compliance program 

requirement are not required to be 

routinely submitted to the relevant 

Agency as provided in Appendix A, but 

are subject to the recordkeeping 

requirements set forth in subpart D, 

including the requirement to promptly 

produce such records to the relevant 

Agency upon request. Where a banking 

entity is not subject to the requirements 

of Appendix A, that banking entity 

would likewise not be required by this 

rule to routinely submit these additional 

quantitative measurements to the 

relevant Agency, but would be subject 

to the recordkeeping requirements set 

forth in subpart D, including the 

requirement to promptly produce such 

records to the relevant Agency upon 

request. 

In addition to the other requirements 

that are specific to proprietary trading, 

the banking entity’s compliance 

program must identify the activities of 

each trading desk that will be conducted 

in reliance on the exemptions contained 

in §§ 75.4 through 75.6, including an 

explanation of (i) how and where in the 

organization such activity occurs, and 

(ii) which exemption is being relied on 

and how the activity meets the specific 

requirements of such exemption. For 

trading activities that rely on an 

exemption contained in §§ 75.4 through 

75.6, the banking entity’s compliance 

program should include an explanation 

of how, and its policies, procedures and 

internal controls that demonstrate that, 

such trading activities satisfy such 

exemption and any other requirements 

of section 13 of the BHC Act and the 

final rule that are applicable to such 

activities. A foreign banking entity that 

engages in proprietary trading in 

reliance on the exemption contained in 

§ 75.6(e) will be expected to provide 

information regarding the compliance 

program implemented to ensure 

compliance with the requirements of 

that section, including compliance by 

the U.S. operations of the foreign 

banking firm, but will only be expected 

to provide trading information regarding 

activity conducted within the United 

States (absent an indication of activity 

conducted or designed to evade the 

requirements of section 13 of the BHC 

Act of the final rule).2602

In addition, the compliance program 

must describe the process for ensuring 

that liquidity management activities are 

conducted in conformance with the 

limits and policies contained in 

§ 75.3(d)(3). This includes processes for 

ensuring that liquidity management 

activities are not conducted for the 

purpose of prohibited proprietary 

trading. 

The banking entity’s compliance 

program must be reasonably designed 

and established to effectively monitor 

and identify for further analysis any 

proprietary trading activity that may 

indicate potential violations of section 

13 of the BHC Act and subpart B and to 

prevent violations of section 13 of the 

BHC Act and subpart B. The standards 

set forth in subpart D direct the banking 

entity to include requirements in its 

compliance program for documenting 

remediation efforts, assessing the extent 

to which modification of the 

compliance program is warranted and 

providing prompt notification to 

appropriate management and the board 

of directors of material weakness or 

significant deficiencies in the 

implementation of the compliance 

program. 

b. Covered Fund Activities or 

Investments 

Section II.b of Appendix B requires a 

banking entity subject to the enhanced 

minimum standards contained in 

Appendix B to establish, maintain and 

enforce a compliance program that 

includes written policies and 

procedures that are appropriate for the 

types, size, complexity and risks of the 

covered fund and related activities 

conducted and investments made, by 

the banking entity. 

The enhanced compliance program 

requirements for covered funds and 

investments focus on: (i) Ensuring that 

the compliance program provides a 

process for identifying all covered funds 

that the banking entity sponsors, 

organizes or offers, and covered funds in 

which the banking entity invests; (ii) 

ensuring that the compliance program 

provides a method for identifying all 

funds and pools that the banking entity 

sponsors or has an interest in and the 

type of exemption from the Investment 

Company Act or Commodity Exchange 

Act (whether or not the fund relies on 

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


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2603See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Wells Fargo (Prop. Trading). 

2604See Wells Fargo (Prop. Trading). 

2605See Occupy. 

2606See Occupy. 

2607See Occupy. 

2608See 12 U.S.C. 1851(b)(2)(B)(i). 

2609See Barclays; Goldman (Prop. Trading); BoA; 

SIFMA Funds et al. (Prop. Trading) (Feb. 2012); 

Comm. on Capital Markets Regulation. 

2610See 12 U.S.C. 1851(b)(2)(B). 

2611Accordingly, the SEC’s and the CFTC’s final 

rules, unlike the applicable proposals, do not 

incorporate by reference the rules and 

interpretations of the Federal banking agencies with 

respect to covered fund activities or investments. 

See SEC proposed rule § 255.10(a)(2), Joint 

Proposal, 76 FR at 68942–68943, and CFTC 

Proposal, 77 FR at 8421–8423. 

2612See Joint Proposal, 76 FR at 68966. 

Investment Company Act or section 4.7 

of the regulations under the Commodity 

Exchange Act), and the amount of 

ownership interest the banking entity 

has in those funds or pools; (iii) 

identifying, documenting, and mapping 

where any covered fund activities are 

permitted to be conducted within the 

banking entity; and (iv) including an 

explanation of compliance; (v) 

describing sponsorship activities related 

to covered funds; and (vi) establishing, 

maintaining and enforcing internal 

controls that are reasonably designed to 

ensure that its covered fund activities or 

investments comply with the 

requirements of section 13 of the BHC 

Act and subpart C, and (vii) monitoring 

of the banking entity’s investments in 

and transactions with any covered 

funds. 

In addition, the banking entity’s 

compliance program must document the 

banking entity’s plan for seeking 

unaffiliated investors to ensure that any 

investment by the banking entity in a 

covered fund conforms to the limits 

contained in the final rule or that the 

covered fund is registered in 

compliance with the securities laws 

within the conformance period 

provided in the final rule. Similarly, the 

compliance program must ensure that 

the banking entity complies with any 

limits on transactions or relationships 

with the covered fund contained in the 

final rule, including in situations in 

which the banking entity is designated 

as a sponsor, investment manager, 

investment adviser or commodity 

trading adviser by another banking 

entity. 

The banking entity’s compliance 

program must be reasonably designed 

and established to effectively monitor 

and identify for further analysis any 

covered fund activity that may indicate 

potential violations of section 13 of the 

BHC Act and subpart C. The standards 

set forth in subpart D require the 

banking entity to include requirements 

in its compliance program for 

documenting remediation efforts, 

assessing the extent to which 

modification of the compliance program 

is warranted and providing prompt 

notification to appropriate management 

and the board of directors of material 

weakness or significant deficiencies in 

the design or implementation of the 

compliance program. 

c. Enterprise-Wide Programs 

Appendix C in the proposed rule 

contained a provision that permitted a 

banking entity to establish a compliance 

program on an enterprise-wide basis. 

Some commenters argued that a less 

specific and more flexible compliance 

regime would be essential to make the 

enterprise-wide compliance structures 

contemplated in Appendix C effective 

because requiring individualized 

policies and procedures for each 

business line would diminish the 

benefits of enterprise-wide compliance 

and prevent consistency of these 

policies and procedures within the 

banking entity.2603 One of these 

commenters recommended the Agencies 

provide greater options for developing a 

compliance program and not limit a 

banking entity to a choice between a 

single enterprise-wide program or a 

separate program for each subsidiary 

engaged in activities covered by the 

proposed rule.2604

In contrast, one commenter argued 

that any enterprise-wide compliance 

program would only be effective if 

combined with additional programs at 

the trading unit or subsidiary level to 

train all employees at a banking 

entity.2605 This commenter argued that 

each trading unit is different and 

suggested that it would be more efficient 

to mandate enterprise-wide default 

internal controls, but provide each 

individual trading unit the flexibility to 

tailor these requirements to its own 

specific business.2606 This commenter 

also urged that Appendix C’s elements 

III (internal controls), IV (responsibility 

and accountability) and VII 

(recordkeeping) should not be imposed 

solely at the enterprise-wide level.2607

After considering carefully the 

comments on the proposal, the Agencies 

have removed the reference to an 

enterprise-wide compliance program 

from the final rule; however, the 

Agencies acknowledge that a banking 

entity may establish a compliance 

program on an enterprise-wide basis, as 

long as the program satisfies the 

requirements of § 75.20 and, where 

applicable, Appendix B. A banking 

entity may employ common policies 

and procedures that are established at 

the enterprise-wide level or at a 

business-unit level to the extent that 

such policies and procedures are 

appropriately applicable to more than 

one trading desk or activity, as long as 

the required elements of Appendix B 

and all of the other applicable 

compliance-related provisions of the 

rule are incorporated in the compliance 

program and effectively administered 

across trading desks and banking 

entities within the consolidated 

enterprise or designated business. If a 

banking entity establishes an enterprisewide program, like a non-enterprise 

wide program, that program will be 

subject to supervisory review and 

examination by any Agency vested with 

rule writing authority under section 13 

of the BHC Act with respect to the 

compliance program and the activities 

or investments of each banking entity 

for which the Agency has such 

authority.2608 The banking organization 

would be expected to provide each 

appropriate Agency with access to all 

records related to the enterprise-wide 

compliance program pertaining to any 

banking entity that is supervised by the 

Agency vested with such rule writing 

authority. 

For similar reasons, the Agencies have 

determined not to adopt some 

commenters’ requests that a single 

agency be responsible for determining 

compliance with section 13.2609 At this 

time the Agencies do not believe such 

an approach would be consistent with 

the statute, which requires each Agency 

to adopt a rule for the types of banking 

entities under its jurisdiction,2610 or 

effective given the different authorities 

and expertise of each Agency. The 

Agencies expect to continue to 

coordinate their supervisory efforts 

related to section 13 of the BHC Act and 

to share information as appropriate in 

order to effectively implement the 

requirements of that section and the 

final rule.2611

d. Responsibility and Accountability 

Section III of Appendix B includes the 

enhanced minimum standards for 

responsibility and accountability. 

Section III contains many of the 

provisions contained in the proposed 

rule relating to responsibility and 

accountability, with certain 

modifications.2612 Section III requires a 

banking entity to establish, maintain 

and enforce both a governance and 

management framework to manage its 

business and employees with a view to 

preventing violations of section 13 of 

the BHC Act and the rule. The standards 

in Section III focus on four key 

constituencies—the board of directors, 


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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 6031 

2613See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Wells Fargo (Prop. Trading). 

2614See SIFMA et al. (Prop. Trading); see also 

Wells Fargo (Prop. Trading). 

2615See Occupy; AFR et al. (Feb. 2012); Sens. 

Merkley & Levin (Feb. 2012); Public Citizen; Ralph 

Saul (Oct. 2011); John Reed; see also BEC et al. (Oct. 

2011); Matthew Richardson. 

2616See Merkley & Levin (Feb. 2012). 

2617See SIFMA et al. (Prop. Trading) (Feb. 2012); 

see also Wells Fargo (Prop. Trading). 

2618See Joint Proposal, 76 FR at 68967. 

2619One commenter suggested that any 

compliance testing under the final rule be 

monitored by the Agencies and initially tested by 

internal audit personnel of the banking entity who 

are subject to a specific licensing and registration 

process for section 13 of the BHC Act and 

supplemented by an annual independent external 

review. See Occupy; see also proposed rule 

§ 75.20(b)(4). The Agencies believe it would be 

unnecessarily burdensome to require particular 

licensing and registration processes for internal 

auditors that are specific to section 13 of the BHC 

Act. 

2620See Joint Proposal, 76 FR at 68967. 

the CEO, senior management, and 

business line managers. Certain of the 

standards contained in the proposed 

rule relating to business management 

are separately covered by specific 

requirements contained in sections II.a 

and II.b of Appendix B. Section III 

makes it clear that the board of 

directors, or similar corporate body, and 

the CEO and senior management are 

responsible for creating an appropriate 

‘‘tone at the top’’ by setting an 

appropriate culture of compliance and 

establishing clear policies regarding the 

management of the firm’s trading 

activities and its fund activities and 

investments. Senior management must 

be made responsible for communicating 

and reinforcing the culture of 

compliance established by it and the 

board of directors, for the actual 

implementation and enforcement of the 

approved compliance program, and for 

taking corrective action where 

appropriate. 

In response to a question in the 

preamble to the proposed rule regarding 

whether the chief executive officer or 

similar officer of a banking entity 

should be required to provide a 

certification regarding the compliance 

program requirements, a few 

commenters urged that the final rule 

should not require that the board of 

directors or CEO of a banking entity 

review or certify the effectiveness of the 

compliance program.2613 These 

commenters argued that existing 

processes developed by large, complex 

banking entities for board of director 

reporting and governance processes 

ensure that compliance programs work 

appropriately, and argued that these 

protocols would establish appropriate 

management and board of directors’ 

oversight of the section 13 compliance 

program.2614 By contrast, several 

commenters advocated requiring CEO 

attestation regarding compliance with 

section 13.2615 One commenter 

suggested that the rule require an 

annual assessment by management of 

the effectiveness of internal controls and 

policies and require a public accounting 

firm to attest to the accuracy of those 

annual assessments.2616

After considering comments received 

on the proposal, the Agencies have 

determined to include a requirement in 

the final rule that a banking entity’s 

CEO annually attest in writing to the 

appropriate Agency for the banking 

entity that the banking entity has in 

place processes to establish, maintain, 

enforce, review, test and modify the 

compliance program established 

pursuant to Appendix B and § 75.20 of 

the rule in a manner reasonably 

designed to achieve compliance with 

section 13 of the BHC Act and this rule. 

Although some commenters stated that 

existing protocols of certain banking 

entities would establish appropriate 

oversight of the rule’s compliance 

program,2617 the Agencies believe this 

requirement will better help to ensure 

that a strong governance framework is 

implemented with respect to 

compliance with section 13 of the BHC 

Act, and that it more directly 

underscores the importance of CEO 

engagement in the governance and 

management framework supporting 

compliance with the rule. In the case of 

the U.S. operations of a foreign banking 

entity, including a U.S. branch or 

agency of a foreign banking entity, the 

attestation may be provided for the 

entire U.S. operations of the foreign 

banking entity by the senior 

management officer of the U.S. 

operations of the foreign banking entity 

who is located in the United States. 

e. Independent Testing 

Section IV of the Appendix B 

includes the enhanced minimum 

standards for independent testing, 

which are substantially similar to the 

proposed independent testing 

standards.2618 A banking entity subject 

to Appendix B must ensure that 

independent testing regarding the 

effectiveness of the banking entity’s 

compliance program is conducted by a 

qualified independent party, such as the 

banking entity’s internal audit 

department, compliance personnel or 

risk managers independent of the 

trading desk or other organizational unit 

being tested, outside auditors, 

consultants, or other qualified 

independent parties. If a banking entity 

uses internal personnel to conduct the 

independent testing, the Agencies 

would expect that the banking entity 

ensure that the personnel responsible 

for the testing are separate from the unit 

and functions being tested (e.g., the 

personnel do not report to a person who 

is directly responsible for the unit or 

involved in the functions being tested) 

and have knowledge of the requirements 

of section 13 and its implementing 

rules. Although an external audit is not 

required to meet the independent 

testing requirement, the Agencies would 

expect that, when external auditors are 

engaged to review compliance by a 

banking entity with laws and 

regulations, the banking entity would 

give appropriate consideration to the 

need to review the compliance program 

required under this rule. 

While one commenter suggested the 

final rule prescribe the precise manner 

in which a banking entity must conduct 

its compliance testing,2619 the Agencies 

believe such a requirement is 

unnecessary because the standards in 

the final rule will ensure that 

independent testing of the effectiveness 

of a banking entity’s compliance 

program is objective and robust. The 

independent testing must examine both 

the banking entity’s compliance 

program and its actual compliance with 

the rule. This testing must include not 

only testing of the overall adequacy and 

effectiveness of the compliance program 

and compliance efforts, but also the 

effectiveness of each element of the 

compliance program and the banking 

entity’s compliance with each provision 

of the rule. This requirement is intended 

to ensure that a banking entity 

continually reviews and assesses, in an 

objective manner, the strength of its 

compliance efforts and promptly 

identifies and remedies any weaknesses 

or matters requiring attention within the 

compliance framework. 

f. Training 

Like the proposed compliance 

appendix, Section V of Appendix B 

includes the enhanced minimum 

standards for training.2620 It requires 

that a banking entity provide adequate 

training to its trading personnel and 

managers, as well as other appropriate 

personnel, in order to effectively 

implement and enforce the compliance 

program. In particular, personnel 

engaged in covered trading activities 

and investments should be educated 

with respect to applicable prohibitions 

and restrictions, exemptions, and 

compliance program elements to an 

extent sufficient to permit them to make 

informed, day-to-day decisions that 


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6032 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

2621See Joint Proposal, 76 FR at 68967. 2622One commenter specifically urged that 

records for any type of compliance program be 

required to be kept on all hedges, rather than only 

those placed at a different level or trading unit as 

under the proposal, and that the retention period 

for all compliance records be changed from 5 years 

to 6 years in line with the statute of limitations on 

civil suits for fraud, contracts and collection of debt 

in accounts in New York State. See Occupy. 

2623Section 13(e)(1) of the BHC Act requires the 

Agencies to issue regulations regarding internal 

controls and recordkeeping to ensure compliance 

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

75.20 and Appendix C of the proposed rule also 

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

2624See Part III.D. of this SUPPLEMENTARY

INFORMATION. 

2625See proposed rule § 75.7. 

2626See supra Part VI.A.3.c.8 (explaining why 

Appendix B was removed from the final rule). 

2627See proposed rule § 75.7(a). 

support the banking entity’s compliance 

with section 13 of the BHC Act and the 

rule. In particular, any personnel with 

discretionary authority to trade, in any 

amount, should be appropriately trained 

regarding the differentiation of 

prohibited proprietary trading and 

permitted trading activities and given 

detailed guidance regarding what types 

of trading activities are prohibited. 

Similarly, personnel providing 

investment management or advisory 

services, or acting as general partner, 

managing member, or trustee of a 

covered fund, should be appropriately 

trained regarding what covered fund 

activities and investments are permitted 

and prohibited. 

g. Recordkeeping 

Section VI of Appendix B contains the 

enhanced minimum standards for 

recordkeeping which are consistent 

with the proposed recordkeeping 

standards.2621 Generally, a banking 

entity must create records sufficient to 

demonstrate compliance and support 

the operation and effectiveness of its 

compliance program (i.e., records 

demonstrating the banking entity’s 

compliance with the requirements of 

section 13 of the BHC Act and the rule, 

any scrutiny or investigation by 

compliance personnel or risk managers, 

and any remedies taken in the event of 

a violation or non-compliance), and 

retain these records for no less than five 

years in a form that allows the banking 

entity to promptly produce these 

records to any relevant Agency upon 

request. Records created and retained 

under the compliance program must 

include trading records of the trading 

units, including trades and positions of 

each such unit. Records created and 

retained under the enhanced 

compliance program must also include 

documentation of any exemption in the 

final rule relied on by the banking entity 

to invest in or sponsor a covered fund. 

While one commenter requested that 

the period for retaining records be 

extended from 5 years to 6 years, the 

final rule does not make this change.2622

The Agencies believe that 5 years is an 

appropriate minimum period for 

requiring retention of records to 

demonstrate compliance with the final 

rule. The final rule allows the Agencies 

to require a banking entity to retain 

records for a longer period if 

appropriate. 

3. Section 75.20(d) and Appendix A: 

Reporting and Recordkeeping 

Requirements Applicable to Trading 

Activities 

Section 75.7 of the proposed rule, 

which the Agencies proposed to 

implement in part section 13(e)(1) of the 

BHC Act,2623 required certain banking 

entities to comply with the reporting 

and recordkeeping requirements 

specified in Appendix A of the 

proposed rule. In addition, § 75.7 

required banking entities to comply 

with the recordkeeping requirements in 

§ 75.20 of the proposed rule, related to 

the banking entity’s compliance 

program,2624 as well as any other 

reporting or recordkeeping requirements 

that the relevant Agency may impose to 

evaluate the banking entity’s 

compliance with the proposed rule.2625

Proposed Appendix A required a 

banking entity with significant trading 

activities to furnish periodic reports to 

the relevant Agency regarding various 

quantitative measurements of its trading 

activities and create and retain records 

documenting the preparation and 

content of these reports. The 

measurements varied depending on the 

scope, type, and size of trading 

activities. In addition, proposed 

Appendix B contained a detailed 

commentary regarding the 

characteristics of permitted market 

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.2626 Under the proposal, a 

banking entity was required to comply 

with proposed Appendix A’s reporting 

and recordkeeping requirements only if 

it had, together with its affiliates and 

subsidiaries, trading assets and 

liabilities the average gross sum of 

which (on a worldwide consolidated 

basis) was, as measured as of the last 

day of each of the four prior calendar 

quarters, equal to or greater than $1 

billion.2627 The Agencies did not 

propose to extend the reporting and 

recordkeeping requirements to banking 

entities with smaller amounts of trading 

activity, as it appeared that the more 

limited benefits of applying these 

requirements to such banking entities, 

whose trading activities are typically 

small, less complex, and easier to 

supervise, would not justify the burden 

associated with complying with the 

reporting and recordkeeping 

requirements. 

a. Approach to Reporting and 

Recordkeeping Requirements Under the 

Proposal 

The proposal explained that the 

reporting and recordkeeping 

requirements of § 75.7 and Appendix A 

of the proposed rule were an important 

part of the proposed rule’s multi-faceted 

approach to implementing the 

prohibition on proprietary trading. 

These requirements were intended, in 

particular, to address some of the 

difficulties associated with (i) 

identifying permitted market makingrelated activities and distinguishing 

such activities from prohibited 

proprietary trading, and (ii) identifying 

certain trading activities resulting in 

material exposure to high-risk assets or 

high-risk trading strategies. To do so, 

the proposed rule required certain 

banking entities to calculate and report 

detailed quantitative measurements of 

their trading activity, by trading unit. 

These measurements were meant to 

help banking entities and the Agencies 

in assessing whether such trading 

activity is consistent with permitted 

trading activities in scope, type and 

profile. The quantitative measurements 

required to be reported under the 

proposed rule were generally designed 

to reflect, and to provide meaningful 

information regarding, certain 

characteristics of trading activities that 

appear to be particularly useful in 

differentiating permitted market 

making-related activities from 

prohibited proprietary trading. For 

example, the proposed quantitative 

measurements measured the size and 

type of revenues generated, and the 

types of risks taken, by a trading unit. 

Each of these measurements appeared to 

be useful in assessing whether a trading 

unit was (i) engaged in permitted market 

making-related activity or (ii) materially 

exposed to high-risk assets or high-risk 

trading strategies. Similarly, the 

proposed quantitative measurements 

also measured how much revenue was 

generated per such unit of risk, the 

volatility of a trading unit’s profitability, 

and the extent to which a trading unit 

trades with customers. Each of those 

characteristics appeared to be useful in 

assessing whether a trading unit is 


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2628 Joint Proposal, 76 FR at 68883. 

2629See 12 U.S.C. 1851(c)(2); Joint Proposal, 76 

FR at 68883. 

engaged in permitted market makingrelated activity. 

However, as noted in the proposal, 

the Agencies recognize that no single 

quantitative measurement or 

combination of measurements can 

accurately identify prohibited 

proprietary trading without further 

analysis of the context, facts, and 

circumstances of the trading activity. In 

addition, certain quantitative 

measurements may be useful for 

assessing one type of trading activity, 

but not helpful in assessing another type 

of trading activity. As a result, the 

Agencies proposed to use a variety of 

quantitative measurements to help 

identify transactions or activities that 

warrant more in-depth analysis or 

review. 

To be effective, this approach requires 

identification of useful quantitative 

measurements as well as judgment 

regarding the type of measurement 

results that suggest a further review of 

the trading unit’s activity is warranted. 

The Agencies proposed to take a 

heuristic approach to implementation in 

this area that recognized that 

quantitative measurements can only be 

usefully identified and employed after a 

process of substantial public comment, 

practical experience, and revision. In 

particular, the Agencies noted that, 

although a variety of quantitative 

measurements have traditionally been 

used by market participants and others 

to manage the risks associated with 

trading activities, these quantitative 

tools have not been developed, nor have 

they previously been utilized, for the 

explicit purpose of identifying trading 

activity that warrants additional 

scrutiny in differentiating prohibited 

proprietary trading from permitted 

market making-related activities.2628

Consistent with this heuristic 

approach, the proposed rule included a 

large number of potential quantitative 

measurements on which public 

comment was sought, many of which 

overlap to some degree in terms of their 

informational value. The proposal 

explained that not all of these 

quantitative measurements may 

ultimately be adopted in the final rule, 

depending on their relative strengths, 

weaknesses, costs, and benefits. The 

Agencies noted that some of the 

proposed quantitative measurements 

may not be relevant to all types of 

trading activities or may provide only 

limited benefits, relative to cost, when 

applied to certain types of trading 

activities. In addition, certain 

quantitative measurements may be 

difficult or impracticable to calculate for 

a specific covered trading activity due to 

differences between asset classes, 

market structure, or other factors. The 

Agencies therefore requested comment 

on a large number of issues related to 

the relevance, practicability, costs, and 

benefits of the quantitative 

measurements proposed. The Agencies 

also sought comment on whether the 

quantitative measurements described in 

the proposal were appropriate to use to 

help assess compliance with section 13 

of the BHC Act. 

In addition to the proposed 

quantitative measurements, the proposal 

explained that a banking entity may 

itself develop and implement other 

quantitative measurements in order to 

effectively monitor its covered trading 

activities for compliance with section 13 

of the BHC Act and the proposed rule 

and to establish, maintain, and enforce 

an effective compliance program, as 

required by § 75.20 of the proposed rule 

and Appendix C. The Agencies noted 

that the proposed quantitative 

measurements in Appendix A were 

intended to assist banking entities and 

Agencies in monitoring compliance 

with the proprietary trading restrictions 

and would not necessarily provide all 

the data necessary for the banking entity 

to establish an effective compliance 

program. The Agencies also recognized 

that appropriate and effective 

quantitative measurements may differ 

based on the profile of the banking 

entity’s businesses in general and, more 

specifically, of the particular trading 

unit, including types of instruments 

traded, trading activities and strategies, 

and history and experience (e.g., 

whether the trading desk is an 

established, successful market maker or 

a new entrant to a competitive market). 

In all cases, banking entities needed to 

ensure that they have robust measures 

in place to identify and monitor the 

risks taken in their trading activities, to 

ensure the activities are within risk 

tolerances established by the banking 

entity, and to monitor for compliance 

with the proprietary trading restrictions 

in the proposed rule. 

To the extent that data regarding 

measurements, as set forth in the 

proposed rule, are collected, the 

Agencies proposed to utilize the 

conformance period provided in section 

13 of the BHC Act to carefully review 

that data, further study the design and 

utility of these measurements, and if 

necessary, propose changes to the 

reporting requirements as the Agencies 

believe are needed to ensure that these 

measurements are as effective as 

possible.2629 This heuristic, gradual 

approach to implementing reporting 

requirements for quantitative 

measurements was intended to ensure 

that the requirements are formulated in 

a manner that maximizes their utility for 

identifying trading activity that warrants 

additional scrutiny in assessing 

compliance with the prohibition on 

proprietary trading, while limiting the 

risk that the use of quantitative 

measurements could inadvertently 

curtail permissible market makingrelated activities that provide an 

important service to market participants 

and the capital markets at large. 

In addition, the Agencies requested 

comment on the use of numerical 

thresholds for certain quantitative 

measurements that, if reported by a 

banking entity, would require the 

banking entity to review its trading 

activities for compliance and summarize 

that review to the relevant Agency. The 

Agencies did not propose specific 

numerical thresholds in the proposal 

because substantial public comment and 

analysis would be beneficial prior to 

formulating and proposing specific 

numerical thresholds. Instead, the 

Agencies intended to carefully consider 

public comments provided on this issue 

and to separately determine whether it 

would be appropriate to propose, 

subsequent to finalizing the current 

proposal, such numerical thresholds. 

Part III of proposed Appendix A 

defined the scope of the reporting 

requirements. The proposed rule 

adopted a tiered approach that required 

banking entities with the most extensive 

trading activities to report the largest 

number of quantitative measurements, 

while banking entities with smaller 

trading activities had fewer or no 

reporting requirements. This tiered 

approach was intended to reflect the 

heightened compliance risks of banking 

entities with extensive trading activities 

and limit the regulatory burden imposed 

on banking entities with relatively small 

or no trading activities, which appear to 

pose significantly less compliance risk. 

Under the proposal, any banking 

entity that had, together with its 

affiliates and subsidiaries, trading assets 

and liabilities the average gross sum of 

which (on a worldwide consolidated 

basis), as measured as of the last day of 

each of the four prior calendar quarters, 

equals or exceeds $5 billion would be 

required the banking entity to furnish 

quantitative measurements for all 

trading units of the banking entity 

engaged in trading activity subject to 

§§ 75.4, 75.5, or 75.6(a) of the proposed 


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6034 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

2630See proposed rule Appendix A.III.A. These 

seventeen quantitative measurements are discussed 

further below. 2631See 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. 

2632See 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. 

2633See, e.g., Paul Volcker; SIFMA et al. (Prop. 

Trading) (Feb. 2012); Invesco; Comm. on Capital 

Markets Regulation. 

2634See Goldman (Prop. Trading). 

2635See Sens. Merkley & Levin (Feb. 2012). 

2636See Occupy. 

2637See Barclays; see also BoA; Invesco; ISDA 

(Feb. 2012); JPMC; Morgan Stanley; SIFMA et al. 

(Prop. Trading) (Feb. 2012). 

2638See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Wells Fargo (Prop. Trading); NYSE Euronext; Oliver 

Wyman (Feb. 2012); UBS; Western Asset Mgmt.; 

Goldman (Prop. Trading); Northern Trust. 

2639See John Reed; Public Citizen. 

2640See Morgan Stanley; SIFMA et al. (Prop. 

Trading) (Feb. 2012); Stephen Roach. 

2641See Wells Fargo (Prop. Trading); Morgan 

Stanley; SIFMA et al. (Prop. Trading) (Feb. 2012); 

Stephen Roach. 

2642See UBS. 

2643See Goldman (Prop. Trading); Northern Trust; 

see also UBS. 

2644See Comm. on Capital Markets Regulation. 

rule (i.e., permitted underwriting and 

market making-related activity, riskmitigated hedging, and trading in 

certain government obligations). The 

scope of data to be furnished depended 

on the activity in which the trading unit 

was engaged. First, for the trading units 

of such a banking entity that are 

engaged in market making-related 

activity pursuant to § 75.4(b) of the 

proposed rule, proposed Appendix A 

required that a banking entity furnish 

seventeen quantitative 

measurements.2630 Second, all trading 

units of such a banking entity engaged 

in trading activity subject to §§ 75.4(a), 

75.5, or 75.6(a) of the proposed rule 

were required to report five quantitative 

measurements designed to measure the 

general risk and profitability of the 

trading unit.2631 The Agencies expected 

that each of these general types of 

measurements would be useful in 

assessing the extent to which any 

permitted trading activity involves 

exposure to high-risk assets or high-risk 

trading strategies. These requirements 

would apply to all type of trading units 

engaged in underwriting and market 

making-related activity, risk-mitigated 

hedging, and trading in certain 

government obligations. These 

additional measurements applicable 

only to trading units engaged in market 

making-related activities were designed 

to help evaluate the extent to which the 

quantitative profile of a trading unit’s 

activities is consistent with permissible 

market making-related activities. 

Under the proposal, any banking 

entity that had, together with its 

affiliates and subsidiaries, trading assets 

and liabilities the average gross sum of 

which (on a worldwide consolidated 

basis), as measured as of the last day of 

each of the four prior calendar quarters, 

equals or exceeds $1 billion but is less 

than $5 billion would be required to 

provide quantitative measurements to 

be furnished for trading units that 

engaged in market making-related 

activity subject to § 75.4(b) of the 

proposed rule. Trading units of such 

banking entities that engaged in market 

making-related activities needed to 

report eight quantitative measurements 

designed to help evaluate the extent to 

which the quantitative profile of a 

trading unit’s activities is consistent 

with permissible market making-related 

activities.2632 The proposal applied a 

smaller number of measurements to a 

smaller universe of trading units for this 

class of banking entities because they 

are likely to pose lesser compliance risk 

and fewer supervisory and examination 

challenges. The Agencies noted in the 

proposal that a less burdensome 

reporting regime, coupled with other 

elements of the proposal (e.g., the 

compliance program requirement), was 

likely to be equally as effective in 

ensuring compliance with section 13 of 

the BHC Act and the proposed rule for 

banking entities with smaller trading 

operations. 

Section III.B of proposed Appendix A 

specified the frequency of required 

calculation and reporting of quantitative 

measurements. Under the proposed 

rule, each required quantitative 

measurement needed to be calculated 

for each trading day. Required 

quantitative measurements were 

required to be reported to the relevant 

Agency on a monthly basis, within 30 

days of the end of the relevant calendar 

month, or on such other reporting 

schedule as the relevant Agency may 

require. Section III.C of proposed 

Appendix A required a banking entity to 

create and retain records documenting 

the preparation and content of any 

quantitative measurement furnished by 

the banking entity, as well as such 

information as is necessary to permit the 

relevant Agency to verify the accuracy 

of such measurements, for a period of 5 

years. This included records for each 

trade and position. 

b. General Comments on the Proposed 

Metrics 

A number of commenters were 

supportive of metrics. A few 

commenters argued that the metrics 

could reveal prohibited proprietary 

trading activity and be an appropriate 

and valuable tool in analyzing 

positions.2633 One commenter argued 

that metrics are the single most valuable 

tool available to the Agencies for 

distinguishing between prohibited and 

permitted activities and recommended 

the compliance program be structured 

around metrics.2634 Another commenter 

stated that the identification of metrics 

is one of the strengths of the proposed 

rule and offered great promise for 

successful implementation of the 

rule.2635 One commenter expressed 

support for the metrics and argued that 

there would be substantial evasion of 

the rule without reporting of these 

measurements.2636 Some commenters 

proposed a presumption of compliance 

so long as trading activity is conducted 

in a manner consistent with tailored 

quantitative metrics and related specific 

thresholds as coordinated and agreed 

with the relevant Agency.2637 A few of 

commenters suggested that metrics not 

be used as a bright-line trigger and 

recommended flexibility in the 

application of metrics for assessing 

market-making activities.2638 Two 

commenters supported metrics as part 

of a bright lines approach.2639

A number of commenters felt that 

some metrics might be more relevant 

than others, depending upon the 

particular asset class, activity, particular 

market, and unique characteristics of 

each banking entity.2640 These 

commenters advocated an approach 

where banking entities and examiners 

would determine over time the 

usefulness and relevance of particular 

metrics.2641 One commenter expressed 

support for the 5 metrics required for 

trading in U.S. government 

obligations.2642 A number of 

commenters recommended that metrics 

be tailored to different asset classes and 

markets, to avoid the drawbacks of a 

one-size-fits-all approach.2643 One 

commenter argued that application of 

metrics to market-making activities at 

different firms may produce very 

different results, all of which might 

reflect legitimate market-making.2644

Commenters also indicated that not all 

metrics are meaningful and calculable 


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2645See Morgan Stanley; see also ISDA (Feb. 

2012). 

2646See ABA (Keating); Barclays; Citigroup (Feb. 

2012); ISDA (Feb. 2012); UBS; Oliver Wyman (Feb. 

2012); Prof. Duffie; Wellington. 

2647See Oliver Wyman (Feb. 2012). 

2648See BoA (expressing concern about the need 

for new systems to distinguish bid-ask spreads from 

price appreciation); UBS; Wellington. 

2649See BoA; Barclays; Citigroup (Feb. 2012). 

2650See Credit Suisse (Seidel); Morgan Stanley; 

UBS; Wells Fargo (Prop. Trading); Socie ́te ́ Ge ́ne ́rale 

(arguing that many calculation questions need to be 

resolved before banking entities can create 

necessary systems to measure metrics). 

2651See Occupy; AFR et al. (Feb. 2012); Western 

Asset Mgmt.; Public Citizen. For example, one 

commenter cited a study finding that 14 out of 17 

of the proposed metrics are either in wide use today 

or are possible to implement fairly easily using data 

already collected for internal risk management and 

profit and loss purposes. See AFR et al. (Feb. 2012) 

(citing John Lester and Dylan Walsh, ‘‘The Volcker 

Rule Ban On Prop Trading: A Step Closer to Reality, 

Point of View,’’ Oliver Wyman Company (Oct. 

2011)). 

2652See Paul Volcker. 

2653See, e.g., UBS. 

2654See BoA; UBS; Wellington. 

2655See AFR (Nov. 2012); see also Occupy; Public 

Citizen. 

2656See Occupy; AFR (Nov. 2012); Wells Fargo 

(Prop. Trading). 

2657See Occupy. 

2658See Sens. Merkley & Levin (Feb. 2012). 

2659See ISDA (Feb. 2012) (citing Mason v. Florida 

Bar, 208 F.3d 952, 958–59 (11th Cir. 2000)). 

2660See Sens. Merkley & Levin (Feb. 2012); see 

also Occupy; Public Citizen. 

2661See Sens. Merkley & Levin (Feb. 2012); see 

also Public Citizen; John Reed. 

2662See ICBA; Occupy. 

2663See Occupy (suggesting all banking entities 

that engage in trading be required to provide VaR 

Exceedance, Risk Factor Sensitivities and Risk and 

Position Limits). 

2664See PNC et al.; M&T Bank; see also ABA 

(Abernathy). 2665See ABA (Keating); M&T Bank; PNC et al. 2666See State Street (Feb. 2012). 2667See PNC et al. 2668See PNC et al. 2669See Northern Trust. 2670See Occupy at 60. 

for all trading units and some would be 

unnecessarily burdensome.2645

Other commenters did not support the 

use of metrics. These commenters 

argued that metrics reporting was one 

aspect of the complexity of the proposal 

that increased the cost and difficulty of 

distinguishing market-making from 

prohibited proprietary trading.2646 One 

commenter argued that banking entities 

may avoid legitimate market making 

activities that would produce ‘‘worse’’ 

metrics results.2647

Several commenters expressed 

concern that the costs exceeded the 

benefits of the required quantitative 

metrics in the proposal. In particular, 

commenters argued that the 17 metrics 

in the proposal calculated at each 

trading unit was excessive, would 

generate an unmanageable amount of 

data, would yield numerous false 

positives, and would require the 

construction and programming of highly 

sophisticated systems that are not 

currently employed.2648 A few 

commenters suggested that a more 

limited set of metrics would reduce 

compliance complexity.2649 Some 

commenters noted that many of these 

metrics have not been historically 

reported by banking entities and some 

of the metrics would require substantial 

resources and investment infrastructure 

to produce some of the metrics without 

a clear functional purpose.2650

According to other commenters, 

however, banking entities currently use 

all or nearly all of the proposed 

metrics.2651 One commenter urged that 

it would be good to make metrics 

consistent with the banking entities’ 

internal reporting and control 

systems.2652 Some commenters argued it 

was critical for the Agencies to get the 

metrics right,2653 while others indicated 

it was unclear how the Agencies could 

analyze such information to draw useful 

conclusions.2654

Some commenters expressed concern 

that metrics were vulnerable to 

manipulation and arbitrage.2655 These 

commenters generally felt that the 

quantitative measurements were only 

appropriate for certain liquid and 

transparent trading activities but not 

meaningful for illiquid markets, 

including opaque securities and 

derivatives.2656 These commenters also 

argued that the vast majority of 

proprietary trading would not be 

differentiable through analysis of the 

data.2657 Other commenters expressed 

concern that the use of metrics not 

replace regulatory review of actual 

specific trading positions held by 

banking entities.2658 One commenter 

argued that in relying on metrics to be 

elaborated upon and discussed in the 

examination process, the proposed rule 

did not meet the fundamental fair notice 

goal of regulation.2659

A few commenters also recommended 

creation of a central data repository or 

data sharing protocol that would 

promote consistency and accountability 

in oversight and regulation and 

suggested the Office of Financial 

Research (‘‘OFR’’) be given access to this 

data so that it can provide centralized 

analysis and monitoring to identify any 

trends that give rise to systemic risk.2660

These commenters generally supported 

compliance benefits that would result 

from increased public disclosure of 

banking entities’ trading and funds 

activities, including all of their trading 

positions, their valuation models, and 

their compliance metrics.2661

Some commenters expressed support 

for the reporting thresholds contained in 

Appendix A.2662 One commenter 

suggested that all banking entities that 

engage in any trading (regardless of 

threshold) report certain metrics.2663

Other commenters supported metrics 

reporting, but recommended the 

threshold for trading assets and 

liabilities be increased from $1 billion to 

$10 billion to mitigate any cost and 

burden impact on smaller banking 

entities.2664 These commenters pointed 

out that even if the minimum dollar 

threshold were raised to $10 billion, an 

overwhelming percentage of trading 

assets and liabilities in the banking 

industry (approximately 98 percent) 

would still remain subject to heightened 

compliance requirements including 

Appendix A.2665 One commenter 

suggested the threshold be raised to $50 

billion in combined trading assets and 

liabilities.2666

Commenters also offered a number of 

suggestions for modifying the activity 

that would be considered in meeting the 

thresholds for determining which 

reporting requirements apply to a 

banking entity. Several commenters 

argued that certain types of trading 

assets or fund investments should not 

be included for purposes of determining 

whether the relevant dollar threshold 

for compliance was met, particularly 

those that are not prohibited activities 

or investments. For instance, some 

commenters urged that trading in U.S. 

government obligations should not 

count toward the calculation of whether 

a banking organization meets the trading 

threshold triggering metrics 

reporting.2667 These commenters also 

argued that other positions or 

transactions that do not involve 

financial instruments and that may 

constitute trading assets and liabilities, 

such as loans, should be excluded from 

the thresholds because exempt activities 

should not determine the type of 

compliance program a banking entity 

must implement.2668 One commenter 

urged that foreign exchange swaps and 

forwards be excluded from the 

definition of a ‘‘derivative’’ and not be 

subject to compliance requirements as a 

result.2669 Conversely, one commenter 

urged that all assets and liabilities 

defined as trading assets for purposes of 

the Market Risk Capital Rule should be 

included in the $1 billion standard for 

becoming subject to any reporting and 

record-keeping requirements under the 

final rule.2670

A number of commenters argued that 

monthly reporting was too frequent 

because of the complexity of the process 

that surrounds generation of regulatory 


emcdonald on DSK67QTVN1PROD with RULES3
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2671See JPMC; see also Stephen Roach. 

2672See Occupy. 

2673See BoA; Barclays; Citigroup (Feb. 2012); 

Goldman (Prop. Trading); JPMC; Morgan Stanley; 

SIFMA et al. (Prop. Trading) (Feb. 2012); UBS; 

Stephen Roach. 

2674See Credit Suisse (Seidel); JPMC; Wells Fargo 

(Prop. Trading). 

2675See BoA. 

2676See Morgan Stanley; see also SIFMA et al. 

(Prop. Trading) (Feb. 2012). 

2677See Goldman (Prop. Trading). 

2678See Wells Fargo (Prop. Trading). 

2679See AFR et al. (Feb. 2012). 

2680See GE (Feb. 2012). 

2681See Occupy. 

2682See, e.g., BoA; Goldman (Prop. Trading); 

JPMC; SIFMA et al. (Prop. Trading) (Feb. 2012); 

Morgan Stanley; RBC. 

2683See JPMC; Goldman (Prop. Trading); SIFMA 

et al. (Prop. Trading) (Feb. 2012); BoA. See also 

Sen. Gillibrand. 

2684See Goldman (Prop. Trading); SIFMA et al. 

(Prop. Trading) (Feb. 2012); BoA. 

2685See Goldman (Prop. Trading); SIFMA et al. 

(Prop. Trading) (Feb. 2012). 

2686See Sens. Merkley & Levin (Feb. 2012); 

Occupy. 

2687See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Occupy; Alfred Brock. 

2688See Wellington; Barclays; Goldman (Prop. 

Trading); CalPERS; John Reed. 

2689See Occupy. 

2690See SIFMA et al. (Prop. Trading) (Feb. 2012). 

2691See Wellington; CalPERS; John Reed. 

2692See Goldman (Prop. Trading); Barclays. 

reports and suggested that the frequency 

of reporting should be quarterly.2671

One commenter supported the reporting 

frequency as extremely effective and 

said it should not be reduced in any 

way.2672

A number of comments were received 

on the implementation timeframe for 

metrics reporting. Several commenters 

urged allowing banking entities the use 

of the full conformance period for 

creating the systems and processes to 

capture and report the quantitative 

metrics.2673 Some commenters 

suggested that metrics should not be 

required to be reported until one year 

after adoption of final regulations.2674 A 

different commenter suggested that the 

Agencies provide a one-year period 

during which they determine which 

metrics will be employed for different 

asset classes and an additional one-year 

period during which such metrics could 

be reviewed so metrics would be a 

required component of a banking 

entity’s compliance program no sooner 

than 2 years after issuance of the final 

rule.2675 Another commenter suggested 

that banking entities and regulators use 

the first year of the conformance period 

to consult with one another and 

determine the usefulness and relevance 

of individual metrics for different 

activities, asset classes, and markets and 

the second year of the conformance 

period to test the metrics systems to 

validate the accuracy and relevance of 

metrics that are agreed upon the first 

year.2676 One commenter suggested a 

subset of metrics be rolled out gradually 

across trading units before 

implementing the full suite of metrics 

that are ultimately adopted or metrics 

could be rolled out one trading unit at 

a time.2677 Another commenter said the 

Agencies should identify key metrics 

that are clearly workable across all 

ranges of trading activity and most 

likely to provide useful data and require 

those metrics be implemented first and 

require other metrics to be phased in 

over time in consultation with the 

banking entity’s primary Federal 

regulator.2678 One commenter supported 

the heuristic approach of the proposal 

and suggested the Agencies should draw 

on resources and comment from the 

public and the industry in continuing 

the process of developing and building 

out metrics.2679

Another commenter requested that 

the final rule specify how trading assets 

and liabilities should be reported for 

savings and loan holding 

companies.2680 This commenter 

requested clarification that positions 

held for hedging or liquidity 

management purposes should not count 

as trading assets or liabilities for the $5 

billion threshold in Appendix A. 

Another commenter expressed concern 

that derivatives valuation may value 

derivatives substantially lower than 

their notional exposure and thereby 

make high reporting thresholds not 

meaningful or reflective of inherent 

risk.2681

Many commenters expressed concern 

that the smallest trading unit level was 

too low a level for collecting metrics 

data and suggested the final rule 

provide a higher reporting level.2682

These commenters stated that 

calculating at too low of a level would 

be more likely to generate false 

positives2683 and would be burdensome, 

particularly for firms with large trading 

operations.2684 In addition, some 

commenters indicated that it would be 

problematic if the definition of ‘‘trading 

unit’’ is applied at a legal entity level 

and cannot be applied across multiple 

legal entities within the same affiliate 

group.2685 By contrast, two commenters 

supported the collection of metrics at 

the trading desk level and appropriate 

levels above the trading desk.2686 One of 

these commenters expressed concern 

that the rule allowed for an 

inappropriately large trading desk unit 

that could combine significantly 

unrelated trading desks, which would 

impede detection of proprietary trading 

and supported measurements at 

multiple levels of organization to 

combat evasion concerns. 

In response to questions in the 

proposal about whether the Agencies 

should establish numerical thresholds 

for some or all of the proposed 

quantitative measurements, a number of 

commenters expressed opposition to 

establishing numerical thresholds for 

purposes of the rule,2687 while others 

stated that thresholds should be 

established over time.2688 In opposition 

of thresholds, one commenter expressed 

concern that numerical thresholds could 

be easily abused and evaded and may 

need to be constantly revised and 

updated as financial markets evolve.2689

In addition, another commenter stated 

that numerical thresholds should not be 

imposed because metric levels will 

differ by asset class and type of 

activity.2690 A few commenters 

suggested that numerical thresholds, 

based on the specific asset class or 

market, would be useful to provide 

clarity or consistency about the types of 

activity that are permitted under the 

rule.2691 Two commenters expressed 

support for banking entities establishing 

numerical thresholds, in consultation 

with the relevant regulator, for different 

trading units based on differences 

between markets and asset classes.2692

c. Approach of the Final Rule 

As explained below, the Agencies 

have reduced the number of metrics that 

banking entities must report under 

Appendix A from the 17 metrics in the 

proposal to 7 metrics in the final rule. 

The final rule also increases the level of 

activity that is required to trigger 

mandatory reporting of metrics data and 

phases in the reporting requirement 

over time. 

Under the final rule, a banking entity 

engaged in significant trading activity as 

defined by § 75.20 must furnish the 

following quantitative measurements for 

each of its trading desks engaged in 

covered trading activity calculated in 

accordance with Appendix A: 

• Risk and Position Limits and Usage; 

• Risk Factor Sensitivities; 

• Value-at-Risk and Stress VaR; 

• Comprehensive Profit and Loss 

Attribution; 

• Inventory Turnover; 

• Inventory Aging; and 

• Customer Facing Trade Ratio. 

In response to comments, the final 

rule raises the threshold for metrics 

reporting from the proposal to capture 

only firms that engage in significant 

trading activity, identified at specified 

aggregate trading asset and liability 

thresholds, and delays the dates for 

reporting metrics through a phased-in 


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2693As noted above, a number of commenters 

suggested setting a higher threshold than the 

proposed $1 billion and $5 billion trading asset and 

liability thresholds because even thresholds of $10 

billion to $50 billion would capture a significant 

percentage of the total trading assets and liabilities 

in the banking system. See ABA (Keating); M&T 

Bank; PNC et al.; State Street (Feb. 2012). The 

Agencies believe that the phase-in approach to the 

metrics requirement established in the final rule 

should generally address commenters’ concerns 

about the implementation timeframe by providing 

time for analysis, development of systems (if 

needed), and implementation of the quantitative 

measurements requirement. See, e.g., BoA; 

Barclays; Citigroup (Feb. 2012); Goldman (Prop. 

Trading); JPMC; Morgan Stanley; SIFMA et al. 

(Prop. Trading) (Feb. 2012); UBS; Stephen Roach; 

Credit Suisse (Seidel); Wells Fargo (Prop. Trading). 

The Agencies are establishing a phase-in approach, 

rather than requiring all banking entities above the 

$10 billion threshold to report metrics within the 

same timeframe, to strike a balance between the 

benefits of receiving data to help monitor 

compliance with the rule against the need for time 

to assess the effectiveness and usefulness of the 

quantitative measurements in practice and for some 

firms to develop additional systems for purposes of 

this requirement. 

2694Consistent with certain commenters’ 

requests, the final rule generally requires less 

frequent reporting than was proposed. However, the 

Agencies continue to believe that monthly reporting 

is appropriate for the largest banking entities above 

the $50 billion threshold. More frequent reporting 

for these firms is appropriate to allow for more 

effective supervision of their large-scale trading 

operations. See JPMC; Stephen Roach. 

2695See final rule § 75.20(d)(3). The final rule 

includes a shorter period of time for reporting 

quantitative measurements after the end of the 

relevant period than was proposed for the largest 

banking entities. Like the monthly reporting 

requirement for these firms, this is intended to 

allow for more effective supervision of their largescale trading operations. 

2696See final rule § 75.3(e)(13); see also supra 

Parts VI.A.2.c.1.c.ii. and VI.A.3.c.1.c.i. 

2697See Wellington; CalPERS; John Reed. 

approach based on the size of trading 

assets and liabilities.2693 Banking 

entities that meet the relevant 

thresholds must collect and report 

metrics for all trading desks engaged in 

covered trading activity beginning on 

the dates established in § 75.20 of the 

final rule. Specifically, the Agencies 

have delayed the reporting of metrics 

until June 30, 2014 for the largest 

banking entities that, together with their 

affiliates and subsidiaries, have trading 

assets and liabilities the average gross 

sum of which equal or exceed $50 

billion on a worldwide consolidated 

basis over the previous four calendar 

quarters (excluding trading assets and 

liabilities involving obligations of or 

guaranteed by the United States or any 

agency of the United States). Banking 

entities with less than $50 billion and 

greater than or equal to $25 billion in 

trading assets and liabilities and 

banking entities with less than $25 

billion and greater than or equal to $10 

billion in trading assets and liabilities 

would also be required to report these 

metrics beginning on April 30, 2016, 

and December 31, 2016, respectively. 

The Agencies believe that these delayed 

dates for reporting metrics should allow 

firms adequate time to develop systems 

to calculate and report the quantitative 

metrics. The Agencies will review the 

data collected and revise this collection 

requirement as appropriate based on a 

review of the data collected prior to 

September 30, 2015. 

Under the final rule, a banking entity 

required to report metrics must 

calculate any applicable quantitative 

measurement for each trading day. Each 

banking entity required to report must 

report each applicable quantitative 

measurement to its primary supervisory 

Agency on the reporting schedule 

established in § 75.20 unless otherwise 

requested by the primary supervisory 

Agency for the entity. The largest 

banking entities with $50 billion or 

greater in trading assets and liabilities 

must report the metrics on a monthly 

basis. Other banking entities required to 

report metrics must do so on a quarterly 

basis.2694 All quantitative measurements 

for any calendar month must be 

reported no later than 10 days after the 

end of the calendar month required by 

§ 75.20, unless another time is requested 

by the primary supervisory Agency for 

the entity except for a preliminary 

period when reporting will be required 

no later than 30 days after the end of the 

calendar month. Banking entities 

subject to quarterly reporting will be 

required to report quantitative 

measurements within 30 days of the end 

of the quarter, unless another time is 

requested by the primary supervisory 

Agency for the entity in writing.2695

The Agencies believe that together the 

reduced number of metrics, the higher 

thresholds for reporting metrics, 

delayed reporting dates, and modified 

reporting frequency reduce the costs 

and burden from the proposal while 

allowing collection of data to permit 

better monitoring of compliance with 

section 13 of the BHC Act. The Agencies 

also believe that the delayed dates for 

reporting quantitative metrics will 

provide banking entities with the time 

to develop systems to calculate and 

report these metrics. The Agencies are 

not applying these reporting and 

recordkeeping requirements to banking 

entities with smaller amounts of trading 

activity, as it appears that the more 

limited benefits of applying these 

requirements to banking entities with 

lower levels of trading activities, which 

represent entities that are typically 

small, less complex, and easier to 

supervise, would not justify the burden 

associated with complying with the 

reporting and recordkeeping 

requirements of Appendix A. 

The final rule defines ‘‘trading desk’’ 

to replace the concept of ‘‘trading unit’’ 

in the proposal.2696 Under the final rule, 

trading desk means the smallest discrete 

unit of organization of a banking entity 

that buys or sells financial instruments 

for the trading account of the banking 

entity or an affiliate thereof. The 

Agencies believe that applying 

quantitative measurements to a level 

that aggregates a variety of distinct 

trading activities may obscure or 

‘‘smooth’’ differences between distinct 

lines of business, asset categories and 

risk management processes in a way 

that renders the measurement relatively 

uninformative because it does not 

adequately reflect the specific 

characteristics of the trading activities 

being conducted. 

While the Agencies recognize that 

applying quantitative measurements at 

the trading desk level may result in 

some ‘‘noise’’ in the data and false 

positives, the Agencies believe it is 

necessary to apply the quantitative 

measurements at the trading desk level 

to enhance consistency with other 

provisions of the final rule. For 

example, because the requirements of 

the market-making exemption apply at 

the trading desk level of organization, 

the Agencies believe quantitative 

measurements used to monitor a 

banking entity’s market making-related 

activities should also calculated, 

reported, and recorded at the trading 

desk level. In response to commenters’ 

concerns that trading desk level 

measurements are more likely to 

generate false positives, the Agencies 

emphasize that quantitative 

measurements will not be used as a 

dispositive tool for determining 

compliance and, rather, will be used to 

monitor patterns and identify activity 

that may warrant further review. 

Like the proposal, the final rule does 

not include specific numerical 

thresholds. Commenters did not suggest 

specific thresholds for particular metrics 

or provide data and analysis that would 

support particular thresholds.2697 Given 

the range of financial instruments and 

trading activity covered by the final 

rule, as well as potential differences 

among banking entities’ organizational 

structures, trading strategies, and level 

of presence in a particular market, the 

Agencies are concerned that numerical 

thresholds for specific metrics would 

not account for these differences and 

could inappropriately constrain 


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6038 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

2698See SIFMA et al. (Prop. Trading) (Feb. 2012). 

2699See Goldman (Prop. Trading); Barclays. See 

also final rule Appendix B. 

2700See, e.g., AFR et al. (Feb. 2012); Barclays; 

Citigroup (Feb. 2012); Prof. Duffie; Goldman (Prop. 

Trading); Invesco; JPMC; Occupy; Public Citizen; 

see also BNY Mellon et al. (suggesting the use of 

VaR measures for foreign exchange trading activity). 

2701See, e.g., Citigroup (Feb. 2012); Prof. Duffie; 

Goldman (Prop. Trading); Invesco; Public Citizen. 

2702See Goldman (Prop. Trading). 

2703See Prof. Duffie. 

2704See Occupy. 

2705See Occupy. 

2706See JPMC; State Street (Feb. 2012); see also 

BoA; CH/ABASA. For instance, one of these 

commenters stated that the proposed reliance on 

VaR and Stress VaR to demonstrate bona fide 

hedging is misleading for ALM activities due to the 

typical accounting asymmetry in ALM where, for 

example, managed liabilities such as deposits are 

not mark-to-market but the corresponding hedge 

may be. See State Street (Feb. 2012). 

2707See Public Citizen. 

2708See AFR et al. (Feb. 2012); Public Citizen. 

legitimate activity.2698 Further, 

mandated thresholds for the metrics 

would not recognize the impact 

changing market conditions may have 

on a given trading desk’s quantitative 

measurements. Consistent with two 

commenters’ suggested approach, 

banking entities will be required to 

establish their own numerical 

thresholds for quantitative 

measurements under the enhanced 

compliance program requirement in 

Appendix B.2699

d. Proposed Quantitative Measurements 

and Comments on Specific Metrics 

Section IV of proposed Appendix A 

described, in detail, the individual 

quantitative measurements that must be 

furnished. These measurements were 

grouped into the following five broad 

categories, each of which is described in 

more detail below: 

• Risk-management measurements— 

VaR, Stress VaR, VaR Exceedance, Risk 

Factor Sensitivities, and Risk and 

Position Limits; 

• Source-of-revenue measurements— 

Comprehensive Profit and Loss, 

Portfolio Profit and Loss, Fee Income 

and Expense, Spread Profit and Loss, 

and Comprehensive Profit and Loss 

Attribution; 

• Revenues-relative-to-risk 

measurements—Volatility of 

Comprehensive Profit and Loss, 

Volatility of Portfolio Profit and Loss, 

Comprehensive Profit and Loss to 

Volatility Ratio, Portfolio Profit and 

Loss to Volatility Ratio, Unprofitable 

Trading Days based on Comprehensive 

Profit and Loss, Unprofitable Trading 

Days based on Portfolio Profit and Loss, 

Skewness of Portfolio Profit and Loss, 

and Kurtosis of Portfolio Profit and 

Loss; 

• Customer-facing activity 

measurements—Inventory Turnover, 

Inventory Aging, and Customer-facing 

Trade Ratio; and 

• Payment of fees, commissions, and 

spreads measurements—Pay-to-Receive 

Spread Ratio. 

The Agencies proposed these 

quantitative measurements because, 

taken together, these measurements 

appeared useful for understanding the 

context in which trading activities occur 

and identifying activities that may 

warrant additional scrutiny to 

determine whether these activities 

involve prohibited proprietary trading 

because the trading activity either is 

inconsistent with permitted market 

making-related activities or presents a 

material exposure to high-risk assets or 

high-risk trading strategies. As 

described below, different quantitative 

measurements were proposed to 

identify different aspects and 

characteristics of trading activity for the 

purpose of helping to identify 

prohibited proprietary trading, and the 

Agencies stated in the proposal that 

they expected that the quantitative 

measurements would be most useful for 

this purpose when implemented and 

reviewed collectively, rather than in 

isolation. The Agencies stated in the 

proposal that they believed that, in the 

aggregate, many banking entities already 

collect and review many of these 

measurements as part of their risk 

management activities, and stated that 

they expected that many of the 

quantitative measurements proposed 

would be readily computed and 

monitored at the multiple levels of 

organization included in proposed 

Appendix A’s definition of ‘‘trading 

unit,’’ to which they would apply. 

Under the proposal, the first set of 

quantitative measurements related to 

risk management, and included VaR, 

Stress VaR, VaR Exceedance, Risk 

Factor Sensitivities, and Risk and 

Position Limits. Commenters generally 

supported the use of risk-management 

metrics as the most important measure 

of compliance, indicating that these 

metrics could potentially provide useful 

supervisory information.2700

In general, commenters supported the 

use of the VaR metric.2701 One of these 

commenters argued that VaR was not 

particularly indicative of proprietary 

trading, but could be helpful to reveal 

a trading unit’s overall size and risk 

profile.2702 Another commenter 

indicated that significant, abrupt or 

inconsistent changes to VaR may need 

to be absorbed by market makers who 

absorb large demand and supply shocks 

into their inventories.2703 This 

commenter contended that the six 

largest bank holding companies had 

proprietary trading losses that 

frequently exceeded their VaR estimates 

and the design and supervision of such 

risk measures should be revisited. 

One commenter argued that the 

definition of VaR was not made clear in 

the proposal and was missing some 

important information regarding 

methodology as VaR methodologies 

tend to vary among banking entities.2704

This commenter recommended the 

development of a standard methodology 

by the OFR including a central 

repository for historical calculation data 

for each asset for the purpose of 

ensuring standard calculation across the 

industry. This commenter also 

expressed concern that VaR calculations 

are heavily reliant on the quality of 

input data and stated that many markets 

are unable to provide sufficient 

information such that VaR calculations 

are meaningful, including markets for 

illiquid products for which accurate 

historical price and market information 

is sparse and could severely under 

represent true potential losses under 

VaR calculations.2705

A few commenters expressed concern 

about the applicability of VaR when 

applied to ALM activities.2706 These 

commenters argued that risk 

management metrics such as VaR would 

not help to distinguish ALM and valid 

risk mitigating hedging activities from 

prohibited proprietary trading. For 

instance, one of these commenters 

stated that the proposed reliance on VaR 

and Stress VaR to demonstrate bona fide 

hedging is misleading for ALM activities 

due to the typical accounting 

asymmetry in ALM where, for example, 

managed liabilities such as deposits are 

not marked to market but the 

corresponding hedge may be. 

One commenter argued that the use of 

stress VaR would be important to guard 

against excessive risk taking.2707 A few 

commenters suggested that additional 

guidance be provided for Stress VaR 

including linking it to the broader stress 

testing regime and based on extreme 

conditions that are not based on historic 

precedent.2708 These commenters also 

argued that a one-day holding period 

assumption is inadequate, especially for 

less liquid asset classes, and 

recommended that stress be measured 

over a longer period. One commenter 

argued that Stress VaR should be 

removed from the list of required 

metrics as it is not in regular use for 

day-to-day risk management and 

provides little relevant information 

about the intent or proportionality 


emcdonald on DSK67QTVN1PROD with RULES3
Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 6039 

2709See JPMC. 

2710See ABA (Keating); Barclays; Goldman (Prop. 

Trading); SIFMA et al. (Prop. Trading) (Feb. 2012); 

Wells Fargo (Prop. Trading); UBS. 

2711See Occupy. 

2712See Citigroup (Feb. 2012). 

2713See SIFMA et al. (Prop. Trading) (Feb. 2012). 

2714See Citigroup (Feb. 2012); Prof. Duffie; 

Occupy. 

2715See Goldman (Prop. Trading). 

2716See Occupy. 

2717See Occupy. 

2718See Occupy. 

2719See, e.g., Barclays; Citigroup (Feb. 2012); 

Prof. Duffie; Goldman (Prop. Trading). 

2720See Barclays. 

2721See Occupy. 

2722See, e.g., AFR et al. (Feb. 2012); Barclays; 

Citigroup (Feb. 2012); Prof. Duffie; Goldman (Prop. 

Trading); Invesco; JPMC; Occupy; Public Citizen; 

see also Northern Trust; State Street (Feb. 2012). 

2723See ABA (Keating); Barclays; Goldman (Prop. 

Trading); SIFMA et al. (Prop. Trading) (Feb. 2012); 

Wells Fargo (Prop. Trading); UBS. 

2724See Joint Proposal, 76 FR at 68887. 

2725The Agencies believe this clarification 

responds to one commenter’s question regarding 

how risk and position limits will be used and 

assessed for purposes of the rule. See Occupy. 

2726See Joint Proposal, 76 FR at 68887. 

between risk assumed and client 

demands.2709

A number of commenters requested 

that VaR Exceedance be removed from 

the list of metrics. These commenters 

argued that the primary function of VaR 

Exceedance is to analyze the quality of 

a VaR model and that VaR backtesting 

is already reported to regulators as part 

of the supervisory process. These 

commenters argued that VaR 

Exceedance does not reveal trading 

intent or actual risk taken.2710 One 

commenter argued that VaR Exceedance 

may be useful to the Agencies as an 

indicator of the quality of the VaR 

measure relative to the profit and loss of 

the trading unit but that a more rigorous 

back-testing process would serve as a 

better analytical tool than VaR 

Exceedance to evaluate the quality of 

the VaR model result and should be 

included as an additional metric.2711

One commenter suggested that riskbased metrics should measure risk as a 

function of capital.2712 Another 

commenter warned that risk metrics 

could be significantly higher during 

times of market stress and volatility 

than during normal times.2713

A few commenters expressed support 

for risk factor sensitivities as useful, 

supervisory information.2714 One of 

these commenters suggested that risk 

factor sensitivities could orient 

regulators to a trading unit’s overall size 

and risk profile,2715 while another 

commenter stated that risk factor 

sensitivities would be the most useful 

tool for identifying the accumulation of 

market risk in different areas of a 

banking entity.2716 One commenter 

suggested that several risk factor 

sensitivity snapshots be taken 

throughout the day with an average 

value reported at the end of day.2717

This commenter also recommended that 

trading strategies that rely heavily on 

models to calculate risk exposures (e.g., 

correlation trading portfolios), should 

trigger additional disclosures in risk 

factor sensitivity reporting.2718

Commenters also supported risk and 

position limits as providing useful, 

supervisory information. Several 

commenters indicated that these limits 

could be helpful to orient regulators to 

a trading unit’s overall size and risk 

profile.2719 Another commenter 

expressed the view risk and position 

limits are the most comprehensive 

measures of risk taking and incorporate 

VaR, Stress VaR, and Risk Factor 

Sensitivities.2720 A different commenter 

argued it was unclear how position 

limits are in fact a quantitative metric 

and not a description of a banking 

entity’s internal risk policies.2721

After carefully considering the 

comments received, the final rule 

retains the risk-management metrics 

other than VaR Exceedance. The 

collection of information regarding Risk 

and Position Limits, VaR, Stress VaR, 

and Risk Factor Sensitivities is 

consistent with the aim of providing a 

means of characterizing the overall risk 

profile of the trading activities of each 

trading desk and evaluating the extent 

to which the quantitative profile of a 

trading desk’s activities is consistent 

with permissible activities. Moreover, a 

number of commenters indicated that 

the risk management measures would be 

effective at achieving these goals.2722

The risk management measure that was 

not retained in the final rule, VaR 

Exceedance, was considered, in light of 

the comments, as not offering significant 

additional information on the overall 

risk profile and activities of the trading 

desk relative to the burden associated 

with computing, auditing and reporting 

it on an ongoing basis.2723

The risk-management measurements 

included in the final rule are widely 

used by banking entities to measure and 

manage trading risks and activities.2724

VaR, Stress VaR, and Risk Factor 

Sensitivities provide internal, modelbased 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. 

The provided description and 

calculation guidance for each of these 

measures is consistent with both current 

market practice and regulatory capital 

requirements for banks. The final rule 

does not provide a prescriptive 

definition of each of these 

measurements as these measures must 

be flexible enough to be tailored to the 

specific trading activities of each trading 

desk. Supervisory guidance and 

comparisons of these measures across 

similarly situated trading desks at a 

given entity as well as across entities 

will be used to ensure that the provided 

measurements conform to the 

description and calculation guidance 

provided in Appendix A. Risk and 

Position Limits and Usage provide an 

explicit assessment of management’s 

expectation of how much risk is 

required to perform permitted marketmaking, underwriting and hedging 

activities. The final rule requires that 

the usage of each risk and position limit 

be reported so that the risk taking by 

each trading desk can be monitored and 

assessed on an ongoing basis.2725

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.2726 In the 

context of permitted market makingrelated activities, these risk management 

measures are useful in assessing 

whether the actual risk taken is 

consistent with the level of principal 

risk that a banking entity must retain in 

order to service the near-term demands 

of customers. Significant, abrupt or 

inconsistent changes to key risk 

management measures, such as VaR, 

that are inconsistent with prior 

experience, the experience of similarly 

situated trading desks and 

management’s stated expectations for 

such measures may indicate 

impermissible proprietary trading, and 

may warrant further review. In addition, 

indicators of unanticipated or unusual 

levels of risk taken, such as breaches of 

internal Risk and Position Limits, may 

suggest behavior that is inconsistent 

with appropriate levels of risk and may 

warrant further scrutiny. The limits 

required under § 75.4(b)(2)(iii) and 

§ 75.5(b)(1)(i) must meet the applicable 

requirements under § 75.4(b)(2)(iii) and 

§ 75.5(b)(1)(i) and also must include 

appropriate metrics for the trading desk 

limits including, at a minimum, the 

‘‘Risk Factor Sensitivities’’ and ‘‘Valueat-Risk and Stress Value-at-Risk’’ 

metrics except to the extent any of the 

‘‘Risk Factor Sensitivities’’ or ‘‘Value-atRisk and Stress Value-at-Risk’’ metrics 

are demonstrably ineffective for 

measuring and monitoring the risks of a 


emcdonald on DSK67QTVN1PROD with RULES3
6040 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

2727See Goldman (Prop. Trading); Japanese 

Bankers Ass’n; Occupy; see also Barclays. 

2728See supra Part VI.A.3.c.7.b. 

2729See SIFMA (May 2012). 

2730See AFR (Nov. 2012). 

2731See Occupy. 

2732See Barclays. 

2733See Public Citizen. 

2734See NYSE Euronext. 

2735See Goldman (Prop. Trading); Japanese 

Bankers Ass’n; Occupy. 

2736See Goldman (Prop. Trading). 

2737See Occupy. 

2738See Goldman (Prop. Trading); Japanese 

Bankers Ass’n; Occupy. 

2739See Goldman (Prop. Trading). This 

commenter urged that fee income and expense 

should be considered together with Spread P&L 

arguing that these two both measures of customer 

revenues and, in practice, may function as 

substitutes for each other. 

2740See Occupy. 

2741See Northern Trust. 

2742See, e.g., Goldman (Prop. Trading); JPMC; 

UBS. 

2743See Goldman (Prop. Trading). 

2744See Goldman (Prop. Trading); see also Paul 

Volcker (supporting a metric considering the extent 

to which earnings are generated by pricing spreads 

rather than changes in price). 

2745See JPMC; UBS; see also SIFMA et al. (Prop. 

Trading) (Feb. 2012). 2746See ABA et al.; BoA; Barclays; Credit Suisse 

(Seidel); Japanese Bankers Ass’n; Northern Trust; 

SIFMA et al. (Prop. Trading) (Feb. 2012); Wells 

Fargo (Prop. Trading); see also AFR et al. (Feb. 

2012); Occupy. 

2747See Barclays; Occupy. 

2748See BOK; Goldman (Prop. Trading); SIFMA et 

al. (Prop Trading) (Feb. 2012); Wells Fargo (Prop. 

Trading). 

2749See SIFMA et al. (Prop Trading) (Feb. 2012). 

trading desk based on the types of 

positions traded by, and risk exposures 

of, that desk. 

Under the proposal, the second set of 

quantitative measurements related to 

the source of revenues, and included 

Comprehensive Profit and Loss, 

Portfolio Profit and Loss, Fee Income, 

Spread Profit and Loss, and 

Comprehensive Profit and Loss 

Attribution. A few commenters 

expressed support for Comprehensive 

Profit and Loss as a reasonable 

contextual metric and contended that 

the metric could inform the analysis of 

whether market-making revenues are 

from customer transactions.2727

As described above, a number of 

commenters expressed concern about a 

focus on revenues as part of evaluating 

market-making.2728 For instance, one 

commenter argued that the rule should 

not require, even in guidance, that 

market making-related permitted 

activities be ‘‘designed to generate 

revenues from fees, commissions, bidasks spreads or other income,’’ arguing 

that this prejudges appropriate results 

for revenue metrics and implies that a 

bona fide market maker is not permitted 

to benefit from revenues from market 

movements.2729 One commenter 

expressed concern that the source-ofrevenue metrics are subject to 

manipulation as these metrics depend 

on correctly classifying revenue into 

market bid-ask spreads as opposed to 

other sources of revenue.2730 One 

commenter stated that this metric 

should serve as a secondary indication 

of risk levels because it could be subject 

to manipulation.2731 Another 

commenter recommended use of the 

sub-metric in Comprehensive P&L 

Attribution.2732 A different commenter 

recommended the adoption of clearer 

metrics to distinguish customer 

revenues from revenues from price 

movements.2733 One commenter 

indicated that after-the-fact application 

of quantitative measurements such as 

Comprehensive Profit and Loss may 

cause firms to reconsider their 

commitment to market making and 

recommended that, to the extent this 

metric is used, it should be applied 

flexibly in light of market conditions 

prevailing during the relevant time 

period, and as one of many factors 

relevant to an overall assessment of 

bona fide market making.2734

A few commenters supported 

Portfolio Profit and Loss as a reasonable 

contextual metric to inform whether 

revenues from market-making 

transactions are from customer 

transactions.2735 However, one of these 

commenters argued that this metric 

would not necessarily be indicative of 

prohibited proprietary trading and 

profits may reflect bona fide market 

making-related, underwriting, and 

hedging activities.2736 Another 

commenter argued that this metric 

should serve as a secondary indication 

of risk levels and may be subject to 

manipulation.2737

Some commenters felt that Fee 

Income and Expense was a useful 

metric.2738 One of these commenters 

argued this metric has the potential to 

help distinguish permitted activities 

from prohibited proprietary trading.2739

Another commenter felt this metric 

would be useful in liquid markets that 

trade with the convention of fees and 

commissions but less useful, but still 

indicative, in other markets that use 

inter-dealer brokers to conduct clientrelated activities.2740 One commenter 

argued that it would be impracticable to 

produce Fee Income and Expense data 

for foreign exchange trading, which is 

predominantly based on bid/offer 

spread.2741

A few commenters thought that 

Spread P&L could be useful.2742 One of 

these commenters argued that Spread 

P&L has the potential to help 

distinguish permitted activities from 

prohibited proprietary trading.2743 This 

commenter suggested that the final rule 

remove the proposal’s revenue 

requirement as part of market-making 

and instead rely on revenue metrics 

such as Spread P&L.2744 This 

commenter argued, however, that it will 

not always be clear how to best 

calculate Spread P&L and it would be 

critical for the Agencies to be flexible 

and work with banking entities to 

determine the appropriate proxies for 

spreads on an asset-class-by-asset class 

and trading desk-by-trading-desk basis. 

One commenter contended that the 

proposed implementation in the 

proposal was more difficult than 

necessary and suggested End of Day 

Spread Proxy is sufficient. Another 

commenter suggested expanding the 

flexibility offered in choosing a bid-offer 

source to calculate Spread P&L.2745

However, the majority of commenters 

recommended removal of Spread P&L as 

a metric.2746 These commenters argued 

that a meaningful measure for Spread 

P&L cannot be calculated in the absence 

of a continuous bid-ask spread, making 

this metric misleading especially for 

illiquid positions and shallow markets. 

A few commenters generally 

expressed support for the inclusion of 

Comprehensive Profit and Loss 

Attribution.2747 One of these 

commenters stated that this metric was 

the most comprehensive metric for 

measuring sources of revenue and 

included other metrics as sub-metrics, 

such as Comprehensive Profit and Loss, 

Portfolio Profit and Loss, and Fee 

Income and Expense. Another 

commenter contended the mention of 

‘‘customer spreads’’ and ‘‘bid-ask 

spreads’’ was unclear and that both of 

these terms should be removed from the 

calculation guidance. Other commenters 

argued that the benefits of this metric do 

not justify the costs of generating a 

report of Comprehensive P&L 

Attribution on a daily basis.2748 One 

commenter urged the Agencies to 

ensure that each institution be 

permitted to calculate this metric in a 

way that reflects the institution’s unique 

characteristics.2749

After carefully considering the 

comments received, the final rule 

maintains only a modified version of 

Comprehensive P&L Attribution metric 

and does not retain the proposed 

Comprehensive Profit and Loss, 

Portfolio Profit and Loss, Fee Income, or 

Spread Profit and Loss metrics. The 

final rule also requires volatility of 

comprehensive profit and loss to be 

reported. As pointed out by a number of 


emcdonald on DSK67QTVN1PROD with RULES3
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2750See Barclays. 

2751See JPMC; UBS; SIFMA et al. (Prop Trading) 

(Feb. 2012); ABA (Keating); BoA; Barclays; Credit 

Suisse (Seidel). 

2752See BoA. 

2753See supra Part VI.A.3.c.7.c. 

2754See, e.g., Goldman (Prop. Trading); Volcker; 

John S. Reed; see also AFR et al. (Feb. 2012); Sen. 

Merkley; Occupy; Public Citizen. 

2755See Occupy; Public Citizen; Sen. Merkley. 

2756See Goldman (Prop. Trading) (also suggesting 

that New Trades P&L be substituted for Portfolio 

P&L in Comprehensive Profit and Loss to Volatility 

Ratio and Portfolio Profit and Loss to Volatility 

Ratio and Unprofitable Trading Days based on 

Comprehensive Profit and Loss and Unprofitable 

Trading Days based on Portfolio Profit and Loss). 

2757See Barclays. 

2758See NYSE Euronext. 

2759See AFR et al. (Feb. 2012). 

2760See Occupy. 

2761See Barclays. 

2762See Barclays. 

2763See Goldman (Prop. Trading). 

commenters, Comprehensive Profit and 

Loss Attribution provides a holistic 

attribution of each trading desk’s profit 

and loss and contains much of the 

information content that is provided by 

many of the other metrics, such as Fee 

Income and Expense.2750 Accordingly, 

the use of Comprehensive Profit and 

Loss Attribution in the final rule greatly 

simplifies the metric reporting 

requirement and reduces burden while 

retaining much of the information and 

analysis that was provided in the full set 

of five metrics that were contained in 

the proposal. In addition, in response to 

commenters’ concerns about the 

burdens of separately identifying 

specific revenue sources (e.g., revenues 

from bid-ask spreads, revenues from 

price appreciation), the Agencies have 

modified the focus of the proposed 

source of revenue metrics to focus on 

when revenues are generated, rather 

than the specific sources of revenue.2751

This approach should also help address 

one commenter’s concern about the 

need for new, sophisticated systems to 

differentiate bid-ask spreads from price 

appreciation.2752 The utility of this 

modified approach is discussed in more 

detail in the discussion of the marketmaking exemption.2753 Finally, the 

Comprehensive Profit and Loss 

Attribution metric will ensure that all 

components of a trading desk’s profit 

and loss are measured in a consistent 

and comprehensive fashion so that each 

individual component can be reliably 

compared against other components of a 

trading desk’s profit and loss without 

being considered in isolation or taken 

out of context. 

This measurement is intended to 

capture the extent, scope, and type of 

profits and losses generated by trading 

activities and provide important context 

for understanding how revenue is 

generated by trading activities. Because 

permitted market making-related 

activities seek to generate profits by 

providing customers with 

intermediation and related services 

while managing, and to the extent 

practicable minimizing, the risks 

associated with any asset or risk 

inventory required to meet customer 

demands, these revenue measurements 

would appear to provide helpful 

information to banking entities and the 

Agencies regarding whether actual 

revenues are consistent with these 

expectations. 

Under the proposal, the third set of 

measurements related to realized risks 

and revenue relative to realized risks, 

and includes Volatility of Profit and 

Loss, Comprehensive Profit and Loss to 

Volatility Ratio and Portfolio Profit and 

Loss to Volatility Ratio, Unprofitable 

Trading Days based on Comprehensive 

Profit and Loss and Unprofitable 

Trading Days based on Portfolio Profit 

and Loss, and Skewness of Portfolio 

Profit and Loss and Kurtosis of Portfolio 

Profit and Loss. 

A few commenters indicated support 

for these metrics as appropriate, 

contextual metrics.2754 These 

commenters indicated that these metrics 

may serve to highlight areas requiring 

further investigation, since high P&L 

volatility may indicate a deviation from 

traditional client related activities and 

that a well-structured trading operation 

should be able to obtain relatively high 

ratios of revenue-to-risk (as measured by 

various metrics), low volatility, and 

relatively high turnover.2755 One 

commenter recommended that New 

Trades P&L be substituted for Portfolio 

P&L for purposes of computing 

Volatility of P&L because New Trades 

P&L captures customer revenues more 

completely and is therefore more useful 

for distinguishing market making from 

proprietary trading.2756 Another 

commenter indicated that Skewness of 

Portfolio Profit and Loss and Kurtosis of 

Portfolio Profit and Loss incorporates 

(and therefore obviates the need for a 

separate calculation of) the metric 

Volatility of Portfolio Profit and 

Loss.2757

One commenter urged that after-thefact application of Comprehensive Profit 

and Loss to Volatility Ratio may cause 

firms to reconsider their commitment to 

market making and argued that this 

metric should be applied flexibly in 

light of market conditions prevailing 

during the relevant time period and as 

one of many factors relevant to an 

assessment of overall bona fide market 

making.2758 One commenter supported 

monitoring Portfolio Profit and Loss to 

Volatility Ratio and argued that the 

Agencies should establish a clear 

pattern of profit and loss results of 

individual trading units through 

iterative application of the metrics.2759

One commenter expressed support for 

Unprofitable Trading Days based on 

Comprehensive Profit and Loss and 

Unprofitable Trading Days based on 

Portfolio Profit and Loss indicating that 

these metrics may serve to highlight 

areas requiring further investigation, 

since a significant number of 

unprofitable trading days may indicate 

a deviation from traditional clientrelated activities.2760 Another 

commenter suggested that these metrics 

be removed as they would result in 

market makers being less likely to take 

client-facing positions due to reluctance 

to incur unprofitable trading days that 

could indicate the presence of 

impermissible activity despite the 

utility of such trades in providing 

liquidity to customers.2761

One commenter requested including 

Skewness of Portfolio Profit and Loss 

and Kurtosis of Portfolio Profit and Loss 

in the metrics set as the most 

comprehensive metric in the revenuerelative-to-risk category making other 

metrics unnecessary in this area.2762

Another commenter argued that this 

metric would produce inconsistent 

results within and across trading units 

and would generally not support any 

meaningful conclusions regarding the 

permissibility or risk of trading 

activities.2763

After carefully considering the 

comments received, the final rule does 

not include any of the proposed 

revenue-relative-to-risk measurements. 

Each of these measures provides 

information that may generally be useful 

for characterizing the overall risk profile 

of the trading activities of each trading 

unit and evaluating the extent to which 

the quantitative profile of a trading 

unit’s activities is consistent with 

permissible trading activities. The broad 

information content of these measures, 

however, can largely be reproduced 

from transformations of information that 

will be provided in the Comprehensive 

Profit and Loss Attribution and, as 

noted above, volatility of 

comprehensive profit and loss must be 

reported. Analogs to the other metrics 

such as Skewness of Portfolio Profit and 

Loss and Kurtosis of Portfolio Profit and 

Loss can be computed similarly from 

information that will be provided in the 

Comprehensive Profit and Loss 

Attribution. Accordingly, the 

information contained in these metrics 


emcdonald on DSK67QTVN1PROD with RULES3
6042 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

2764See Goldman (Prop. Trading); Barclays; John 

Reed; JPMC; SIFMA et al. (Prop. Trading) (Feb. 

2012); Wells Fargo (Prop. Trading). 

2765See Barclays. 

2766See Goldman (Prop. Trading). 

2767See, e.g., Barclays; Goldman (Prop. Trading); 

JPMC; John Reed. 

2768See Goldman (Prop. Trading); JPMC; SIFMA 

et al. (Prop. Trading) (Feb. 2012); see also Morgan 

Stanley. 

2769See Japanese Bankers Ass’n; SIFMA (Asset 

Mgmt.) (Feb. 2012); Morgan Stanley. 

2770See Barclays; see also Invesco. 

2771See Barclays; Goldman (Prop. Trading); 

Japanese Bankers Ass’n; Morgan Stanley; SIFMA 

(Prop. Trading) (Feb. 2012). 

2772See Goldman (Prop. Trading). 

2773See Socie ́te ́ Ge ́ne ́rale. 

2774See Goldman (Prop. Trading); see also 

Invesco. 

2775See Barclays; Goldman (Prop. Trading) ; 

JPMC; SIFMA (Prop. Trading) (Feb. 2012); UBS. 

2776See Occupy. 

2777See Wells Fargo (Prop. Trading). 

2778See SIFMA (Prop. Trading) (Feb. 2012). 

2779See SIFMA (Prop. Trading) (Feb. 2012); see 

also Goldman (Prop Trading). 

2780See Barclays; Japanese Bankers Ass’n; Oliver 

Wyman (Dec. 2011); SIFMA (Prop. Trading) (Feb. 

2012). 

2781See Barclays; Wells Fargo (Prop. Trading). 

2782See Goldman (Prop. Trading); JPMC; SIFMA 

(Prop. Trading) (Feb. 2012). 

is retained in the final rule while the 

burden associated with computing, 

auditing and reporting these additional 

metrics on an ongoing basis has been 

eliminated. 

Under the proposal, the fourth set of 

quantitative measurements related to 

customer-facing activity measurements. 

These metrics include Inventory Risk 

Turnover, Inventory Aging, and 

Customer-facing Trade Ratio. 

A few commenters supported the 

proposal’s Inventory Risk Turnover 

metric though some of these 

commenters suggested modifications to 

the metric.2764 One commenter argued 

that this metric could indicate whether 

a given trading unit holds risk and 

inventory consistently with the asset 

class in which such trading unit deals, 

the types of trading activity in which 

the trading unit engages, and the scale 

and scope of the client activity that such 

trading unit serves.2765 Another 

commenter argued that the final rule 

should explicitly state that a trading 

unit’s inventory management practices 

will be evaluated using this metric.2766

Some commenters expressed the view 

that this metric might be useful in the 

case of liquid positions but not in the 

case of illiquid or difficult-to-hedge 

products, which naturally have lower 

risk turnover. Others noted support for 

this metric tailored on an asset-by-asset 

basis.2767

A few commenters requested that the 

final rule clarify that this metric will not 

be required to be calculated for every 

possible Risk Factor Sensitivity 

measurement for the applicable 

portfolio and that a banking entity and 

its regulator should determine one or 

two core risk factors per asset classes 

with respect to which this metric that 

will be calculated to strike a reasonable 

balance between costs of calculations 

and benefits of this metric.2768 Other 

commenters argued the Inventory Risk 

Turnover Metric was difficult to 

measure, burdensome, and would create 

uncertainty for derivatives 

counterparties.2769

A few commenters supported the 

Inventory Aging metric. One commenter 

argued it should be included in the 

metrics set to indicate whether a given 

trading desk holds risk and inventory 

consistently within the asset class in 

which such trading desk deals, the type 

of trading activity in which the trading 

unit engages, and the scale and scope of 

the client activity that such trading desk 

serves.2770 This commenter suggested 

tailoring the metric based on the market 

for a particular asset class and market 

conditions because aging levels may be 

higher in less liquid markets. A number 

of commenters argued that application 

of the Inventory Aging metric is only 

appropriate for cash products and 

should not be used for trading units 

engaged in transactions in financial 

instruments such as derivatives.2771

Another commenter argued that the 

Inventory Aging metric is generally not 

useful for derivatives, and for nonderivatives it provides essentially 

similar information to Inventory Risk 

Turnover.2772 One commenter requested 

additional guidance on how to calculate 

this metric.2773

A few commenters indicated that the 

Customer-Facing Trade Ratio could be 

helpful in distinguishing prohibited 

proprietary trading from market making 

and would be more effective than the 

proposal’s negative presumption against 

interdealer trading to evaluate the 

amount of interdealer trading that is 

consistent with market making-related 

or hedging activity in a particular 

business.2774 Some commenters 

suggested that the metric could be 

improved and argued that the number of 

transactions executed over a calculation 

period does not provide an adequate 

measure for the level of customer-facing 

trading because it does not reflect the 

size of transactions or the amount of 

risk. These commenters suggested 

replacing the metric with a more risksensitive metric or defining the ratio so 

that it measures notional principal risk 

associated with customer transactions 

and is appropriately tailored to the 

relevant asset class or market.2775

A number of commenters raised 

concerns about the definition of 

customer for purposes of this metric. 

One commenter argued that a failure to 

define ‘‘customer’’ to differentiate 

between customers and non-customers 

would render this metric 

meaningless.2776 Another commenter 

contended that the metric would be 

appropriate as long as banking entities 

have the flexibility to determine who is 

a customer.2777 One commenter argued 

that using a definition of ‘‘customer’’ 

that is different between the market 

making-related activity and the reported 

metric could make legitimate market 

making-related activity with customers 

appear to be prohibited proprietary 

trading.2778 This commenter argued that 

other dealers and other registered 

market participants should be 

recognized as customers of the banking 

entity. A few commenters contended 

that this metric would be burdensome if 

it required a banking entity to tag 

individual trades as customer or noncustomer.2779 A few commenters argued 

that interdealer trading should be 

allowed as part of market making and 

argued this metric would not provide a 

useful measure of customer-facing 

activity.2780 Some commenters also 

expressed concern about the 

implications of such a metric for 

hedging activity, which may involve 

relatively less customer-facing 

activity.2781

After carefully considering the 

comments received, the final rule 

retains all three of the customer-facing 

activity measurements from the 

proposal, though each measure has been 

modified. A number of commenters 

raised issues regarding the complexities 

associated with computing the 

Inventory Risk Turnover metric. In 

particular, as noted above, some 

commenters argued that computing the 

metric for every reported risk factor 

sensitivity would be burdensome and 

would not be informative.2782 The 

inventory metric required in the final 

rule, Inventory Turnover, is applied at 

the transaction level and not at the risk 

factor sensitivity level. Accordingly, for 

a given trading desk and calculation 

period, e.g., 30 days, there is only one 

value of the Inventory Turnover metric 

rather than one value for each risk factor 

sensitivity that is managed and reported 

by the trading desk. In this sense, the 

turnover metric required in the final 

rule is similar to more traditional and 

common measures of inventory 

turnover. Moreover, the required 

turnover metric is simpler and less 

costly to track and record while still 


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2783The Agencies believe that this should address 

commenters’ uncertainty with respect to how the 

Inventory Risk Turnover metric would work for 

derivatives. See Japanese Bankers Ass’n; SIFMA 

(Asset Mgmt.) (Feb. 2012); Morgan Stanley. 

2784See Barclays; Goldman (Prop. Trading); 

Japanese Bankers Ass’n; Morgan Stanley; SIFMA 

(Prop. Trading) (Feb. 2012). 

2785See SIFMA (Prop. Trading) (Feb. 2012). 

2786See NYSE Euronext. 

2787See UBS. 

2788See CH/ABASA; Goldman (Prop. Trading); 

Japanese Bankers Ass’n; Occupy; SIFMA (Prop. 

Trading) (Feb. 2012); Wells Fargo (Prop. Trading). 2789See Morgan Stanley. 2790See Morgan Stanley. 2791See Prof. Duffie; Occupy. 2792See Occupy. 

providing banking entities and Agencies 

with meaningful information regarding 

the extent to which the size and volume 

of trading activities are directed at 

servicing the demands of customers. In 

addition, the description of Inventory 

Turnover in the final rule provides 

explicit guidance on how to apply the 

metric to derivative positions.2783

Inventory Aging provides banking 

entities and Agencies with meaningful 

information regarding the extent to 

which the size and volume of trading 

activities are directed at servicing the 

demands of customers. In the case of 

Inventory Aging, the proposal required 

that the aging schedule be organized 

according to a specific set of age ranges 

(i.e., 0–30 days, 30–60 days, 60–90 days, 

90–180 days, 180–360 days, and more 

than 360 days). This requirement has 

not been adopted in the final rule in 

order to provide greater flexibility and 

to recognize that specific age ranges that 

may be relevant for one asset class may 

be less relevant for another asset class. 

Also, to address commenters’ 

uncertainty about how this metric 

would apply to derivatives, the final 

rule’s description of the Inventory Aging 

metric provides guidance on how to 

apply the metric to derivative 

positions.2784

The Customer Facing Trade Ratio 

provides directionally useful 

information regarding the extent to 

which trading transactions are 

conducted with customers. In the case 

of the Customer Facing Trade Ratio, the 

proposal required that customer trades 

be measured on a trade count basis. The 

final rule requires that the Customer 

Facing Trade Ratio be computed in two 

ways. As in the proposal, the metric 

must be computed by measuring trades 

on a trade count basis. Additionally, as 

suggested by some commenters, the 

final rule requires that the metric be 

computed by measuring trades on a 

notional value basis. The value based 

approach is required to reflect the fact 

noted by some commenters, that a trade 

count based measure may not accurately 

represent the amount of customer facing 

activity if customer trade sizes 

systematically differ from the sizes of 

non-customer trades. In addition, the 

term ‘‘customer’’ for purposes of the 

Customer-Facing Trade Ratio is defined 

in the same manner as the terms client, 

customer, and counterparty used for 

purposes of the market-making 

exemption. This will ensure that the 

information provided by this metric is 

useful for purposes of monitoring 

compliance with the market-making 

exemption.2785

The fifth set of quantitative 

measurements relates to the payment of 

fees, commissions, and spreads, and 

includes the Pay-to-Receive Spread 

Ratio. This measurement was intended 

to measure the extent to which trading 

activities generate revenues for 

providing intermediation services, 

rather than generate expenses paid to 

other intermediaries for such services. 

Because market making-related 

activities ultimately focus on servicing 

customer demands, they typically 

generate substantially more fees, 

spreads and other sources of customer 

revenue than must be paid to other 

intermediaries to support customer 

transactions. Proprietary trading 

activities, however, that generate almost 

no customer facing revenue will 

typically pay a significant amount of 

fees, spreads and commissions in the 

execution of trading strategies that are 

expected to benefit from short-term 

price movements. Accordingly, the 

Agencies expected that the proposed 

Pay-to-Receive Spread Ratio 

measurement would be useful in 

assessing whether permitted market 

making-related activities are primarily 

generating, rather than paying, fees, 

spreads and other transactional 

revenues or expenses. A level of fees, 

commissions, and spreads paid that is 

inconsistent with prior experience, the 

experience of similarly situated trading 

desks and management’s stated 

expectations for such measures could 

indicate impermissible proprietary 

trading. 

One commenter expressed concern 

that after-the-fact application of the Payto-Receive Spread Ratio could cause 

firms to reconsider their commitment to 

market making. This commenter 

suggested that if this measure is used, it 

be applied flexibly, in light of market 

conditions prevailing during the 

relevant time period, and as one of 

many factors relevant to an overall 

assessment of bona fide market 

making.2786 Another commenter 

suggested expanding the flexibility 

offered in choosing a bid-offer source to 

the entire process of calculating Pay-toReceive Spread Ratio.2787 A number of 

commenters argued for removing this 

metric because its calculation 

incorporates the Spread P&L metric.2788

Some of these commenters argued that 

the metric requires a trade-by-trade 

analysis which would be expensive to 

compute and would not provide any 

additional information that is not 

available from other metrics. One 

commenter alleged that this metric was 

not calculable by any methodology.2789

The Pay-to-Receive Spread Ratio has 

not been retained in the final rule. As 

noted by some commenters, the broad 

information content of this metric will 

largely be captured in the 

Comprehensive Profit and Loss 

Attribution measurement. In addition, 

the Comprehensive Profit and Loss 

Attribution will place such factors that 

are related to the proposed Pay-toReceive Spread Ratio in context with 

other factors that determine total 

profitability. Accordingly, factors 

relating to the payment of fees, 

commissions and spreads will not be 

considered in isolation but will be 

viewed in a context that is appropriate 

to the entirety of the trading desk’s 

activities. Finally, using the information 

contained in the Comprehensive Profit 

and Loss Attribution to holistically 

assess the range of factors that 

determine overall profitability, rather 

than requiring a large number of 

separate and distinct measurements, 

will reduce the resulting compliance 

burden while ensuring an integrated 

and holistic approach to assessing the 

activities of each trading desk. 

Commenters also suggested a number 

of additional metrics be added to the 

final rule that were not contained in the 

proposal. One commenter, who 

advocated for an alternative framework 

for market making supported by 

structural and transactional metrics, 

suggested that structural metrics could 

include the ratio of salespeople to 

traders and the level of resources 

devoted to client research and trading 

content.2790 Two commenters supported 

the use of a counterparty risk exposure 

measure, not only to the risk of 

counterparty default but also to 

potential gains and losses to major 

counterparties for each of a list of 

systemically important scenarios.2791

One of these commenters suggested that 

entity-wide inflation risk assessments be 

produced on a daily basis.2792 This 

commenter also argued that an 

important metric that is missing is a 

Liquidity Gap Risk metric that estimates 


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2793See AFR et al. (Feb. 2012). 

2794See AFR et al. (Feb. 2012); see also Public 

Citizen. 

2795See Credit Suisse (Seidel); Morgan Stanley; 

UBS; Wells Fargo (Prop. Trading); Socie ́te ́ Ge ́ne ́rale; 

Occupy; Paul Volcker; AFR et al. (Feb. 2012); 

Western Asset Mgmt.; Public Citizen. 

2796The Agencies believe this review, along with 

the fact that quantitative measurements will not be 

used as a dispositive tool for determining 

compliance and the removal of many of the 

proposed metrics, should help address commenters’ 

concerns that some of the proposed quantitative 

measurements will not be as relevant for certain 

asset classes, markets, and activities. See Morgan 

Stanley; SIFMA et al. (Prop. Trading); Stephen 

Roach. 

2797See 12 U.S.C. 1851(e)(2). 

2798 Id. 

the price change that occurs following a 

sudden disruption in liquidity for a 

product, arguing that there needs to be 

an industry-wide effort to more 

accurately measure and account for the 

significant effect that liquidity and 

changes in its prevailing level have on 

the valuation of each asset. 

One commenter argued that the 

metrics regime was well-designed for 

market-making but lacking in other 

areas like hedging. This commenter 

recommended the addition of additional 

metrics more applicable to other nonmarket making activities like a net profit 

metric for hedging.2793 Two commenters 

argued that quantitative measurement 

for underwriting was not included in 

the proposal and stated that in a bona 

fide underwriting, unsold balances 

should be relatively small so a marker 

for potential non-bona fide underwriting 

should be recognized if VaR (unhedged 

and uncovered) of the unsold balance 

that is allocated to a banking entity is 

large relative to the expected revenue 

measured by the pro rata underwriting 

spread.2794

After carefully considering the 

comments received, these and other 

proposed metrics have not been 

included as part of the final rule. One 

major concern raised by a range of 

commenters was the degree of 

complexity and burden that would be 

required by the metrics reporting 

regime. In light of these comments, the 

final rule includes a number of 

quantitative measurements that are 

expected to provide a means of 

characterizing the overall risk profile of 

the trading activities of each trading 

desk and evaluating the extent to which 

the quantitative profile of a trading 

desk’s activities is consistent with 

permissible trading activities in a cost 

effective and efficient manner while 

being appropriate for a range of different 

trading activities. Moreover, while many 

commenters suggested a number of 

different alternative metrics, many of 

these alternatives are consistent with 

the broad themes, risk management, 

sources of revenues, customer facing 

activity, that inform the quantitative 

measurements that are retained in the 

final rule. Finally, banking entities will 

be expected to develop their own 

metrics, as appropriate, to further 

inform and improve their own 

monitoring and understanding of their 

trading activities. Many of the 

alternative metrics that were suggested 

by commenters, especially those that 

relate to a specific market or type of 

instrument, may be used by banking 

entities as they develop their own 

quantitative measurements. 

For each individual quantitative 

measurement in the final rule, 

Appendix A describes the measurement, 

provides general guidance regarding 

how the measurement should be 

calculated and specifies the period over 

which each calculation should be made. 

The proposed quantitative 

measurements attempt to incorporate, 

wherever possible, measurements 

already used by banking entities to 

manage risks associated with their 

trading activities. Of the measurements 

proposed, the Agencies expect that a 

large majority of measurements 

proposed are either (i) already routinely 

calculated by banking entities or (ii) 

based solely on underlying data that are 

already routinely calculated by banking 

entities. However, calculating these 

measurements according to the 

specifications described in Appendix A 

and at the trading desk level mandated 

by the final rule may require banking 

entities to implement new processes to 

calculate and furnish the required 

data.2795

The extent of the burden associated 

with calculating and reporting 

quantitative measurements will likely 

vary depending on the particular 

measurements and differences in the 

sophistication of management 

information systems at different banking 

entities. As noted, the proposal tailored 

these data collections to the size and 

type of activity conducted by each 

banking entity in an effort to minimize 

the burden in particular on firms that 

engage in few or no trading activities 

subject to the proposed rule. 

The Agencies have also attempted to 

provide, to the extent possible, a 

standardized description and general 

method of calculating each quantitative 

measurement that, while taking into 

account the potential variation among 

trading practices and asset classes, 

would facilitate reporting of sufficiently 

uniform information across different 

banking entities so as to permit 

horizontal reviews and comparisons of 

the quantitative profile of trading desks 

across firms. 

The Agencies expect to evaluate the 

data collected during the compliance 

period both for its usefulness as a 

barometer of impermissible trading 

activity and excessive risk-taking and 

for its costs. This evaluation will 

consider, among other things, whether 

all of the quantitative measurements are 

useful for all asset classes and markets, 

as well as for all the trading activities 

subject to the metrics requirement, or if 

further tailoring is warranted.2796 The 

Agencies propose to revisit the metrics 

and determine, based on a review of the 

data collected by September 30, 2015, 

whether to modify, retain or replace the 

metrics. To allow firms to develop 

systems to calculate and report these 

metrics, the Agencies have delayed all 

reporting of the metrics until July 2014, 

phased in the reporting requirements 

over a multi-year period, and reduced 

the category of banking entities that 

must report the metrics to a smaller 

number of firms that engage in 

significant trading activity. These steps, 

combined with the reduction in the 

number of metrics required to be 

reported, are designed to reduce the cost 

and burden associated with compiling 

and reporting the metrics while 

retaining the usefulness of this data 

collection in helping to ensure that 

trading activities are conducted in 

compliance with section 13 of the BHC 

Act and the final rule and in a manner 

that monitors, assesses and controls the 

risks associated with these activities. 

4. Section 75.21: Termination of 

Activities or Investments; Authorities 

for Violations 

Section 75.21 implements section 

13(e)(2) of the BHC Act, which 

authorizes an Agency to order a banking 

entity subject to its jurisdiction to 

terminate activities or investments that 

violate or function as an evasion of 

section 13 of the Act.2797 Section 

13(e)(2) further provides that this 

paragraph shall not be construed to 

limit the inherent authority of any 

Federal agency or State regulatory 

authority to further restrict any 

investments or activities under 

otherwise applicable provisions of 

law.2798

The proposed rule implemented 

section 13(e)(2) in two parts. First, 

§ 75.21(a) of the proposal required any 

banking entity that engages in an 

activity or makes an investment in 

violation of section 13 of the BHC Act 

or the proposed rule, or in a manner that 

functions as an evasion of the 


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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 6045 

2799See proposed rule § 75.21(a). The proposal 

noted that the Agencies included § 75.21(a), in 

addition to the provisions of § 75.21(b) of the 

proposed rule, to clarify that the requirement to 

terminate an activity or, as relevant, dispose of an 

investment would be triggered when a banking 

entity discovers the violation or evasion, regardless 

of whether an Agency order has been issued. 

2800See proposed rule § 75.21(b). 

2801See Sen. Merkley; Better Markets (Feb. 2012); 

Occupy; AFR et al. (Feb. 2012); Public Citizen. 

2802See, e.g., BEC et al. (Jan. 2012); John Reed; 

Better Markets (Feb. 2012); AFR et al. (Feb. 2012); 

Occupy; Sen. Merkley; Public Citizen. 

2803See, e.g., Form Letter Type A; Form Letter 

Type B; Sarah McKee; David R. Wilkes; Ben Leet; 

Karen Michaelis; Barry Rein; Allan Richardson; 

Ronald Gedrim; Susan Pashkoff; Joan Budd; Frances 

Vreman; Lisa Kazmier; Michael Wenger; Dyanne 

DiRosario; Alexander Clayton; James Ofsink; 

Richard Leining (arguing that violators should face 

penalties such as seizure and discharge of the board 

and executives); Lee Smith; see also Occupy; Public 

Citizen. 

2804See Better Markets (Feb. 2012) (contending 

that penalties should include specific 

administrative penalties, including monetary 

penalties, bars, cease and desist orders, 

strengthened penalties for recurring violations, and 

sanctioning of employees involved in the violation 

and public reporting of such sanctions); AFR et al. 

(arguing that section 8 of the BHC Act provides civil 

penalties for violations by a company or individual 

and criminal penalties for willful violations of the 

BHC Act). See also Occupy (requesting the Agencies 

provide penalties that are specific to this rule in 

addition to the general framework for criminal and 

civil penalties in section 8 of the BHC Act). 2805See Better Markets (Feb. 2012); Occupy; AFR 

et al. (Feb. 2012). 2806See John Reed; Better Markets (Feb. 2012). 

See also BEC et al. (Jan. 2012) (arguing that CEOs 

and CFOs should be held fully responsible for any 

violations of the rule by any employees above the 

clerical level); Occupy (recommending that traders 

relying on an exemption in the proposed rule be 

held personally liable for any losses on trading 

positions). 

2807See Occupy. 2808See 12 U.S.C. 1851(g)(3). 2809See, e.g., 12 U.S.C. 1818(i) (authorizing 

imposition of civil money penalties up to the 

maximum daily amount of $1,000,000 for, among 

other things, knowing violations of law or 

regulation). 

2810See 12 U.S.C. 1813(u) (defining ‘‘institutionaffiliated party’’). 

2811See, e.g., 12 U.S.C. 164 (authorizing 

imposition of civil money penalties for, among 

other things, submitting false or misleading reports 

or information to the OCC); 18 U.S.C. 1005 

(authorizing imposition of fines of not more than 

$1,000,000 or imprisonment not more than 30 

years, or both, for, among other things, making a 

false entry in the books, reports or statements of a 

bank with intent to injure, defraud or deceive). 

2812See Better Markets (Feb. 2012). 

2813See Sen. Merkley; Public Citizen; Better 

Markets (Feb. 2012); Profs. Admati & Pfleiderer. 

2814See Regulatory Capital Rules: Regulatory 

Capital, Implementation of Basel III, Capital 

Adequacy, Transition Provisions, Prompt Corrective 

Action, Standardized Approach for Risk-weighted 

Assets, Market Discipline and Disclosure 

Requirements, Advanced Approaches Risk-Based 

Capital Rule, and Market Risk Capital Rule; Final 

Rule, 78 FR 62017 (Friday, October 11, 2013). 

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.2799

Second, § 75.21(b) of the proposal 

provided that if, after due notice and an 

opportunity for hearing, the respective 

Agency finds reasonable cause to 

believe that any banking entity has 

engaged in an activity or made an 

investment described in paragraph (a), 

the Agency may, by order, direct the 

entity to restrict, limit, or terminate the 

activity and, as relevant, dispose of the 

investment.2800

Several commenters urged the 

Agencies to strengthen the authorities 

provided for under § 75.21,2801 with 

some commenters expressing concern 

that the proposed rule does not establish 

sufficient enforcement mechanisms and 

penalties for violations of the rule’s 

requirements.2802 Some commenters 

suggested the Agencies add language in 

§ 75.21 authorizing the imposition of 

automatic and significant financial 

penalties—as significant as the potential 

gains from illegal proprietary trading— 

on traders, supervisors, executives, and 

firms for violating section 13 of the BHC 

Act and the final rule.2803 These 

commenters suggested the Agencies 

incorporate reference to the Board’s 

authority under section 8 of the BHC 

Act into the rule,2804 and others 

encouraged the Agencies to rely on their 

inherent authority to impose automatic 

penalties and fines.2805 A few 

commenters stated that traders, 

management, and banking entities 

should be held responsible for 

violations under certain 

circumstances.2806 Finally, another 

commenter recommended that officers 

and directors of a banking entity be 

removed from office, be prohibited from 

being affiliated with a banking entity, 

and be subject to salary clawbacks for 

violations of section 13 of the BHC Act 

and the final rule.2807

The Agencies note that the authorities 

provided for in § 75.21 are not 

exclusive. The Agencies have a number 

of enforcement tools at their disposal to 

carry out their obligations to ensure 

compliance with section 13 of the BHC 

Act and the final rule, and need not 

reference them expressly in § 75.21 in 

order to exercise them. Specifically, the 

Agencies may rely on their inherent 

authorities under otherwise applicable 

provisions of banking, securities, and 

commodities laws to bring enforcement 

actions against banking entities, their 

officers and directors, and other 

institution-affiliated parties for 

violations of law.2808 For example, a 

banking entity that violates section 13 of 

the BHC Act and the final rule may be 

subject to criminal and civil penalties 

under section 8 of the BHC Act. Banking 

entities may also be subject to formal 

enforcement actions under section 8 of 

the Federal Deposit Insurance Act 

(FDIA), such as cease and desist orders 

or civil money penalty actions,2809 or 

safety and soundness orders under 

section 39 of the FDIA which may be 

enforceable through assessment of civil 

money penalties and through the 

Federal court system. In addition, 

officers, directors, and other institutionaffiliated parties 2810 may be subject to 

civil money penalties, prohibition or 

removal actions, and personal cease and 

desist orders under section 8 of the 

FDIA. Submission of late, false, or 

misleading reports, including false 

statements on compliance with section 

13 of the BHC Act or the final rule, may 

also result in actions under applicable 

securities, commodities, banking, and 

criminal laws, including imposition of 

civil money and criminal penalties.2811

Therefore, the final rule is consistent 

with the proposal and does not mention 

other enforcement actions available to 

address violations of section 13 of the 

BHC Act and this final rule. 

Section 13 of the BHC Act and the 

final rule do not limit the reach or 

applicability of the antifraud and other 

provisions of the Federal laws to 

banking entities, including, for example, 

section 17(a) of the Securities Act of 

1933 or section 10(b) and 15(c) of the 

Exchange Act and the rules promulgated 

thereunder. 

One commenter also suggested that 

the Agencies use their authority under 

section 13(d)(3) of the BHC Act to 

impose additional capital requirements 

and quantitative limitations on banking 

entities for repeat violations of the 

prohibition on proprietary trading.2812

The Agencies believe they can rely on 

other inherent enforcement authorities 

to address repeat violations. The 

Agencies note that several other 

commenters also requested the Agencies 

to exercise their authority under section 

13(d)(3).2813 The Agencies do not 

believe that it is appropriate to exercise 

their authority under this section at this 

time, primarily because the capital 

treatment of banking entities’ trading 

activities is currently being addressed 

through the Agencies’ risk-based capital 

rulemakings.2814 Additionally, the 

Agencies believe Congress intended 

section 13(d)(3) to serve the prudential 

purposes of bolstering the safety and 

soundness of individual banking 

entities and the wider U.S. financial 

system. To the extent commenters 


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2815See SIFMA et al. (Prop. Trading) (Feb. 2012); 

JPMC; Barclays; Goldman (Prop. Trading); BoA; 

ABA (Keating); Comm. on Capital Market 

Regulation; BEC et al.; ISDA (Apr. 2012). 

2816See Barclays (arguing that ideally the 

umbrella Federal regulator of the enterprise should 

take this role); Goldman (Prop. Trading). 

2817See BoA; BEC et al. 

2818See Comm. on Capital Market Regulation. 

2819See SIFMA et al. (Prop. Trading) (Feb. 2012); 

BoA (recommending that the Board be responsible 

for resolving potentially conflicting supervisory 

recommendations or matters requiring attention 

arising from examinations as well); ISDA (Apr. 

2012). See also ABA (Keating) (arguing that the 

Agencies should defer to the Board’s sole authority 

to interpret provisions of Volcker that intersect with 

other statutory provisions subject to the Board’s 

jurisdictional authority, such as Super 23A); JPMC 

(contending that the Agencies should adopt and 

seek comment on a protocol for supervision and 

enforcement that will ensure a given banking entity 

will face one set of rules and different banking 

entities will face the same set of rules). The 

Agencies decline to adopt the commenter’s 

suggested approach of deferring to the Board’s sole 

interpretive authority with respect to the provisions 

of the final rule. The Agencies believe at this time 

that such an approach would be neither appropriate 

nor effective given the different authorities and 

expertise of each Agency. See Part VI.C (discussing 

the Agencies’ decision not to adopt some 

commenters’ requests that a single agency be 

responsible for determining compliance with 

section 13). 

2820See SIFMA et al. (Prop. Trading) (Feb. 2012); 

BoA (stating that the Agencies should issue one set 

of exam findings under these circumstances); ISDA 

(Apr. 2012). 

2821See 12 U.S.C. 1851(c)(2). 

2822See 12 U.S.C. 1851(e)(2) (requiring ‘‘due 

notice and opportunity for hearing’’). 

2823See 12 U.S.C. 1844 (establishing 

jurisdictional boundaries for regulation of bank 

holding companies); see also 12 U.S.C. 1828a 

(antievasion statute empowering OCC, FDIC, and 

the Board to impose restrictions on relationships or 

transactions between banks and their subsidiaries 

and affiliates). 

2824 44 U.S.C. 3501 et seq. 

2825See 76 FR 68846, 68936, Nov. 7, 2011 (joint 

release of the Board, OCC, FDIC, and the SEC), and 

77 FR 8332, 8420, Feb. 14, 2012. 

2826 76 FR at 68936. 

suggested section 13(d)(3) be employed 

for a punitive purpose, the Agencies do 

not believe the provision was designed 

to serve such a purpose nor do the 

Agencies believe that would be an 

appropriate use of the provision. Thus, 

the Agencies believe section 13(d)(3) is 

more appropriately employed for the 

prudential purposes of bolstering the 

safety and soundness of individual 

banking entities and the wider financial 

stability of the U.S. financial system. 

Commenters also urged the Agencies 

to clearly delineate in the final rule the 

jurisdictional authority of each of the 

Agencies to enforce compliance with 

section 13 of the BHC Act and the 

implementing final rule. A number of 

commenters recommended approaches 

to coordinating examinations and 

enforcement among the Agencies, as 

well as to providing interpretive 

guidance.2815 For example, some 

commenters observed that more than 

one Agency would have jurisdiction 

over a given banking entity, and 

recommended that supervision and 

enforcement of the final rule for all 

entities within a banking enterprise 

remain completely with one Agency.2816

Further, some commenters 

recommended that a single Agency be 

appointed to provide interpretations, 

supervision, and enforcement of section 

13 and the rules thereunder for all 

banking entities.2817 Similarly, one 

commenter suggested that the Board be 

given initial authority to supervise the 

implementation of the rule because it is 

the primary enforcer of the BHC Act and 

the single regulator that can currently 

look across a banking group’s entire 

global businesses, regardless of legal 

entity. This commenter stated that the 

Board could then determine whether an 

activity should be delegated to one of 

the other Agencies for further 

examination or enforcement.2818 In 

addition, with respect to interpretive 

authority, some commenters indicated 

that the Board should be given sole 

interpretive authority of the statute and 

the rules thereunder.2819 Other 

commenters urged the Agencies to 

supervise and enforce the rule on a 

coordinated basis so as to minimize 

duplicative enforcement efforts, reduce 

costs, and promote certainty.2820

Section 13(e)(2) mandates that each 

Agency enforce compliance of section 

13 with respect to a banking entity 

‘‘under the respective [A]gency’s 

jurisdiction.’’ 2821 This section provides 

the Agencies with the authority to order 

a banking entity to terminate activities 

or investments that violate or function 

as an evasion of section 13 of the BHC 

Act.2822 Decisions about whether to 

issue such orders could be made after 

examinations or otherwise. Nothing in 

the final rule limits an Agency’s 

inherent authority to conduct 

examinations or otherwise inspect 

banking entities to ensure compliance 

with the final rule. Section 75.1 of each 

Agency’s proposed rule described the 

specific types of banking entities to 

which that Agency’s rule applies. The 

Agencies acknowledge commenters’ 

concerns about overlapping 

jurisdictional authority. The Agencies 

recognize that, on occasion, a banking 

entity may be subject to jurisdiction by 

more than one Agency. As is customary, 

the Agencies plan to coordinate their 

examination and enforcement 

proceedings under section 13, to the 

extent possible and practicable, so as to 

limit duplicative actions and undue 

costs and burdens for banking 

entities.2823

The Agencies are adopting § 75.21 

substantially as proposed. Accordingly, 

§ 75.21(a) of the final rule provides that 

any banking entity that engages in an 

activity or makes an investment in 

violation of section 13 of the BHC Act 

or the final rule or acts in a manner that 

functions as an evasion of the 

requirements of section 13 of the BHC 

Act or the final rule, including through 

an abuse of any activity or investment 

permitted or expressly excluded by the 

terms of the final rule, or otherwise 

violates the restrictions and 

requirements of section 13 of the BHC 

Act or the final rule, shall, upon 

discovery, promptly terminate the 

activity and, as relevant, dispose of the 

investment. This provision allows the 

Agencies to enforce the rule’s 

prohibitions against proprietary trading 

and sponsoring or owning interests in 

covered funds regardless of how 

banking entities classify their actions, 

while also providing banking entities 

the freedom to legitimately engage in 

those banking activities which are 

outside the scope of the statute. 

VII. Administrative Law Matters 

A. Paperwork Reduction Act Analysis 

The Paperwork Reduction Act 

(‘‘PRA’’) provides that a Federal agency 

may not conduct or sponsor, and a 

person is not required to respond to, a 

collection of information unless it 

displays a currently valid control 

number issued by the Office of 

Management and Budget (‘‘OMB’’).2824

This final rulemaking contains several 

collections of information for which the 

three Federal banking agencies—the 

Board, the OCC, and FDIC—sought 

control numbers at the time they 

proposed the same substantive 

requirements that the Commission later 

proposed.2825

To avoid double accounting of 

information collections for which 

control numbers were sought, the 

Commission did not propose and is not 

finalizing an information collection 

request for this rulemaking. Rather, as 

indicated in its proposed rulemaking, 

the Board provided that it would submit 

its information collection to OMB once 

its final rule is published, and that the 

submission would include burden for 

Federal Reserve-supervised institutions, 

as well as burden for OCC-, FDIC-, 

SEC-, and CFTC-supervised institutions 

under a holding company.2826 The 

Board, OCC, and FDIC, as well as the 

SEC, are expected to adopt equivalent 

final rulemakings on or about the same 

date as the CFTC adopts its final rule. 

The Board, OCC, and FDIC included in 


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2827See 13 CFR 121.201; see also 13 CFR 

121.103(a)(6) (noting factors that the Small Business 

Administration considers in determining whether 

an entity qualifies as a small business, including 

receipts, employees, and other measures of its 

domestic and foreign affiliates). 

2828See Joint Proposal, 76 FR at 68938–68939. 

2829See BoA; SIFMA et al. (Covered Funds) (Feb. 

2012); Chamber (Feb. 2012); ABA (Keating). 

2830See SIFMA et al. (Covered Funds) (Feb. 

2012); Chamber (Feb. 2012). 

2831See Part VI.B.1. of this SUPPLEMENTARY

INFORMATION. 

the Supplementary Information of their 

final rulemakings an overview of their 

PRA analyses including burden cost 

estimates, with further analyses to be 

provided in the supporting statements 

required to be submitted to OMB 

according to their regulations 

implementing the PRA. 

In particular, section 619 of the DoddFrank Act provides that the banking 

agencies, the SEC, and the Commission 

engage in ‘‘coordinated rulemaking,’’ 

which includes all entities for which the 

Commission ‘‘is the primary financial 

regulatory agency, as defined in section 

2’’ of the Dodd-Frank Act. Section 2 

defines ‘‘primary financial regulatory 

agency’’ as a Federal banking agency 

with respect to certain depository 

institutions except as provided in other 

subsections of section 2. In subsection 

(12)(C), the Commission is designated as 

the primary financial regulatory agency 

for, among other things, ‘‘any . . . swap 

dealer . . . registered with the 

[Commission] . . ..’’ Section 4s(c)(1) of 

the CEA, as adopted in section 731 of 

the Dodd-Frank Act, provides that ‘‘any 

person that is required to be registered 

as a swap dealer shall register with the 

Commission regardless of whether the 

person is also a depository institution.’’ 

Accordingly, banking entities, 

including domestic depository 

institutions and branches and agencies 

of foreign banks subject to supervision 

by OCC or the Board, have registered 

with the Commission. It is presently not 

known how many additionally may 

register. To ensure that the Commission 

has access to fulfill its statutory 

obligations and not unduly burden its 

registrants with duplicative information 

collection requirements, and pursuant 

to its proposed rulemaking, the 

Commission will request, pursuant to 44 

U.S.C. 3509, that the director of the 

OMB designate the banking agencies as 

the respective collection agencies for 

PRA purposes for all banking entities for 

which the Commission is the primary 

financial regulatory agency with respect 

to this rulemaking. 

B. Regulatory Flexibility Act Analysis 

In general, section 4 of the Regulatory 

Flexibility Act (5 U.S.C. 604) (RFA) 

requires an agency to prepare a final 

regulatory flexibility analysis (FRFA) for 

a final rule unless the agency certifies 

that the rule will not, if promulgated, 

have a significant economic impact on 

a substantial number of small entities 

(defined as of July 22, 2013, to include 

banking entities with total assets of $500 

million or less (‘‘small banking 

entities’’).2827 Pursuant to section 605(b) 

of the RFA, a FRFA is not required if an 

agency certifies that the final rule will 

not have a significant economic impact 

on a substantial number of small 

entities. The Agencies have considered 

the potential economic impact of the 

final rule on small banking entities in 

accordance with the RFA. The Agencies 

believe that the final rule will not have 

a significant economic impact on a 

substantial number of small banking 

entities for the reasons described below. 

The Agencies previously considered 

the impact of the proposed rule for 

purposes of the RFA and concluded that 

the proposed rule would not appear to 

have a significant economic impact on 

a substantial number of small banking 

entities. In support of this conclusion, 

the proposed rule, among other things, 

noted that the thresholds for the metrics 

reporting requirements under § 75.7 and 

Appendix A and for the enhanced and 

core compliance program requirements 

under § 75.20 and Appendix C of the 

proposed rule would not capture small 

banking entities.2828

The Agencies received several 

comments on the impact of the 

proposed rule on small entities. 

Commenters argued that the Agencies 

incorrectly concluded that the proposed 

rule would not have a significant 

economic impact on a substantial 

number of small entities.2829

Commenters asserted that the proposed 

rule would have a significant economic 

impact on numerous small non-banking 

entities by restricting their access to a 

variety of products and services, 

including covered fund-linked products 

for investment and hedging purposes 

and underwriting and market-making 

related services.2830

The Agencies have carefully 

considered these comments in 

developing a final rule. To minimize 

burden on small banking entities, 

section 75.20(f)(1) of the final rule 

provides that a banking entity that does 

not engage in covered trading activities 

(other than trading in U.S. government 

or agency obligations, obligations of 

specified government sponsored 

entities, and state and municipal 

obligations) or covered fund activities 

and investments need only establish a 

compliance program prior to becoming 

engaged in such activities or making 

such investments. In addition, to 

minimize the burden on small banking 

entities, a banking entity with total 

consolidated assets of $10 billion or less 

that engages in covered trading 

activities and/or covered fund activities 

may satisfy the requirements of the final 

rule by including in its existing 

compliance policies and procedures 

appropriate references to the 

requirements of section 13 and the final 

rule and adjustments as appropriate 

given the activities, size, scope and 

complexity of the banking entity. Only 

those banking entities with total assets 

of greater than $10 billion will need to 

adopt more detailed or enhanced 

compliance requirements under the 

final rule. (For purposes of the 

enhanced compliance program in 

Appendix B of the final rule, the 

threshold for banking entities is total 

consolidated assets of $50 billion or 

more.) Accordingly, the compliance 

requirements under the final rule do not 

have a significant economic impact on 

a substantial number of small banking 

entities. 

Likewise, the final rule raises the 

threshold for metrics reporting from the 

proposed rule to capture only firms that 

engage in significant trading activities. 

Specifically, the metrics reporting 

requirements under § 75.20 and 

Appendix A of the final rule apply only 

to banking entities with average trading 

assets and liabilities on a consolidated, 

worldwide basis for the preceding year 

equal to or greater than $10 billion. 

Accordingly, the metrics reporting 

requirements under the final rule do not 

impact small banking entities. 

Moreover, the Agencies have revised 

the definition of covered fund in the 

final rule to address many of the 

concerns raised by commenters 

regarding the unintended consequences 

of the proposed definition.2831 The 

definition of covered fund under the 

final rule contains a number of 

exclusions for entities that may rely on 

exclusions from the Investment 

Company Act of 1940 contained in 

section 3(c)(1) or 3(c)(7) of that Act but 

that are not engaged in investment 

activities of the type contemplated by 

section 13 of the BHC Act. These 

include, for example, exclusions for 

wholly owned subsidiaries, joint 

ventures, acquisition vehicles, 

insurance company separate accounts, 

registered investments companies, and 

public welfare investment funds. The 

Agencies believe that these changes will 


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2832See SIFMA et al. (Covered Funds) (Feb. 

2012); Chamber (Feb. 2012). 

2833See e.g., In Mid-Tex Electric Cooperative v. 

FERC, 773 F.2d 327 (D.C. Cir. 1985); United 

Distribution Cos. v. FERC, 88 F.3d 1105, 1170 (D.C. 

Cir. 1996); Cement Kiln Recycling Coalition v. EPA, 

255 F.3d 855 (D.C. Cir. 2001). Commenters relied 

on Aeronautical Repair Station Association v. 

Federal Aviation Administration, 494 F.3d 161 (DC 

Cir 2007) to argue that the Agencies must consider 

the indirect economic effects of the final rule on 

small non-banking entities. This case is inapposite, 

however, because there the agency’s own 

rulemaking release expressly stated that the rule 

imposed responsibilities directly on certain small 

business contractors. The court reaffirmed its prior 

holdings that the RFA limits its application to small 

entities ‘‘which will be subject to the proposed 

regulation—that is, those small entities to which the 

proposed rule will apply.’’ Id. at 176 (emphasis and 

internal quotations omitted). 

further minimize the burden for small 

banking entities such as those that may 

use wholly owned subsidiaries for 

organizational convenience or make 

public welfare investments to achieve 

their financial and Community 

Reinvestment Act goals. 

Finally, in response to commenters’ 

assertion that the proposed rule would 

have had a significant economic impact 

on numerous small non-banking entities 

by restricting their access to a variety of 

products and services,2832 the Agencies 

note that the RFA does not require the 

Agencies to consider the impact of the 

final rule, including its indirect 

economic effects, on small entities that 

are not subject to the requirements of 

the final rule.2833

For the reasons stated above, the OCC, 

FDIC, SEC, and CFTC certify, for the 

banking entities subject to each such 

Agency’s jurisdiction, that the final rule 

will not result in a significant economic 

impact on a substantial number of small 

entities. In light of the foregoing, the 

Board does not believe, for the banking 

entities subject to the Board’s 

jurisdiction, that the final rule would 

have a significant economic impact on 

a substantial number of small entities. 

List of Subjects in 17 CFR Part 75 

Banks, Banking, Compensation, 

Credit, Derivatives, Federal branches 

and agencies, Federal savings 

associations, Government securities, 

Hedge funds, Insurance, Investments, 

National banks, Penalties, Proprietary 

trading, Reporting and recordkeeping 

requirements, Risk, Risk retention, 

Securities, Swap dealers, Trusts and 

trustees, Volcker rule. 

For the reasons discussed in the 

preamble, the Commodity Futures 

Trading Commission adds part 75 to 17 

CFR Chapter I to read as follows: 

PART 75—PROPRIETARY TRADING 

AND CERTAIN INTERESTS IN AND 

RELATIONSHIPS WITH COVERED 

FUNDS 

Subpart A—Authority and Definitions 

Sec. 

75.1 Authority, purpose, scope, and 

relationship to other authorities. 

75.2 Definitions. 

Subpart B—Proprietary Trading 

75.3 Prohibition on proprietary trading. 

75.4 Permitted underwriting and market 

making-related activities. 

75.5 Permitted risk-mitigating hedging 

activities. 

75.6 Other permitted proprietary trading 

activities. 

75.7 Limitations on permitted proprietary 

trading activities. 

75.8–75.9 [Reserved] 

Subpart C—Covered Fund Activities and 

Investments 

75.10 Prohibition on acquiring or retaining 

an ownership interest in and having 

certain relationships with a covered 

fund. 

75.11 Permitted organizing and offering, 

underwriting, and market making with 

respect to a covered fund. 

75.12 Permitted investment in a covered 

fund. 

75.13 Other permitted covered fund 

activities and investments. 

75.14 Limitations on relationships with a 

covered fund. 

75.15 Other limitations on permitted 

covered fund activities. 

75.16–75.19 [Reserved] 

Subpart D—Compliance Program 

Requirement; Violations 

75.20 Program for compliance; reporting. 

75.21 Termination of activities or 

investments; penalties for violations. 

Appendix A to Part 75—Reporting and 

Recordkeeping Requirements for 

Covered Trading Activities 

Appendix B to Part 75—Enhanced Minimum 

Standards for Compliance Programs 

Authority: 12 U.S.C. 1851. 

Subpart A—Authority and Definitions 

§ 75.1 Authority, purpose, scope, and 

relationship to other authorities. 

(a) Authority. This part is issued by 

the Commission 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 by, and investments 

in or relationships with covered funds 

by, certain banking entities. 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 further explaining 

the statute’s requirements. 

(c) Scope. This part implements 

section 13 of the Bank Holding 

Company Act with respect to banking 

entities for which the CFTC is the 

primary financial regulatory agency, as 

defined in section 2(12) of the DoddFrank Act. 

(d) Relationship to other authorities. 

Except as otherwise provided under 

section 13 of the BHC Act, and 

notwithstanding any other provision of 

law, the prohibitions and restrictions 

under section 13 of the BHC Act shall 

apply to the activities of an applicable 

banking entity, even if such activities 

are authorized for the applicable 

banking entity under other applicable 

provisions of law. 

§ 75.2 Definitions. 

Unless otherwise specified, for 

purposes of this part: 

(a) Affiliate has the same meaning as 

in section 2(k) of the Bank Holding 

Company Act of 1956 (12 U.S.C. 

1841(k)). 

(b) Bank holding company has the 

same meaning as in section 2 of the 

Bank Holding Company Act of 1956 (12 

U.S.C. 1841). 

(c) Banking entity. (1) Except as 

provided in paragraph (c)(2) of this 

section, banking entity means: 

(i) Any insured depository institution; 

(ii) Any company that controls an 

insured depository institution; 

(iii) Any company that is treated as a 

bank holding company for purposes of 

section 8 of the International Banking 

Act of 1978 (12 U.S.C. 3106); and 

(iv) Any affiliate or subsidiary of any 

entity described in paragraphs (c)(1)(i), 

(ii), or (iii) of this section. 

(2) Banking entity does not include: 

(i) A covered fund that is not itself a 

banking entity under paragraphs 

(c)(1)(i), (ii), or (iii) of this section; 

(ii) A portfolio company held under 

the authority contained in section 

4(k)(4)(H) or (I) of the BHC Act (12 

U.S.C. 1843(k)(4)(H), (I)), or any 

portfolio concern, as defined under 13 

CFR 107.50, that is controlled by a small 

business investment company, as 

defined in section 103(3) of the Small 

Business Investment Act of 1958 (15 

U.S.C. 662), so long as the portfolio 

company or portfolio concern is not 

itself a banking entity under paragraphs 

(c)(1)(i), (ii), or (iii) of this section; or 

(iii) The FDIC acting in its corporate 

capacity or as conservator or receiver 

under the Federal Deposit Insurance Act 

or Title II of the Dodd-Frank Wall Street 

Reform and Consumer Protection Act. 

(d) Board means the Board of 

Governors of the Federal Reserve 

System. 


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(e) CFTC or Commission means the 

Commodity Futures Trading 

Commission. 

(f) Dealer has the same meaning as in 

section 3(a)(5) of the Exchange Act (15 

U.S.C. 78c(a)(5)). 

(g) Depository institution has the same 

meaning as in section 3(c) of the Federal 

Deposit Insurance Act (12 U.S.C. 

1813(c)). 

(h) Derivative. (1) Except as provided 

in paragraph (h)(2) of this section, 

derivative means: 

(i) Any swap, as that term is defined 

in section 1a(47) of the Commodity 

Exchange Act (7 U.S.C. 1a(47)), or 

security-based swap, as that term is 

defined in section 3(a)(68) of the 

Exchange Act (15 U.S.C. 78c(a)(68)); 

(ii) Any purchase or sale of a 

commodity, that is not an excluded 

commodity, for deferred shipment or 

delivery that is intended to be 

physically settled; 

(iii) Any foreign exchange forward (as 

that term is defined in section 1a(24) of 

the Commodity Exchange Act (7 U.S.C. 

1a(24)) or foreign exchange swap (as 

that term is defined in section 1a(25) of 

the Commodity Exchange Act (7 U.S.C. 

1a(25)); 

(iv) Any agreement, contract, or 

transaction in foreign currency 

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

Commodity Exchange Act (7 U.S.C. 

2(c)(2)(C)(i)); 

(v) Any agreement, contract, or 

transaction in a commodity other than 

foreign currency described in section 

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

Act (7 U.S.C. 2(c)(2)(D)(i)); and 

(vi) Any transaction authorized under 

section 19 of the Commodity Exchange 

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

(2) A derivative does not include: 

(i) Any consumer, commercial, or 

other agreement, contract, or transaction 

that the CFTC and SEC have further 

defined by joint regulation, 

interpretation, guidance, or other action 

as not within the definition of swap, as 

that term is defined in section 1a(47) of 

the Commodity Exchange Act (7 U.S.C. 

1a(47)), or security-based swap, as that 

term is defined in section 3(a)(68) of the 

Exchange Act (15 U.S.C. 78c(a)(68)); or 

(ii) Any identified banking product, as 

defined in section 402(b) of the Legal 

Certainty for Bank Products Act of 2000 

(7 U.S.C. 27(b)), that is subject to section 

403(a) of that Act (7 U.S.C. 27a(a)). 

(i) Employee includes a member of the 

immediate family of the employee. 

(j) Exchange Act means the Securities 

Exchange Act of 1934 (15 U.S.C. 78a et 

seq.). 

(k) Excluded commodity has the same 

meaning as in section 1a(19) of the 

Commodity Exchange Act (7 U.S.C. 

1a(19)). 

(l) FDIC means the Federal Deposit 

Insurance Corporation. 

(m) Federal banking agencies means 

the Board, the Office of the Comptroller 

of the Currency, and the FDIC. 

(n) Foreign banking organization has 

the same meaning as in section 

211.21(o) of the Board’s Regulation K 

(12 CFR 211.21(o)), but does not include 

a foreign bank, as defined in section 

1(b)(7) of the International Banking Act 

of 1978 (12 U.S.C. 3101(7)), that is 

organized under the laws of the 

Commonwealth of Puerto Rico, Guam, 

American Samoa, the United States 

Virgin Islands, or the Commonwealth of 

the Northern Mariana Islands. 

(o) Foreign insurance regulator means 

the insurance commissioner, or a 

similar official or agency, of any country 

other than the United States that is 

engaged in the supervision of insurance 

companies under foreign insurance law. 

(p) General account means all of the 

assets of an insurance company except 

those allocated to one or more separate 

accounts. 

(q) Insurance company means a 

company that is organized as an 

insurance company, primarily and 

predominantly engaged in writing 

insurance or reinsuring risks 

underwritten by insurance companies, 

subject to supervision as such by a state 

insurance regulator or a foreign 

insurance regulator, and not operated 

for the purpose of evading the 

provisions of section 13 of the BHC Act 

(12 U.S.C. 1851). 

(r) Insured depository institution has 

the same meaning as in section 3(c) of 

the Federal Deposit Insurance Act (12 

U.S.C. 1813(c)), but does not include an 

insured depository institution that is 

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

BHC Act (12 U.S.C. 1841(c)(2)(D)). 

(s) Loan means any loan, lease, 

extension of credit, or secured or 

unsecured receivable that is not a 

security or derivative. 

(t) Primary financial regulatory 

agency has the same meaning as in 

section 2(12) of the Dodd-Frank Wall 

Street Reform and Consumer Protection 

Act (12 U.S.C. 5301(12)). 

(u) Purchase includes any contract to 

buy, purchase, or otherwise acquire. For 

security futures products, purchase 

includes any contract, agreement, or 

transaction for future delivery. With 

respect to a commodity future, purchase 

includes any contract, agreement, or 

transaction for future delivery. With 

respect to a derivative, purchase 

includes the execution, termination 

(prior to its scheduled maturity date), 

assignment, exchange, or similar 

transfer or conveyance of, or 

extinguishing of rights or obligations 

under, a derivative, as the context may 

require. 

(v) Qualifying foreign banking 

organization means a foreign banking 

organization that qualifies as such under 

§ 211.23(a), (c) or (e) of the Board’s 

Regulation K (12 CFR 211.23(a), (c), or 

(e)). 

(w) SEC means the Securities and 

Exchange Commission. 

(x) Sale and sell each include any 

contract to sell or otherwise dispose of. 

For security futures products, such 

terms include any contract, agreement, 

or transaction for future delivery. With 

respect to a commodity future, such 

terms include any contract, agreement, 

or transaction for future delivery. With 

respect to a derivative, such terms 

include the execution, termination 

(prior to its scheduled maturity date), 

assignment, exchange, or similar 

transfer or conveyance of, or 

extinguishing of rights or obligations 

under, a derivative, as the context may 

require. 

(y) Security has the meaning specified 

in section 3(a)(10) of the Exchange Act 

(15 U.S.C. 78c(a)(10)). 

(z) Security-based swap dealer has the 

same meaning as in section 3(a)(71) of 

the Exchange Act (15 U.S.C. 78c(a)(71)). 

(aa) Security future has the meaning 

specified in section 3(a)(55) of the 

Exchange Act (15 U.S.C. 78c(a)(55)). 

(bb) Separate account means an 

account established and maintained by 

an insurance company in connection 

with one or more insurance contracts to 

hold assets that are legally segregated 

from the insurance company’s other 

assets, under which income, gains, and 

losses, whether or not realized, from 

assets allocated to such account, are, in 

accordance with the applicable contract, 

credited to or charged against such 

account without regard to other income, 

gains, or losses of the insurance 

company. 

(cc) State means any State, the District 

of Columbia, the Commonwealth of 

Puerto Rico, Guam, American Samoa, 

the United States Virgin Islands, and the 

Commonwealth of the Northern Mariana 

Islands. 

(dd) Subsidiary has the same meaning 

as in section 2(d) of the Bank Holding 

Company Act of 1956 (12 U.S.C. 

1841(d)). 

(ee) State insurance regulator means 

the insurance commissioner, or a 

similar official or agency, of a State that 

is engaged in the supervision of 

insurance companies under State 

insurance law. 


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(ff) Swap dealer has the same meaning 

as in section 1(a)(49) of the Commodity 

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

Subpart B—Proprietary Trading 

§ 75.3 Prohibition on proprietary trading. 

(a) Prohibition. Except as otherwise 

provided in this subpart, a banking 

entity may not engage in proprietary 

trading. Proprietary trading means 

engaging as principal for the trading 

account of the banking entity in any 

purchase or sale of one or more 

financial instruments. 

(b) Definition of trading account. (1) 

Trading account means any account that 

is used by a banking entity to: 

(i) Purchase or sell one or more 

financial instruments principally for the 

purpose of: 

(A) Short-term resale; 

(B) Benefitting from actual or 

expected short-term price movements; 

(C) Realizing short-term arbitrage 

profits; or 

(D) Hedging one or more positions 

resulting from the purchases or sales of 

financial instruments described in 

paragraphs (b)(1)(i)(A), (B), or (C) of this 

section; 

(ii) Purchase or sell one or more 

financial instruments that are both 

market risk capital rule covered 

positions and trading positions (or 

hedges of other market risk capital rule 

covered positions), if the banking entity, 

or any affiliate of the banking entity, is 

an insured depository institution, bank 

holding company, or savings and loan 

holding company, and calculates riskbased capital ratios under the market 

risk capital rule; or 

(iii) Purchase or sell one or more 

financial instruments for any purpose, if 

the banking entity: 

(A) Is licensed or registered, or is 

required to be licensed or registered, to 

engage in the business of a dealer, swap 

dealer, or security-based swap dealer, to 

the extent the instrument is purchased 

or sold in connection with the activities 

that require the banking entity to be 

licensed or registered as such; or 

(B) Is engaged in the business of a 

dealer, swap dealer, or security-based 

swap dealer outside of the United 

States, to the extent the instrument is 

purchased or sold in connection with 

the activities of such business. 

(2) Rebuttable presumption for certain 

purchases and sales. The purchase (or 

sale) of a financial instrument by a 

banking entity shall be presumed to be 

for the trading account of the banking 

entity under paragraph (b)(1)(i) of this 

section if the banking entity holds the 

financial instrument for fewer than sixty 

days or substantially transfers the risk of 

the financial instrument within sixty 

days of the purchase (or sale), unless the 

banking entity can demonstrate, based 

on all relevant facts and circumstances, 

that the banking entity did not purchase 

(or sell) the financial instrument 

principally for any of the purposes 

described in paragraph (b)(1)(i) of this 

section. 

(c) Financial instrument—(1) 

Financial instrument means: 

(i) A security, including an option on 

a security; 

(ii) A derivative, including an option 

on a derivative; or 

(iii) A contract of sale of a commodity 

for future delivery, or option on a 

contract of sale of a commodity for 

future delivery. 

(2) A financial instrument does not 

include: 

(i) A loan; 

(ii) A commodity that is not: 

(A) An excluded commodity (other 

than foreign exchange or currency); 

(B) A derivative; 

(C) A contract of sale of a commodity 

for future delivery; or 

(D) An option on a contract of sale of 

a commodity for future delivery; or 

(iii) Foreign exchange or currency. 

(d) Proprietary trading does not 

include:—(1) Any purchase or sale of 

one or more financial instruments by a 

banking entity that arises under a 

repurchase or reverse repurchase 

agreement pursuant to which the 

banking entity has simultaneously 

agreed, in writing, to both purchase and 

sell a stated asset, at stated prices, and 

on stated dates or on demand with the 

same counterparty; 

(2) Any purchase or sale of one or 

more financial instruments by a banking 

entity that arises under a transaction in 

which the banking entity lends or 

borrows a security temporarily to or 

from another party pursuant to a written 

securities lending agreement under 

which the lender retains the economic 

interests of an owner of such security, 

and has the right to terminate the 

transaction and to recall the loaned 

security on terms agreed by the parties; 

(3) Any purchase or sale of a security 

by a banking entity for the purpose of 

liquidity management in accordance 

with a documented liquidity 

management plan of the banking entity 

that: 

(i) Specifically contemplates and 

authorizes the particular securities to be 

used for liquidity management 

purposes, the amount, types, and risks 

of these securities that are consistent 

with liquidity management, and the 

liquidity circumstances in which the 

particular securities may or must be 

used; 

(ii) Requires that any purchase or sale 

of securities contemplated and 

authorized by the plan be principally for 

the purpose of managing the liquidity of 

the banking entity, and not for the 

purpose of short-term resale, benefitting 

from actual or expected short-term price 

movements, realizing short-term 

arbitrage profits, or hedging a position 

taken for such short-term purposes; 

(iii) Requires that any securities 

purchased or sold for liquidity 

management purposes be highly liquid 

and limited to securities the market, 

credit, and other risks of which the 

banking entity does not reasonably 

expect to give rise to appreciable profits 

or losses as a result of short-term price 

movements; 

(iv) Limits any securities purchased or 

sold for liquidity management purposes, 

together with any other instruments 

purchased or sold for such purposes, to 

an amount that is consistent with the 

banking entity’s near-term funding 

needs, including deviations from 

normal operations of the banking entity 

or any affiliate thereof, as estimated and 

documented pursuant to methods 

specified in the plan; 

(v) Includes written policies and 

procedures, internal controls, analysis, 

and independent testing to ensure that 

the purchase and sale of securities that 

are not permitted under § 75.6(a) or (b) 

are for the purpose of liquidity 

management and in accordance with the 

liquidity management plan described in 

paragraph (d)(3) of this section; and 

(vi) Is consistent with the 

Commission’s supervisory 

requirements, guidance, and 

expectations regarding liquidity 

management; 

(4) Any purchase or sale of one or 

more financial instruments by a banking 

entity that is a derivatives clearing 

organization or a clearing agency in 

connection with clearing financial 

instruments; 

(5) Any excluded clearing activities 

by a banking entity that is a member of 

a clearing agency, a member of a 

derivatives clearing organization, or a 

member of a designated financial market 

utility; 

(6) Any purchase or sale of one or 

more financial instruments by a banking 

entity, so long as: 

(i) The purchase (or sale) satisfies an 

existing delivery obligation of the 

banking entity or its customers, 

including to prevent or close out a 

failure to deliver, in connection with 

delivery, clearing, or settlement activity; 

or 

(ii) The purchase (or sale) satisfies an 

obligation of the banking entity in 

connection with a judicial, 


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administrative, self-regulatory 

organization, or arbitration proceeding; 

(7) Any purchase or sale of one or 

more financial instruments by a banking 

entity that is acting solely as agent, 

broker, or custodian; 

(8) Any purchase or sale of one or 

more financial instruments by a banking 

entity through a deferred compensation, 

stock-bonus, profit-sharing, or pension 

plan of the banking entity that is 

established and administered in 

accordance with the law of the United 

States or a foreign sovereign, if the 

purchase or sale is made directly or 

indirectly by the banking entity as 

trustee for the benefit of persons who 

are or were employees of the banking 

entity; or 

(9) Any purchase or sale of one or 

more financial instruments by a banking 

entity in the ordinary course of 

collecting a debt previously contracted 

in good faith, provided that the banking 

entity divests the financial instrument 

as soon as practicable, and in no event 

may the banking entity retain such 

instrument for longer than such period 

permitted by the Commission. 

(e) Definition of other terms related to 

proprietary trading. For purposes of this 

subpart: 

(1) Anonymous means that each party 

to a purchase or sale is unaware of the 

identity of the other party(ies) to the 

purchase or sale. 

(2) Clearing agency has the same 

meaning as in section 3(a)(23) of the 

Exchange Act (15 U.S.C. 78c(a)(23)). 

(3) Commodity has the same meaning 

as in section 1a(9) of the Commodity 

Exchange Act (7 U.S.C. 1a(9)), except 

that a commodity does not include any 

security; 

(4) Contract of sale of a commodity 

for future delivery means a contract of 

sale (as that term is defined in section 

1a(13) of the Commodity Exchange Act 

(7 U.S.C. 1a(13)) for future delivery (as 

that term is defined in section 1a(27) of 

the Commodity Exchange Act (7 U.S.C. 

1a(27))). 

(5) Derivatives clearing organization 

means: 

(i) A derivatives clearing organization 

registered under section 5b of the 

Commodity Exchange Act (7 U.S.C. 7a– 

1); 

(ii) A derivatives clearing organization 

that, pursuant to CFTC regulation, is 

exempt from the registration 

requirements under section 5b of the 

Commodity Exchange Act (7 U.S.C. 7a– 

1); or 

(iii) A foreign derivatives clearing 

organization that, pursuant to CFTC 

regulation, is permitted to clear for a 

foreign board of trade that is registered 

with the CFTC. 

(6) Exchange, unless the context 

otherwise requires, means any 

designated contract market, swap 

execution facility, or foreign board of 

trade registered with the CFTC, or, for 

purposes of securities or security-based 

swaps, an exchange, as defined under 

section 3(a)(1) of the Exchange Act (15 

U.S.C. 78c(a)(1)), or security-based swap 

execution facility, as defined under 

section 3(a)(77) of the Exchange Act (15 

U.S.C. 78c(a)(77)). 

(7) Excluded clearing activities means: 

(i) With respect to customer 

transactions cleared on a derivatives 

clearing organization, a clearing agency, 

or a designated financial market utility, 

any purchase or sale necessary to 

correct trading errors made by or on 

behalf of a customer provided that such 

purchase or sale is conducted in 

accordance with, for transactions 

cleared on a derivatives clearing 

organization, the Commodity Exchange 

Act, CFTC regulations, and the rules or 

procedures of the derivatives clearing 

organization, or, for transactions cleared 

on a clearing agency, the rules or 

procedures of the clearing agency, or, 

for transactions cleared on a designated 

financial market utility that is neither a 

derivatives clearing organization nor a 

clearing agency, the rules or procedures 

of the designated financial market 

utility; 

(ii) Any purchase or sale in 

connection with and related to the 

management of a default or threatened 

imminent default of a customer 

provided that such purchase or sale is 

conducted in accordance with, for 

transactions cleared on a derivatives 

clearing organization, the Commodity 

Exchange Act, CFTC regulations, and 

the rules or procedures of the 

derivatives clearing organization, or, for 

transactions cleared on a clearing 

agency, the rules or procedures of the 

clearing agency, or, for transactions 

cleared on a designated financial market 

utility that is neither a derivatives 

clearing organization nor a clearing 

agency, the rules or procedures of the 

designated financial market utility; 

(iii) Any purchase or sale in 

connection with and related to the 

management of a default or threatened 

imminent default of a member of a 

clearing agency, a member of a 

derivatives clearing organization, or a 

member of a designated financial market 

utility; 

(iv) Any purchase or sale in 

connection with and related to the 

management of the default or threatened 

default of a clearing agency, a 

derivatives clearing organization, or a 

designated financial market utility; and 

(v) Any purchase or sale that is 

required by the rules or procedures of a 

clearing agency, a derivatives clearing 

organization, or a designated financial 

market utility to mitigate the risk to the 

clearing agency, derivatives clearing 

organization, or designated financial 

market utility that would result from the 

clearing by a member of security-based 

swaps that reference the member or an 

affiliate of the member. 

(8) Designated financial market utility 

has the same meaning as in section 

803(4) of the Dodd-Frank Act (12 U.S.C. 

5462(4)). 

(9) Issuer has the same meaning as in 

section 2(a)(4) of the Securities Act of 

1933 (15 U.S.C. 77b(a)(4)). 

(10) Market risk capital rule covered 

position and trading position means a 

financial instrument that is both a 

covered position and a trading position, 

as those terms are respectively defined: 

(i) In the case of a banking entity that 

is a bank holding company, savings and 

loan holding company, or insured 

depository institution, under the market 

risk capital rule that is applicable to the 

banking entity; and 

(ii) In the case of a banking entity that 

is affiliated with a bank holding 

company or savings and loan holding 

company, other than a banking entity to 

which a market risk capital rule is 

applicable, under the market risk capital 

rule that is applicable to the affiliated 

bank holding company or savings and 

loan holding company. 

(11) Market risk capital rule means 

the market risk capital rule that is 

contained in subpart F of 12 CFR part 

3, 12 CFR parts 208 and 225, or 12 CFR 

part 324, as applicable. 

(12) Municipal security means a 

security that is a direct obligation of or 

issued by, or an obligation guaranteed as 

to principal or interest by, a State or any 

political subdivision thereof, or any 

agency or instrumentality of a State or 

any political subdivision thereof, or any 

municipal corporate instrumentality of 

one or more States or political 

subdivisions thereof. 

(13) Trading desk means the smallest 

discrete unit of organization of a 

banking entity that purchases or sells 

financial instruments for the trading 

account of the banking entity or an 

affiliate thereof. 

§ 75.4 Permitted underwriting and market 

making-related activities. 

(a) Underwriting activities—(1) 

Permitted underwriting activities. The 

prohibition contained in § 75.3(a) does 

not apply to a banking entity’s 

underwriting activities conducted in 

accordance with paragraph (a) of this 

section. 


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(2) Requirements. The underwriting 

activities of a banking entity are 

permitted under paragraph (a)(1) of this 

section only if: 

(i) The banking entity is acting as an 

underwriter for a distribution of 

securities and the trading desk’s 

underwriting position is related to such 

distribution; 

(ii) The amount and type of the 

securities in the trading desk’s 

underwriting position are designed not 

to exceed the reasonably expected near 

term demands of clients, customers, or 

counterparties, and reasonable efforts 

are made to sell or otherwise reduce the 

underwriting position within a 

reasonable period, taking into account 

the liquidity, maturity, and depth of the 

market for the relevant type of security; 

(iii) The banking entity has 

established and implements, maintains, 

and enforces an internal compliance 

program required by subpart D of this 

part that is reasonably designed to 

ensure the banking entity’s compliance 

with the requirements of paragraph (a) 

of this section, including reasonably 

designed written policies and 

procedures, internal controls, analysis 

and independent testing identifying and 

addressing: 

(A) The products, instruments or 

exposures each trading desk may 

purchase, sell, or manage as part of its 

underwriting activities; 

(B) Limits for each trading desk, based 

on the nature and amount of the trading 

desk’s underwriting activities, including 

the reasonably expected near term 

demands of clients, customers, or 

counterparties, on the: 

(1) Amount, types, and risk of its 

underwriting position; 

(2) Level of exposures to relevant risk 

factors arising from its underwriting 

position; and 

(3) Period of time a security may be 

held; 

(C) Internal controls and ongoing 

monitoring and analysis of each trading 

desk’s compliance with its limits; and 

(D) Authorization procedures, 

including escalation procedures that 

require review and approval of any 

trade that would exceed a trading desk’s 

limit(s), demonstrable analysis of the 

basis for any temporary or permanent 

increase to a trading desk’s limit(s), and 

independent review of such 

demonstrable analysis and approval; 

(iv) The compensation arrangements 

of persons performing the activities 

described in paragraph (a) of this 

section are designed not to reward or 

incentivize prohibited proprietary 

trading; and 

(v) The banking entity is licensed or 

registered to engage in the activity 

described in paragraph (a) of this 

section in accordance with applicable 

law. 

(3) Definition of distribution. For 

purposes of paragraph (a) of this section, 

a distribution of securities means: 

(i) An offering of securities, whether 

or not subject to registration under the 

Securities Act of 1933, that is 

distinguished from ordinary trading 

transactions by the presence of special 

selling efforts and selling methods; or 

(ii) An offering of securities made 

pursuant to an effective registration 

statement under the Securities Act of 

1933. 

(4) Definition of underwriter. For 

purposes of paragraph (a) of this section, 

underwriter means: 

(i) A person who has agreed with an 

issuer or selling security holder to: 

(A) Purchase securities from the 

issuer or selling security holder for 

distribution; 

(B) Engage in a distribution of 

securities for or on behalf of the issuer 

or selling security holder; or 

(C) Manage a distribution of securities 

for or on behalf of the issuer or selling 

security holder; or 

(ii) A person who has agreed to 

participate or is participating in a 

distribution of such securities for or on 

behalf of the issuer or selling security 

holder. 

(5) Definition of selling security 

holder. For purposes of paragraph (a) of 

this section, selling security holder 

means any person, other than an issuer, 

on whose behalf a distribution is made. 

(6) Definition of underwriting 

position. For purposes of paragraph (a) 

of this section, underwriting position 

means the long or short positions in one 

or more securities held by a banking 

entity or its affiliate, and managed by a 

particular trading desk, in connection 

with a particular distribution of 

securities for which such banking entity 

or affiliate is acting as an underwriter. 

(7) Definition of client, customer, and 

counterparty. For purposes of paragraph 

(a) of this section, the terms client, 

customer, and counterparty, on a 

collective or individual basis, refer to 

market participants that may transact 

with the banking entity in connection 

with a particular distribution for which 

the banking entity is acting as 

underwriter. 

(b) Market making-related activities— 

(1) Permitted market making-related 

activities. The prohibition contained in 

§ 75.3(a) does not apply to a banking 

entity’s market making-related activities 

conducted in accordance with 

paragraph (b) of this section. 

(2) Requirements. The market makingrelated activities of a banking entity are 

permitted under paragraph (b)(1) of this 

section only if: 

(i) The trading desk that establishes 

and manages the financial exposure 

routinely stands ready to purchase and 

sell one or more types of financial 

instruments related to its financial 

exposure and is willing and available to 

quote, purchase and sell, or otherwise 

enter into long and short positions in 

those types of financial instruments for 

its own account, in commercially 

reasonable amounts and throughout 

market cycles on a basis appropriate for 

the liquidity, maturity, and depth of the 

market for the relevant types of financial 

instruments; 

(ii) The amount, types, and risks of 

the financial instruments in the trading 

desk’s market-maker inventory are 

designed not to exceed, on an ongoing 

basis, the reasonably expected near term 

demands of clients, customers, or 

counterparties, based on: 

(A) The liquidity, maturity, and depth 

of the market for the relevant types of 

financial instrument(s); and 

(B) Demonstrable analysis of 

historical customer demand, current 

inventory of financial instruments, and 

market and other factors regarding the 

amount, types, and risks, of or 

associated with financial instruments in 

which the trading desk makes a market, 

including through block trades; 

(iii) The banking entity has 

established and implements, maintains, 

and enforces an internal compliance 

program required by subpart D of this 

part that is reasonably designed to 

ensure the banking entity’s compliance 

with the requirements of paragraph (b) 

of this section, including reasonably 

designed written policies and 

procedures, internal controls, analysis 

and independent testing identifying and 

addressing: 

(A) The financial instruments each 

trading desk stands ready to purchase 

and sell in accordance with paragraph 

(b)(2)(i) of this section; 

(B) The actions the trading desk will 

take to demonstrably reduce or 

otherwise significantly mitigate 

promptly the risks of its financial 

exposure consistent with the limits 

required under paragraph (b)(2)(iii)(C) of 

this section; the products, instruments, 

and exposures each trading desk may 

use for risk management purposes; the 

techniques and strategies each trading 

desk may use to manage the risks of its 

market making-related activities and 

inventory; and the process, strategies, 

and personnel responsible for ensuring 

that the actions taken by the trading 

desk to mitigate these risks are and 

continue to be effective; 


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(C) Limits for each trading desk, based 

on the nature and amount of the trading 

desk’s market making-related activities, 

that address the factors prescribed by 

paragraph (b)(2)(ii) of this section, on: 

(1) The amount, types, and risks of its 

market-maker inventory; 

(2) The amount, types, and risks of the 

products, instruments, and exposures 

the trading desk may use for risk 

management purposes; 

(3) The level of exposures to relevant 

risk factors arising from its financial 

exposure; and 

(4) The period of time a financial 

instrument may be held; 

(D) Internal controls and ongoing 

monitoring and analysis of each trading 

desk’s compliance with its limits; and 

(E) Authorization procedures, 

including escalation procedures that 

require review and approval of any 

trade that would exceed a trading desk’s 

limit(s), demonstrable analysis that the 

basis for any temporary or permanent 

increase to a trading desk’s limit(s) is 

consistent with the requirements of 

paragraph (b) of this section, and 

independent review of such 

demonstrable analysis and approval; 

(iv) To the extent that any limit 

identified pursuant to paragraph 

(b)(2)(iii)(C) of this section is exceeded, 

the trading desk takes action to bring the 

trading desk into compliance with the 

limits as promptly as possible after the 

limit is exceeded; 

(v) The compensation arrangements of 

persons performing the activities 

described in paragraph (b) of this 

section are designed not to reward or 

incentivize prohibited proprietary 

trading; and 

(vi) The banking entity is licensed or 

registered to engage in activity 

described in paragraph (b) of this 

section in accordance with applicable 

law. 

(3) Definition of client, customer, and 

counterparty. For purposes of paragraph 

(b) of this section, the terms client, 

customer, and counterparty, on a 

collective or individual basis refer to 

market participants that make use of the 

banking entity’s market making-related 

services by obtaining such services, 

responding to quotations, or entering 

into a continuing relationship with 

respect to such services, provided that: 

(i) A trading desk or other 

organizational unit of another banking 

entity is not a client, customer, or 

counterparty of the trading desk if that 

other entity has trading assets and 

liabilities of $50 billion or more as 

measured in accordance with 

§ 75.20(d)(1), unless: 

(A) The trading desk documents how 

and why a particular trading desk or 

other organizational unit of the entity 

should be treated as a client, customer, 

or counterparty of the trading desk for 

purposes of paragraph (b)(2) of this 

section; or 

(B) The purchase or sale by the 

trading desk is conducted anonymously 

on an exchange or similar trading 

facility that permits trading on behalf of 

a broad range of market participants. 

(ii) [Reserved] 

(4) Definition of financial exposure. 

For purposes of paragraph (b) of this 

section, financial exposure means the 

aggregate risks of one or more financial 

instruments and any associated loans, 

commodities, or foreign exchange or 

currency, held by a banking entity or its 

affiliate and managed by a particular 

trading desk as part of the trading desk’s 

market making-related activities. 

(5) Definition of market-maker 

inventory. For the purposes of paragraph 

(b) of this section, market-maker 

inventory means all of the positions in 

the financial instruments for which the 

trading desk stands ready to make a 

market in accordance with paragraph 

(b)(2)(i) of this section that are managed 

by the trading desk, including the 

trading desk’s open positions or 

exposures arising from open 

transactions. 

§ 75.5 Permitted risk-mitigating hedging 

activities. 

(a) Permitted risk-mitigating hedging 

activities. The prohibition contained in 

§ 75.3(a) does not apply to the riskmitigating hedging activities of a 

banking entity in connection with and 

related to individual or aggregated 

positions, contracts, or other holdings of 

the banking entity and designed to 

reduce the specific risks to the banking 

entity in connection with and related to 

such positions, contracts, or other 

holdings. 

(b) Requirements. The risk-mitigating 

hedging activities of a banking entity are 

permitted under paragraph (a) of this 

section only if: 

(1) The banking entity has established 

and implements, maintains and enforces 

an internal compliance program 

required by subpart D of this part that 

is reasonably designed to ensure the 

banking entity’s compliance with the 

requirements of this section, including: 

(i) Reasonably designed written 

policies and procedures regarding the 

positions, techniques and strategies that 

may be used for hedging, including 

documentation indicating what 

positions, contracts or other holdings a 

particular trading desk may use in its 

risk-mitigating hedging activities, as 

well as position and aging limits with 

respect to such positions, contracts or 

other holdings; 

(ii) Internal controls and ongoing 

monitoring, management, and 

authorization procedures, including 

relevant escalation procedures; and 

(iii) The conduct of analysis, 

including correlation analysis, and 

independent testing designed to ensure 

that the positions, techniques and 

strategies that may be used for hedging 

may reasonably be expected to 

demonstrably reduce or otherwise 

significantly mitigate the specific, 

identifiable risk(s) being hedged, and 

such correlation analysis demonstrates 

that the hedging activity demonstrably 

reduces or otherwise significantly 

mitigates the specific, identifiable risk(s) 

being hedged; 

(2) The risk-mitigating hedging 

activity: 

(i) Is conducted in accordance with 

the written policies, procedures, and 

internal controls required under this 

section; 

(ii) At the inception of the hedging 

activity, including, without limitation, 

any adjustments to the hedging activity, 

is designed to reduce or otherwise 

significantly mitigate and demonstrably 

reduces or otherwise significantly 

mitigates one or more specific, 

identifiable risks, including market risk, 

counterparty or other credit risk, 

currency or foreign exchange risk, 

interest rate risk, commodity price risk, 

basis risk, or similar risks, arising in 

connection with and related to 

identified positions, contracts, or other 

holdings of the banking entity, based 

upon the facts and circumstances of the 

identified underlying and hedging 

positions, contracts or other holdings 

and the risks and liquidity thereof; 

(iii) Does not give rise, at the 

inception of the hedge, to any 

significant new or additional risk that is 

not itself hedged contemporaneously in 

accordance with this section; 

(iv) Is subject to continuing review, 

monitoring and management by the 

banking entity that: 

(A) Is consistent with the written 

hedging policies and procedures 

required under paragraph (b)(1) of this 

section; 

(B) Is designed to reduce or otherwise 

significantly mitigate and demonstrably 

reduces or otherwise significantly 

mitigates the specific, identifiable risks 

that develop over time from the riskmitigating hedging activities undertaken 

under this section and the underlying 

positions, contracts, and other holdings 

of the banking entity, based upon the 

facts and circumstances of the 

underlying and hedging positions, 

contracts and other holdings of the 


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banking entity and the risks and 

liquidity thereof; and 

(C) Requires ongoing recalibration of 

the hedging activity by the banking 

entity to ensure that the hedging activity 

satisfies the requirements set out in 

paragraph (b)(2) of this section and is 

not prohibited proprietary trading; and 

(3) The compensation arrangements of 

persons performing risk-mitigating 

hedging activities are designed not to 

reward or incentivize prohibited 

proprietary trading. 

(c) Documentation requirement. (1) A 

banking entity must comply with the 

requirements of paragraphs (c)(2) and 

(c)(3) of this section with respect to any 

purchase or sale of financial 

instruments made in reliance on this 

section for risk-mitigating hedging 

purposes that is: 

(i) Not established by the specific 

trading desk establishing or responsible 

for the underlying positions, contracts, 

or other holdings the risks of which the 

hedging activity is designed to reduce; 

(ii) Established by the specific trading 

desk establishing or responsible for the 

underlying positions, contracts, or other 

holdings the risks of which the 

purchases or sales are designed to 

reduce, but that is effected through a 

financial instrument, exposure, 

technique, or strategy that is not 

specifically identified in the trading 

desk’s written policies and procedures 

established under paragraph (b)(1) of 

this section or under § 75.4(b)(2)(iii)(B) 

as a product, instrument, exposure, 

technique, or strategy such trading desk 

may use for hedging; or 

(iii) Established to hedge aggregated 

positions across two or more trading 

desks. 

(2) In connection with any purchase 

or sale identified in paragraph (c)(1) of 

this section, a banking entity must, at a 

minimum, and contemporaneously with 

the purchase or sale, document: 

(i) The specific, identifiable risk(s) of 

the identified positions, contracts, or 

other holdings of the banking entity that 

the purchase or sale is designed to 

reduce; 

(ii) The specific risk-mitigating 

strategy that the purchase or sale is 

designed to fulfill; and 

(iii) The trading desk or other 

business unit that is establishing and 

responsible for the hedge. 

(3) A banking entity must create and 

retain records sufficient to demonstrate 

compliance with the requirements of 

paragraph (c) of this section for a period 

that is no less than five years in a form 

that allows the banking entity to 

promptly produce such records to the 

Commission on request, or such longer 

period as required under other law or 

this part. 

§ 75.6 Other permitted proprietary trading 

activities. 

(a) Permitted trading in domestic 

government obligations. The prohibition 

contained in § 75.3(a) does not apply to 

the purchase or sale by a banking entity 

of a financial instrument that is: 

(1) An obligation of, or issued or 

guaranteed by, the United States; 

(2) An obligation, participation, or 

other instrument of, or issued or 

guaranteed by, an agency of the United 

States, the Government National 

Mortgage Association, the Federal 

National Mortgage Association, the 

Federal Home Loan Mortgage 

Corporation, a Federal Home Loan 

Bank, the Federal Agricultural Mortgage 

Corporation or a Farm Credit System 

institution chartered under and subject 

to the provisions of the Farm Credit Act 

of 1971 (12 U.S.C. 2001 et seq.); 

(3) An obligation of any State or any 

political subdivision thereof, including 

any municipal security; or 

(4) An obligation of the FDIC, or any 

entity formed by or on behalf of the 

FDIC for purpose of facilitating the 

disposal of assets acquired or held by 

the FDIC in its corporate capacity or as 

conservator or receiver under the 

Federal Deposit Insurance Act or Title II 

of the Dodd-Frank Wall Street Reform 

and Consumer Protection Act. 

(b) Permitted trading in foreign 

government obligations—(1) Affiliates of 

foreign banking entities in the United 

States. The prohibition contained in 

§ 75.3(a) does not apply to the purchase 

or sale of a financial instrument that is 

an obligation of, or issued or guaranteed 

by, a foreign sovereign (including any 

multinational central bank of which the 

foreign sovereign is a member), or any 

agency or political subdivision of such 

foreign sovereign, by a banking entity, 

so long as: 

(i) The banking entity is organized 

under or is directly or indirectly 

controlled by a banking entity that is 

organized under the laws of a foreign 

sovereign and is not directly or 

indirectly controlled by a top-tier 

banking entity that is organized under 

the laws of the United States; 

(ii) The financial instrument is an 

obligation of, or issued or guaranteed 

by, the foreign sovereign under the laws 

of which the foreign banking entity 

referred to in paragraph (b)(1)(i) of this 

section is organized (including any 

multinational central bank of which the 

foreign sovereign is a member), or any 

agency or political subdivision of that 

foreign sovereign; and 

(iii) The purchase or sale as principal 

is not made by an insured depository 

institution. 

(2) Foreign affiliates of a U.S. banking 

entity. The prohibition contained in 

§ 75.3(a) does not apply to the purchase 

or sale of a financial instrument that is 

an obligation of, or issued or guaranteed 

by, a foreign sovereign (including any 

multinational central bank of which the 

foreign sovereign is a member), or any 

agency or political subdivision of that 

foreign sovereign, by a foreign entity 

that is owned or controlled by a banking 

entity organized or established under 

the laws of the United States or any 

State, so long as: 

(i) The foreign entity is a foreign bank, 

as defined in § 211.2(j) of the Board’s 

Regulation K (12 CFR 211.2(j)), or is 

regulated by the foreign sovereign as a 

securities dealer; 

(ii) The financial instrument is an 

obligation of, or issued or guaranteed 

by, the foreign sovereign under the laws 

of which the foreign entity is organized 

(including any multinational central 

bank of which the foreign sovereign is 

a member), or any agency or political 

subdivision of that foreign sovereign; 

and 

(iii) The financial instrument is 

owned by the foreign entity and is not 

financed by an affiliate that is located in 

the United States or organized under the 

laws of the United States or of any State. 

(c) Permitted trading on behalf of 

customers—(1) Fiduciary transactions. 

The prohibition contained in § 75.3(a) 

does not apply to the purchase or sale 

of financial instruments by a banking 

entity acting as trustee or in a similar 

fiduciary capacity, so long as: 

(i) The transaction is conducted for 

the account of, or on behalf of, a 

customer; and 

(ii) The banking entity does not have 

or retain beneficial ownership of the 

financial instruments. 

(2) Riskless principal transactions. 

The prohibition contained in § 75.3(a) 

does not apply to the purchase or sale 

of financial instruments by a banking 

entity acting as riskless principal in a 

transaction in which the banking entity, 

after receiving an order to purchase (or 

sell) a financial instrument from a 

customer, purchases (or sells) the 

financial instrument for its own account 

to offset a contemporaneous sale to (or 

purchase from) the customer. 

(d) Permitted trading by a regulated 

insurance company. The prohibition 

contained in § 75.3(a) does not apply to 

the purchase or sale of financial 

instruments by a banking entity that is 

an insurance company or an affiliate of 

an insurance company if: 


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(1) The insurance company or its 

affiliate purchases or sells the financial 

instruments solely for: 

(i) The general account of the 

insurance company; or 

(ii) A separate account established by 

the insurance company; 

(2) The purchase or sale is conducted 

in compliance with, and subject to, the 

insurance company investment laws, 

regulations, and written guidance of the 

State or jurisdiction in which such 

insurance company is domiciled; and 

(3) The appropriate Federal banking 

agencies, after consultation with the 

Financial Stability Oversight Council 

and the relevant insurance 

commissioners of the States and foreign 

jurisdictions, as appropriate, have not 

jointly determined, after notice and 

comment, that a particular law, 

regulation, or written guidance 

described in paragraph (d)(2) of this 

section is insufficient to protect the 

safety and soundness of the covered 

banking entity, or the financial stability 

of the United States. 

(e) Permitted trading activities of 

foreign banking entities. (1) The 

prohibition contained in § 75.3(a) does 

not apply to the purchase or sale of 

financial instruments by a banking 

entity if: 

(i) The banking entity is not organized 

or directly or indirectly controlled by a 

banking entity that is organized under 

the laws of the United States or of any 

State; 

(ii) The purchase or sale by the 

banking entity is made pursuant to 

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

the BHC Act; and 

(iii) The purchase or sale meets the 

requirements of paragraph (e)(3) of this 

section. 

(2) A purchase or sale of financial 

instruments by a banking entity is made 

pursuant to paragraph (9) or (13) of 

section 4(c) of the BHC Act for purposes 

of paragraph (e)(1)(ii) of this section 

only if: 

(i) The purchase or sale is conducted 

in accordance with the requirements of 

paragraph (e) of this section; and 

(ii)(A) With respect to a banking 

entity that is a foreign banking 

organization, the banking entity meets 

the qualifying foreign banking 

organization requirements of 

§ 211.23(a), (c) or (e) of the Board’s 

Regulation K (12 CFR 211.23(a), (c) or 

(e)), as applicable; or 

(B) With respect to a banking entity 

that is not a foreign banking 

organization, the banking entity is not 

organized under the laws of the United 

States or of any State and the banking 

entity, on a fully-consolidated basis, 

meets at least two of the following 

requirements: 

(1) Total assets of the banking entity 

held outside of the United States exceed 

total assets of the banking entity held in 

the United States; 

(2) Total revenues derived from the 

business of the banking entity outside of 

the United States exceed total revenues 

derived from the business of the 

banking entity in the United States; or 

(3) Total net income derived from the 

business of the banking entity outside of 

the United States exceeds total net 

income derived from the business of the 

banking entity in the United States. 

(3) A purchase or sale by a banking 

entity is permitted for purposes of 

paragraph (e) of this section only if: 

(i) The banking entity engaging as 

principal in the purchase or sale 

(including any personnel of the banking 

entity or its affiliate that arrange, 

negotiate or execute such purchase or 

sale) is not located in the United States 

or organized under the laws of the 

United States or of any State; 

(ii) The banking entity (including 

relevant personnel) that makes the 

decision to purchase or sell as principal 

is not located in the United States or 

organized under the laws of the United 

States or of any State; 

(iii) The purchase or sale, including 

any transaction arising from riskmitigating hedging related to the 

instruments purchased or sold, is not 

accounted for as principal directly or on 

a consolidated basis by any branch or 

affiliate that is located in the United 

States or organized under the laws of 

the United States or of any State; 

(iv) No financing for the banking 

entity’s purchases or sales is provided, 

directly or indirectly, by any branch or 

affiliate that is located in the United 

States or organized under the laws of 

the United States or of any State; and 

(v) The purchase or sale is not 

conducted with or through any U.S. 

entity, other than: 

(A) A purchase or sale with the 

foreign operations of a U.S. entity if no 

personnel of such U.S. entity that are 

located in the United States are 

involved in the arrangement, 

negotiation, or execution of such 

purchase or sale; 

(B) A purchase or sale with an 

unaffiliated market intermediary acting 

as principal, provided the purchase or 

sale is promptly cleared and settled 

through a clearing agency or derivatives 

clearing organization acting as a central 

counterparty; or 

(C) A purchase or sale through an 

unaffiliated market intermediary acting 

as agent, provided the purchase or sale 

is conducted anonymously on an 

exchange or similar trading facility and 

is promptly cleared and settled through 

a clearing agency or derivatives clearing 

organization acting as a central 

counterparty, 

(4) For purposes of paragraph (e) of 

this section, a U.S. entity is any entity 

that is, or is controlled by, or is acting 

on behalf of, or at the direction of, any 

other entity that is, located in the 

United States or organized under the 

laws of the United States or of any State. 

(5) For purposes of paragraph (e) of 

this section, a U.S. branch, agency, or 

subsidiary of a foreign banking entity is 

considered to be located in the United 

States; however, the foreign bank that 

operates or controls that branch, agency, 

or subsidiary is not considered to be 

located in the United States solely by 

virtue of operating or controlling the 

U.S. branch, agency, or subsidiary. 

(6) For purposes of paragraph (e) of 

this section, unaffiliated market 

intermediary means an unaffiliated 

entity, acting as an intermediary, that is: 

(i) A broker or dealer registered with 

the SEC under section 15 of the 

Exchange Act or exempt from 

registration or excluded from regulation 

as such; 

(ii) A swap dealer registered with the 

CFTC under section 4s of the 

Commodity Exchange Act or exempt 

from registration or excluded from 

regulation as such; 

(iii) A security-based swap dealer 

registered with the SEC under section 

15F of the Exchange Act or exempt from 

registration or excluded from regulation 

as such; or 

(iv) A futures commission merchant 

registered with the CFTC under section 

4f of the Commodity Exchange Act or 

exempt from registration or excluded 

from regulation as such. 

§ 75.7 Limitations on permitted proprietary 

trading activities. 

(a) No transaction, class of 

transactions, or activity may be deemed 

permissible under §§ 75.4 through 75.6 

if the transaction, class of transactions, 

or activity would: 

(1) Involve or result in a material 

conflict of interest between the banking 

entity and its clients, customers, or 

counterparties; 

(2) Result, directly or indirectly, in a 

material exposure by the banking entity 

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

strategy; or 

(3) Pose a threat to the safety and 

soundness of the banking entity or to 

the financial stability of the United 

States. 

(b) Definition of material conflict of 

interest. (1) For purposes of this section, 

a material conflict of interest between a 


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banking entity and its clients, 

customers, or counterparties exists if the 

banking entity engages in any 

transaction, class of transactions, or 

activity that would involve or result in 

the banking entity’s interests being 

materially adverse to the interests of its 

client, customer, or counterparty with 

respect to such transaction, class of 

transactions, or activity, and the 

banking entity has not taken at least one 

of the actions in paragraph (b)(2) of this 

section. 

(2) Prior to effecting the specific 

transaction or class or type of 

transactions, or engaging in the specific 

activity, the banking entity: 

(i) Timely and effective disclosure. (A) 

Has made clear, timely, and effective 

disclosure of the conflict of interest, 

together with other necessary 

information, in reasonable detail and in 

a manner sufficient to permit a 

reasonable client, customer, or 

counterparty to meaningfully 

understand the conflict of interest; and 

(B) Such disclosure is made in a 

manner that provides the client, 

customer, or counterparty the 

opportunity to negate, or substantially 

mitigate, any materially adverse effect 

on the client, customer, or counterparty 

created by the conflict of interest; or 

(ii) Information barriers. Has 

established, maintained, and enforced 

information barriers that are 

memorialized in written policies and 

procedures, such as physical separation 

of personnel, or functions, or limitations 

on types of activity, that are reasonably 

designed, taking into consideration the 

nature of the banking entity’s business, 

to prevent the conflict of interest from 

involving or resulting in a materially 

adverse effect on a client, customer, or 

counterparty. A banking entity may not 

rely on such information barriers if, in 

the case of any specific transaction, 

class or type of transactions or activity, 

the banking entity knows or should 

reasonably know that, notwithstanding 

the banking entity’s establishment of 

information barriers, the conflict of 

interest may involve or result in a 

materially adverse effect on a client, 

customer, or counterparty. 

(c) Definition of high-risk asset and 

high-risk trading strategy. For purposes 

of this section: 

(1) High-risk asset means an asset or 

group of related assets that would, if 

held by a banking entity, significantly 

increase the likelihood that the banking 

entity would incur a substantial 

financial loss or would pose a threat to 

the financial stability of the United 

States. 

(2) High-risk trading strategy means a 

trading strategy that would, if engaged 

in by a banking entity, significantly 

increase the likelihood that the banking 

entity would incur a substantial 

financial loss or would pose a threat to 

the financial stability of the United 

States. 

§§ 75.8–75.9 [Reserved] 

Subpart C—Covered Fund Activities 

and Investments 

§ 75.10 Prohibition on acquiring or 

retaining an ownership interest in and 

having certain relationships with a covered 

fund. 

(a) Prohibition. (1) Except as 

otherwise provided in this subpart, a 

banking entity may not, as principal, 

directly or indirectly, acquire or retain 

any ownership interest in or sponsor a 

covered fund. 

(2) Paragraph (a)(1) of this section 

does not include acquiring or retaining 

an ownership interest in a covered fund 

by a banking entity: 

(i) Acting solely as agent, broker, or 

custodian, so long as; 

(A) The activity is conducted for the 

account of, or on behalf of, a customer; 

and 

(B) The banking entity and its 

affiliates do not have or retain beneficial 

ownership of such ownership interest; 

(ii) Through a deferred compensation, 

stock-bonus, profit-sharing, or pension 

plan of the banking entity (or an affiliate 

thereof) that is established and 

administered in accordance with the 

law of the United States or a foreign 

sovereign, if the ownership interest is 

held or controlled directly or indirectly 

by the banking entity as trustee for the 

benefit of persons who are or were 

employees of the banking entity (or an 

affiliate thereof); 

(iii) In the ordinary course of 

collecting a debt previously contracted 

in good faith, provided that the banking 

entity divests the ownership interest as 

soon as practicable, and in no event may 

the banking entity retain such 

ownership interest for longer than such 

period permitted by the Commission; or 

(iv) On behalf of customers as trustee 

or in a similar fiduciary capacity for a 

customer that is not a covered fund, so 

long as: 

(A) The activity is conducted for the 

account of, or on behalf of, the 

customer; and 

(B) The banking entity and its 

affiliates do not have or retain beneficial 

ownership of such ownership interest. 

(b) Definition of covered fund. (1) 

Except as provided in paragraph (c) of 

this section, covered fund means: 

(i) An issuer that would be an 

investment company, as defined in the 

Investment Company Act of 1940 (15 

U.S.C. 80a–1 et seq.), but for section 

3(c)(1) or 3(c)(7) of that Act (15 U.S.C. 

80a–3(c)(1) or (7)); 

(ii) Any commodity pool under 

section 1a(10) of the Commodity 

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

which: 

(A) The commodity pool operator has 

claimed an exemption under § 4.7 of 

this chapter; or 

(B) (1) A commodity pool operator is 

registered with the CFTC as a 

commodity pool operator in connection 

with the operation of the commodity 

pool; 

(2) Substantially all participation 

units of the commodity pool are owned 

by qualified eligible persons under 

§ 4.7(a)(2) and (3) of this chapter; and 

(3) Participation units of the 

commodity pool have not been publicly 

offered to persons who are not qualified 

eligible persons under § 4.7(a)(2) and (3) 

of this chapter; or 

(iii) For any banking entity that is, or 

is controlled directly or indirectly by a 

banking entity that is, located in or 

organized under the laws of the United 

States or of any State, an entity that: 

(A) Is organized or established outside 

the United States and the ownership 

interests of which are offered and sold 

solely outside the United States; 

(B) Is, or holds itself out as being, an 

entity or arrangement that raises money 

from investors primarily for the purpose 

of investing in securities for resale or 

other disposition or otherwise trading in 

securities; and 

(C) (1) Has as its sponsor that banking 

entity (or an affiliate thereof); or 

(2) Has issued an ownership interest 

that is owned directly or indirectly by 

that banking entity (or an affiliate 

thereof). 

(2) An issuer shall not be deemed to 

be a covered fund under paragraph 

(b)(1)(iii) of this section if, were the 

issuer subject to U.S. securities laws, the 

issuer could rely on an exclusion or 

exemption from the definition of 

‘‘investment company’’ under the 

Investment Company Act of 1940 (15 

U.S.C. 80a–1 et seq.) other than the 

exclusions contained in section 3(c)(1) 

and 3(c)(7) of that Act. 

(3) For purposes of paragraph 

(b)(1)(iii) of this section, a U.S. branch, 

agency, or subsidiary of a foreign 

banking entity is located in the United 

States; however, the foreign bank that 

operates or controls that branch, agency, 

or subsidiary is not considered to be 

located in the United States solely by 

virtue of operating or controlling the 

U.S. branch, agency, or subsidiary. 

(c) Notwithstanding paragraph (b) of 

this section, unless the appropriate 

Federal banking agencies, the SEC, and 


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the CFTC jointly determine otherwise, a 

covered fund does not include: 

(1) Foreign public funds. (i) Subject to 

paragraphs (c)(1)(ii) and (iii) of this 

section, an issuer that: 

(A) Is organized or established outside 

of the United States; 

(B) Is authorized to offer and sell 

ownership interests to retail investors in 

the issuer’s home jurisdiction; and 

(C) Sells ownership interests 

predominantly through one or more 

public offerings outside of the United 

States. 

(ii) With respect to a banking entity 

that is, or is controlled directly or 

indirectly by a banking entity that is, 

located in or organized under the laws 

of the United States or of any State and 

any issuer for which such banking 

entity acts as sponsor, the sponsoring 

banking entity may not rely on the 

exemption in paragraph (c)(1)(i) of this 

section for such issuer unless ownership 

interests in the issuer are sold 

predominantly to persons other than: 

(A) Such sponsoring banking entity; 

(B) Such issuer; 

(C) Affiliates of such sponsoring 

banking entity or such issuer; and 

(D) Directors and employees of such 

entities. 

(iii) For purposes of paragraph 

(c)(1)(i)(C) of this section, the term 

public offering means a distribution (as 

defined in § 75.4(a)(3)) of securities in 

any jurisdiction outside the United 

States to investors, including retail 

investors, provided that: 

(A) The distribution complies with all 

applicable requirements in the 

jurisdiction in which such distribution 

is being made; 

(B) The distribution does not restrict 

availability to investors having a 

minimum level of net worth or net 

investment assets; and 

(C) The issuer has filed or submitted, 

with the appropriate regulatory 

authority in such jurisdiction, offering 

disclosure documents that are publicly 

available. 

(2) Wholly-owned subsidiaries. An 

entity, all of the outstanding ownership 

interests of which are owned directly or 

indirectly by the banking entity (or an 

affiliate thereof), except that: 

(i) Up to five percent of the entity’s 

outstanding ownership interests, less 

any amounts outstanding under 

paragraph (c)(2)(ii) of this section, may 

be held by employees or directors of the 

banking entity or such affiliate 

(including former employees or 

directors if their ownership interest was 

acquired while employed by or in the 

service of the banking entity); and 

(ii) Up to 0.5 percent of the entity’s 

outstanding ownership interests may be 

held by a third party if the ownership 

interest is acquired or retained by the 

third party for the purpose of 

establishing corporate separateness or 

addressing bankruptcy, insolvency, or 

similar concerns. 

(3) Joint ventures. A joint venture 

between a banking entity or any of its 

affiliates and one or more unaffiliated 

persons, provided that the joint venture: 

(i) Is comprised of no more than 10 

unaffiliated co-venturers; 

(ii) Is in the business of engaging in 

activities that are permissible for the 

banking entity or affiliate, other than 

investing in securities for resale or other 

disposition; and 

(iii) Is not, and does not hold itself out 

as being, an entity or arrangement that 

raises money from investors primarily 

for the purpose of investing in securities 

for resale or other disposition or 

otherwise trading in securities. 

(4) Acquisition vehicles. An issuer: 

(i) Formed solely for the purpose of 

engaging in a bona fide merger or 

acquisition transaction; and 

(ii) That exists only for such period as 

necessary to effectuate the transaction. 

(5) Foreign pension or retirement 

funds. A plan, fund, or program 

providing pension, retirement, or 

similar benefits that is: 

(i) Organized and administered 

outside the United States; 

(ii) A broad-based plan for employees 

or citizens that is subject to regulation 

as a pension, retirement, or similar plan 

under the laws of the jurisdiction in 

which the plan, fund, or program is 

organized and administered; and 

(iii) Established for the benefit of 

citizens or residents of one or more 

foreign sovereigns or any political 

subdivision thereof. 

(6) Insurance company separate 

accounts. A separate account, provided 

that no banking entity other than the 

insurance company participates in the 

account’s profits and losses. 

(7) Bank owned life insurance. A 

separate account that is used solely for 

the purpose of allowing one or more 

banking entities to purchase a life 

insurance policy for which the banking 

entity or entities is beneficiary, 

provided that no banking entity that 

purchases the policy: 

(i) Controls the investment decisions 

regarding the underlying assets or 

holdings of the separate account; or 

(ii) Participates in the profits and 

losses of the separate account other than 

in compliance with applicable 

supervisory guidance regarding bank 

owned life insurance. 

(8) Loan securitizations—(i) Scope. 

An issuing entity for asset-backed 

securities that satisfies all the 

conditions of paragraph (c)(8) of this 

section and the assets or holdings of 

which are comprised solely of: 

(A) Loans as defined in § 75.2(s); 

(B) Rights or other assets designed to 

assure the servicing or timely 

distribution of proceeds to holders of 

such securities and rights or other assets 

that are related or incidental to 

purchasing or otherwise acquiring and 

holding the loans, provided that each 

asset meets the requirements of 

paragraph (c)(8)(iii) of this section; 

(C) Interest rate or foreign exchange 

derivatives that meet the requirements 

of paragraph (c)(8)(iv) of this section; 

and 

(D) Special units of beneficial interest 

and collateral certificates that meet the 

requirements of paragraph (c)(8)(v) of 

this section. 

(ii) Impermissible assets. For purposes 

of paragraph (c)(8) of this section, the 

assets or holdings of the issuing entity 

shall not include any of the following: 

(A) A security, including an assetbacked security, or an interest in an 

equity or debt security other than as 

permitted in paragraph (c)(8)(iii) of this 

section; 

(B) A derivative, other than a 

derivative that meets the requirements 

of paragraph (c)(8)(iv) of this section; or 

(C) A commodity forward contract. 

(iii) Permitted securities. 

Notwithstanding paragraph (c)(8)(ii)(A) 

of this section, the issuing entity may 

hold securities if those securities are: 

(A) Cash equivalents for purposes of 

the rights and assets in paragraph 

(c)(8)(i)(B) of this section; or 

(B) Securities received in lieu of debts 

previously contracted with respect to 

the loans supporting the asset-backed 

securities. 

(iv) Derivatives. The holdings of 

derivatives by the issuing entity shall be 

limited to interest rate or foreign 

exchange derivatives that satisfy all of 

the following conditions: 

(A) The written terms of the 

derivative directly relate to the loans, 

the asset-backed securities, or the 

contractual rights of other assets 

described in paragraph (c)(8)(i)(B) of 

this section; and 

(B) The derivatives reduce the interest 

rate and/or foreign exchange risks 

related to the loans, the asset-backed 

securities, or the contractual rights or 

other assets described in paragraph 

(c)(8)(i)(B) of this section. 

(v) Special units of beneficial interest 

and collateral certificates. The assets or 

holdings of the issuing entity may 

include collateral certificates and 

special units of beneficial interest 

issued by a special purpose vehicle, 

provided that: 


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(A) The special purpose vehicle that 

issues the special unit of beneficial 

interest or collateral certificate meets 

the requirements in paragraph (c)(8) of 

this section; 

(B) The special unit of beneficial 

interest or collateral certificate is used 

for the sole purpose of transferring to 

the issuing entity for the loan 

securitization the economic risks and 

benefits of the assets that are 

permissible for loan securitizations 

under paragraph (c)(8) of this section 

and does not directly or indirectly 

transfer any interest in any other 

economic or financial exposure; 

(C) The special unit of beneficial 

interest or collateral certificate is 

created solely to satisfy legal 

requirements or otherwise facilitate the 

structuring of the loan securitization; 

and 

(D) The special purpose vehicle that 

issues the special unit of beneficial 

interest or collateral certificate and the 

issuing entity are established under the 

direction of the same entity that 

initiated the loan securitization. 

(9) Qualifying asset-backed 

commercial paper conduits. (i) An 

issuing entity for asset-backed 

commercial paper that satisfies all of the 

following requirements: 

(A) The asset-backed commercial 

paper conduit holds only: 

(1) Loans and other assets permissible 

for a loan securitization under 

paragraph (c)(8)(i) of this section; and 

(2) Asset-backed securities supported 

solely by assets that are permissible for 

loan securitizations under paragraph 

(c)(8)(i) of this section and acquired by 

the asset-backed commercial paper 

conduit as part of an initial issuance 

either directly from the issuing entity of 

the asset-backed securities or directly 

from an underwriter in the distribution 

of the asset-backed securities; 

(B) The asset-backed commercial 

paper conduit issues only asset-backed 

securities, comprised of a residual 

interest and securities with a legal 

maturity of 397 days or less; and 

(C) A regulated liquidity provider has 

entered into a legally binding 

commitment to provide full and 

unconditional liquidity coverage with 

respect to all of the outstanding assetbacked securities issued by the assetbacked commercial paper conduit (other 

than any residual interest) in the event 

that funds are required to redeem 

maturing asset-backed securities. 

(ii) For purposes of this paragraph 

(c)(9) of this section, a regulated 

liquidity provider means: 

(A) A depository institution, as 

defined in section 3(c) of the Federal 

Deposit Insurance Act (12 U.S.C. 

1813(c)); 

(B) A bank holding company, as 

defined in section 2(a) of the Bank 

Holding Company Act of 1956 (12 

U.S.C. 1841(a)), or a subsidiary thereof; 

(C) A savings and loan holding 

company, as defined in section 10a of 

the Home Owners’ Loan Act (12 U.S.C. 

1467a), provided all or substantially all 

of the holding company’s activities are 

permissible for a financial holding 

company under section 4(k) of the Bank 

Holding Company Act of 1956 (12 

U.S.C. 1843(k)), or a subsidiary thereof; 

(D) A foreign bank whose home 

country supervisor, as defined in 

§ 211.21(q) of the Board’s Regulation K 

(12 CFR 211.21(q)), has adopted capital 

standards consistent with the Capital 

Accord for the Basel Committee on 

Banking Supervision, as amended, and 

that is subject to such standards, or a 

subsidiary thereof; or 

(E) The United States or a foreign 

sovereign. 

(10) Qualifying covered bonds—(i) 

Scope. An entity owning or holding a 

dynamic or fixed pool of loans or other 

assets as provided in paragraph (c)(8) of 

this section for the benefit of the holders 

of covered bonds, provided that the 

assets in the pool are comprised solely 

of assets that meet the conditions in 

paragraph (c)(8)(i) of this section. 

(ii) Covered bond. For purposes of 

paragraph (c)(10) of this section, a 

covered bond means: 

(A) A debt obligation issued by an 

entity that meets the definition of 

foreign banking organization, the 

payment obligations of which are fully 

and unconditionally guaranteed by an 

entity that meets the conditions set forth 

in paragraph (c)(10)(i) of this section; or 

(B) A debt obligation of an entity that 

meets the conditions set forth in 

paragraph (c)(10)(i) of this section, 

provided that the payment obligations 

are fully and unconditionally 

guaranteed by an entity that meets the 

definition of foreign banking 

organization and the entity is a whollyowned subsidiary, as defined in 

paragraph (c)(2) of this section, of such 

foreign banking organization. 

(11) SBICs and public welfare 

investment funds. An issuer: 

(i) That is a small business investment 

company, as defined in section 103(3) of 

the Small Business Investment Act of 

1958 (15 U.S.C. 662), or that has 

received from the Small Business 

Administration notice to proceed to 

qualify for a license as a small business 

investment company, which notice or 

license has not been revoked; or 

(ii) The business of which is to make 

investments that are: 

(A) Designed primarily to promote the 

public welfare, of the type permitted 

under paragraph (11) of section 5136 of 

the Revised Statutes of the United States 

(12 U.S.C. 24), including the welfare of 

low- and moderate-income communities 

or families (such as providing housing, 

services, or jobs); or 

(B) Qualified rehabilitation 

expenditures with respect to a qualified 

rehabilitated building or certified 

historic structure, as such terms are 

defined in section 47 of the Internal 

Revenue Code of 1986 or a similar State 

historic tax credit program. 

(12) Registered investment companies 

and excluded entities. An issuer: 

(i) That is registered as an investment 

company under section 8 of the 

Investment Company Act of 1940 (15 

U.S.C. 80a–8), or that is formed and 

operated pursuant to a written plan to 

become a registered investment 

company as described in § 75.20(e)(3) 

and that complies with the requirements 

of section 18 of the Investment 

Company Act of 1940 (15 U.S.C. 80a– 

18); 

(ii) That may rely on an exclusion or 

exemption from the definition of 

‘‘investment company’’ under the 

Investment Company Act of 1940 (15 

U.S.C. 80a–1 et seq.) other than the 

exclusions contained in section 3(c)(1) 

and 3(c)(7) of that Act; or 

(iii) That has elected to be regulated 

as a business development company 

pursuant to section 54(a) of that Act (15 

U.S.C. 80a–53) and has not withdrawn 

its election, or that is formed and 

operated pursuant to a written plan to 

become a business development 

company as described in § 75.20(e)(3) 

and that complies with the requirements 

of section 61 of the Investment 

Company Act of 1940 (15 U.S.C. 80a– 

60). 

(13) Issuers in conjunction with the 

FDIC’s receivership or conservatorship 

operations. An issuer that is an entity 

formed by or on behalf of the FDIC for 

the purpose of facilitating the disposal 

of assets acquired in the FDIC’s capacity 

as conservator or receiver under the 

Federal Deposit Insurance Act or Title II 

of the Dodd-Frank Wall Street Reform 

and Consumer Protection Act. 

(14) Other excluded issuers. (i) Any 

issuer that the appropriate Federal 

banking agencies, the SEC, and the 

CFTC jointly determine the exclusion of 

which is consistent with the purposes of 

section 13 of the BHC Act. 

(ii) A determination made under 

paragraph (c)(14)(i) of this section will 

be promptly made public. 

(d) Definition of other terms related to 

covered funds. For purposes of this 

subpart: 


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(1) Applicable accounting standards 

means U.S. generally accepted 

accounting principles, or such other 

accounting standards applicable to a 

banking entity that the Commission 

determines are appropriate and that the 

banking entity uses in the ordinary 

course of its business in preparing its 

consolidated financial statements. 

(2) Asset-backed security has the 

meaning specified in section 3(a)(79) of 

the Exchange Act (15 U.S.C. 78c(a)(79)). 

(3) Director has the same meaning as 

provided in § 215.2(d)(1) of the Board’s 

Regulation O (12 CFR 215.2(d)(1)). 

(4) Issuer has the same meaning as in 

section 2(a)(22) of the Investment 

Company Act of 1940 (15 U.S.C. 80a– 

2(a)(22)). 

(5) Issuing entity means with respect 

to asset-backed securities the special 

purpose vehicle that owns or holds the 

pool assets underlying asset-backed 

securities and in whose name the assetbacked securities supported or serviced 

by the pool assets are issued. 

(6) Ownership interest—(i) Ownership 

interest means any equity, partnership, 

or other similar interest. An ‘‘other 

similar interest’’ means an interest that: 

(A) Has the right to participate in the 

selection or removal of a general 

partner, managing member, member of 

the board of directors or trustees, 

investment manager, investment 

adviser, or commodity trading advisor 

of the covered fund (excluding the 

rights of a creditor to exercise remedies 

upon the occurrence of an event of 

default or an acceleration event); 

(B) Has the right under the terms of 

the interest to receive a share of the 

income, gains or profits of the covered 

fund; 

(C) Has the right to receive the 

underlying assets of the covered fund 

after all other interests have been 

redeemed and/or paid in full (excluding 

the rights of a creditor to exercise 

remedies upon the occurrence of an 

event of default or an acceleration 

event); 

(D) Has the right to receive all or a 

portion of excess spread (the positive 

difference, if any, between the aggregate 

interest payments received from the 

underlying assets of the covered fund 

and the aggregate interest paid to the 

holders of other outstanding interests); 

(E) Provides under the terms of the 

interest that the amounts payable by the 

covered fund with respect to the interest 

could be reduced based on losses arising 

from the underlying assets of the 

covered fund, such as allocation of 

losses, write-downs or charge-offs of the 

outstanding principal balance, or 

reductions in the amount of interest due 

and payable on the interest; 

(F) Receives income on a pass-through 

basis from the covered fund, or has a 

rate of return that is determined by 

reference to the performance of the 

underlying assets of the covered fund; 

or 

(G) Any synthetic right to have, 

receive, or be allocated any of the rights 

in paragraphs (d)(6)(i)(A) through 

(d)(6)(i)(F) of this section. 

(ii) Ownership interest does not 

include restricted profit interest, which 

is an interest held by an entity (or an 

employee or former employee thereof) 

in a covered fund for which the entity 

(or employee thereof) serves as 

investment manager, investment 

adviser, commodity trading advisor, or 

other service provider so long as: 

(A) The sole purpose and effect of the 

interest is to allow the entity (or 

employee or former employee thereof) 

to share in the profits of the covered 

fund as performance compensation for 

the investment management, investment 

advisory, commodity trading advisory, 

or other services provided to the 

covered fund by the entity (or employee 

or former employee thereof), provided 

that the entity (or employee or former 

employee thereof) may be obligated 

under the terms of such interest to 

return profits previously received; 

(B) All such profit, once allocated, is 

distributed to the entity (or employee or 

former employee thereof) promptly after 

being earned or, if not so distributed, is 

retained by the covered fund for the sole 

purpose of establishing a reserve 

amount to satisfy contractual obligations 

with respect to subsequent losses of the 

covered fund and such undistributed 

profit of the entity (or employee or 

former employee thereof) does not share 

in the subsequent investment gains of 

the covered fund; 

(C) Any amounts invested in the 

covered fund, including any amounts 

paid by the entity (or employee or 

former employee thereof) in connection 

with obtaining the restricted profit 

interest, are within the limits of § 75.12; 

and 

(D) The interest is not transferable by 

the entity (or employee or former 

employee thereof) except to an affiliate 

thereof (or an employee of the banking 

entity or affiliate), to immediate family 

members, or through the intestacy, of 

the employee or former employee, or in 

connection with a sale of the business 

that gave rise to the restricted profit 

interest by the entity (or employee or 

former employee thereof) to an 

unaffiliated party that provides 

investment management, investment 

advisory, commodity trading advisory, 

or other services to the fund. 

(7) Prime brokerage transaction means 

any transaction that would be a covered 

transaction, as defined in section 

23A(b)(7) of the Federal Reserve Act (12 

U.S.C. 371c(b)(7)), that is provided in 

connection with custody, clearance and 

settlement, securities borrowing or 

lending services, trade execution, 

financing, or data, operational, and 

administrative support. 

(8) Resident of the United States 

means a person that is a ‘‘U.S. person’’ 

as defined in rule 902(k) of the SEC’s 

Regulation S (17 CFR 230.902(k)). 

(9) Sponsor means, with respect to a 

covered fund: 

(i) To serve as a general partner, 

managing member, or trustee of a 

covered fund, or to serve as a 

commodity pool operator with respect 

to a covered fund as defined in (b)(1)(ii) 

of this section; 

(ii) In any manner to select or to 

control (or to have employees, officers, 

or directors, or agents who constitute) a 

majority of the directors, trustees, or 

management of a covered fund; or 

(iii) To share with a covered fund, for 

corporate, marketing, promotional, or 

other purposes, the same name or a 

variation of the same name. 

(10) Trustee. (i) For purposes of 

paragraph (d)(9) of this section and 

§ 75.11, a trustee does not include: 

(A) A trustee that does not exercise 

investment discretion with respect to a 

covered fund, including a trustee that is 

subject to the direction of an 

unaffiliated named fiduciary who is not 

a trustee pursuant to section 403(a)(1) of 

the Employee’s Retirement Income 

Security Act (29 U.S.C. 1103(a)(1)); or 

(B) A trustee that is subject to 

fiduciary standards imposed under 

foreign law that are substantially 

equivalent to those described in 

paragraph (d)(10)(i)(A) of this section; 

(ii) Any entity that directs a person 

described in paragraph (d)(10)(i) of this 

section, or that possesses authority and 

discretion to manage and control the 

investment decisions of a covered fund 

for which such person serves as trustee, 

shall be considered to be a trustee of 

such covered fund. 

§ 75.11 Permitted organizing and offering, 

underwriting, and market making with 

respect to a covered fund. 

(a) Organizing and offering a covered 

fund in general. Notwithstanding 

§ 75.10(a), a banking entity is not 

prohibited from acquiring or retaining 

an ownership interest in, or acting as 

sponsor to, a covered fund in 

connection with, directly or indirectly, 

organizing and offering a covered fund, 

including serving as a general partner, 

managing member, trustee, or 


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commodity pool operator of the covered 

fund and in any manner selecting or 

controlling (or having employees, 

officers, directors, or agents who 

constitute) a majority of the directors, 

trustees, or management of the covered 

fund, including any necessary expenses 

for the foregoing, only if: 

(1) The banking entity (or an affiliate 

thereof) provides bona fide trust, 

fiduciary, investment advisory, or 

commodity trading advisory services; 

(2) The covered fund is organized and 

offered only in connection with the 

provision of bona fide trust, fiduciary, 

investment advisory, or commodity 

trading advisory services and only to 

persons that are customers of such 

services of the banking entity (or an 

affiliate thereof), pursuant to a written 

plan or similar documentation outlining 

how the banking entity or such affiliate 

intends to provide advisory or similar 

services to its customers through 

organizing and offering such fund; 

(3) The banking entity and its 

affiliates do not acquire or retain an 

ownership interest in the covered fund 

except as permitted under § 75.12; 

(4) The banking entity and its 

affiliates comply with the requirements 

of § 75.14; 

(5) The banking entity and its 

affiliates do not, directly or indirectly, 

guarantee, assume, or otherwise insure 

the obligations or performance of the 

covered fund or of any covered fund in 

which such covered fund invests; 

(6) The covered fund, for corporate, 

marketing, promotional, or other 

purposes: 

(i) Does not share the same name or 

a variation of the same name with the 

banking entity (or an affiliate thereof); 

and 

(ii) Does not use the word ‘‘bank’’ in 

its name; 

(7) No director or employee of the 

banking entity (or an affiliate thereof) 

takes or retains an ownership interest in 

the covered fund, except for any 

director or employee of the banking 

entity or such affiliate who is directly 

engaged in providing investment 

advisory, commodity trading advisory, 

or other services to the covered fund at 

the time the director or employee takes 

the ownership interest; and 

(8) The banking entity: 

(i) Clearly and conspicuously 

discloses, in writing, to any prospective 

and actual investor in the covered fund 

(such as through disclosure in the 

covered fund’s offering documents): 

(A) That ‘‘any losses in [such covered 

fund] will be borne solely by investors 

in [the covered fund] and not by [the 

banking entity] or its affiliates; 

therefore, [the banking entity’s] losses in 

[such covered fund] will be limited to 

losses attributable to the ownership 

interests in the covered fund held by 

[the banking entity] and any affiliate in 

its capacity as investor in the [covered 

fund] or as beneficiary of a restricted 

profit interest held by [the banking 

entity] or any affiliate’’; 

(B) That such investor should read the 

fund offering documents before 

investing in the covered fund; 

(C) That the ‘‘ownership interests in 

the covered fund are not insured by the 

FDIC, and are not deposits, obligations 

of, or endorsed or guaranteed in any 

way, by any banking entity’’ (unless that 

happens to be the case); and 

(D) The role of the banking entity and 

its affiliates and employees in 

sponsoring or providing any services to 

the covered fund; and 

(ii) Complies with any additional 

rules of the appropriate Federal banking 

agencies, the SEC, or the CFTC, as 

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

Act, designed to ensure that losses in 

such covered fund are borne solely by 

investors in the covered fund and not by 

the covered banking entity and its 

affiliates. 

(b) Organizing and offering an issuing 

entity of asset-backed securities. (1) 

Notwithstanding § 75.10(a), a banking 

entity is not prohibited from acquiring 

or retaining an ownership interest in, or 

acting as sponsor to, a covered fund that 

is an issuing entity of asset-backed 

securities in connection with, directly 

or indirectly, organizing and offering 

that issuing entity, so long as the 

banking entity and its affiliates comply 

with all of the requirements of 

paragraphs (a)(3) through (a)(8) of this 

section. 

(2) For purposes of paragraph (b) of 

this section, organizing and offering a 

covered fund that is an issuing entity of 

asset-backed securities means acting as 

the securitizer, as that term is used in 

section 15G(a)(3) of the Exchange Act 

(15 U.S.C. 78o–11(a)(3)) of the issuing 

entity, or acquiring or retaining an 

ownership interest in the issuing entity 

as required by section 15G of that Act 

(15 U.S.C. 78o–11) and the 

implementing regulations issued 

thereunder. 

(c) Underwriting and market making 

in ownership interests of a covered 

fund. The prohibition contained in 

§ 75.10(a) does not apply to a banking 

entity’s underwriting activities or 

market making-related activities 

involving a covered fund so long as: 

(1) Those activities are conducted in 

accordance with the requirements of 

§ 75.4(a) or (b), respectively; 

(2) With respect to any banking entity 

(or any affiliate thereof) that acts as a 

sponsor, investment adviser or 

commodity trading advisor to a 

particular covered fund or otherwise 

acquires and retains an ownership 

interest in such covered fund in reliance 

on paragraph (a) of this section; acquires 

and retains an ownership interest in 

such covered fund and is either a 

securitizer, as that term is used in 

section 15G(a)(3) of the Exchange Act 

(15 U.S.C. 78o–11(a)(3)), or is acquiring 

and retaining an ownership interest in 

such covered fund in compliance with 

section 15G of that Act (15 U.S.C. 78o– 

11) and the implementing regulations 

issued thereunder each as permitted by 

paragraph (b) of this section; or, directly 

or indirectly, guarantees, assumes, or 

otherwise insures the obligations or 

performance of the covered fund or of 

any covered fund in which such fund 

invests, then in each such case any 

ownership interests acquired or retained 

by the banking entity and its affiliates in 

connection with underwriting and 

market making related activities for that 

particular covered fund are included in 

the calculation of ownership interests 

permitted to be held by the banking 

entity and its affiliates under the 

limitations of § 75.12(a)(2)(ii) and (d); 

and 

(3) With respect to any banking entity, 

the aggregate value of all ownership 

interests of the banking entity and its 

affiliates in all covered funds acquired 

and retained under § 75.11, including 

all covered funds in which the banking 

entity holds an ownership interest in 

connection with underwriting and 

market making related activities 

permitted under paragraph (c) of this 

section, are included in the calculation 

of all ownership interests under 

§ 75.12(a)(2)(iii) and (d). 

§ 75.12 Permitted investment in a covered 

fund. 

(a) Authority and limitations on 

permitted investments in covered funds. 

(1) Notwithstanding the prohibition 

contained in § 75.10(a), a banking entity 

may acquire and retain an ownership 

interest in a covered fund that the 

banking entity or an affiliate thereof 

organizes and offers pursuant to § 75.11, 

for the purposes of: 

(i) Establishment. Establishing the 

fund and providing the fund with 

sufficient initial equity for investment to 

permit the fund to attract unaffiliated 

investors, subject to the limits contained 

in paragraphs (a)(2)(i) and (a)(2)(iii) of 

this section; or 

(ii) De minimis investment. Making 

and retaining an investment in the 

covered fund subject to the limits 

contained in paragraphs (a)(2)(ii) and 

(a)(2)(iii) of this section. 


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(2) Investment limits—(i) Seeding 

period. With respect to an investment in 

any covered fund made or held 

pursuant to paragraph (a)(1)(i) of this 

section, the banking entity and its 

affiliates: 

(A) Must actively seek unaffiliated 

investors to reduce, through 

redemption, sale, dilution, or other 

methods, the aggregate amount of all 

ownership interests of the banking 

entity in the covered fund to the amount 

permitted in paragraph (a)(2)(i)(B) of 

this section; and 

(B) Must, no later than 1 year after the 

date of establishment of the fund (or 

such longer period as may be provided 

by the Board pursuant to paragraph (e) 

of this section), conform its ownership 

interest in the covered fund to the limits 

in paragraph (a)(2)(ii) of this section; 

(ii) Per-fund limits. (A) Except as 

provided in paragraph (a)(2)(ii)(B) of 

this section, an investment by a banking 

entity and its affiliates in any covered 

fund made or held pursuant to 

paragraph (a)(1)(ii) of this section may 

not exceed 3 percent of the total number 

or value of the outstanding ownership 

interests of the fund. 

(B) An investment by a banking entity 

and its affiliates in a covered fund that 

is an issuing entity of asset-backed 

securities may not exceed 3 percent of 

the total fair market value of the 

ownership interests of the fund 

measured in accordance with paragraph 

(b)(3) of this section, unless a greater 

percentage is retained by the banking 

entity and its affiliates in compliance 

with the requirements of section 15G of 

the Exchange Act (15 U.S.C. 78o–11) 

and the implementing regulations 

issued thereunder, in which case the 

investment by the banking entity and its 

affiliates in the covered fund may not 

exceed the amount, number, or value of 

ownership interests of the fund required 

under section 15G of the Exchange Act 

and the implementing regulations 

issued thereunder. 

(iii) Aggregate limit. The aggregate 

value of all ownership interests of the 

banking entity and its affiliates in all 

covered funds acquired or retained 

under this section may not exceed 3 

percent of the tier 1 capital of the 

banking entity, as provided under 

paragraph (c) of this section, and shall 

be calculated as of the last day of each 

calendar quarter. 

(iv) Date of establishment. For 

purposes of this section, the date of 

establishment of a covered fund shall 

be: 

(A) In general. The date on which the 

investment adviser or similar entity to 

the covered fund begins making 

investments pursuant to the written 

investment strategy for the fund; 

(B) Issuing entities of asset-backed 

securities. In the case of an issuing 

entity of asset-backed securities, the 

date on which the assets are initially 

transferred into the issuing entity of 

asset-backed securities. 

(b) Rules of construction—(1) 

Attribution of ownership interests to a 

covered banking entity. (i) For purposes 

of paragraph (a)(2) of this section, the 

amount and value of a banking entity’s 

permitted investment in any single 

covered fund shall include any 

ownership interest held under § 75.12 

directly by the banking entity, including 

any affiliate of the banking entity. 

(ii) Treatment of registered investment 

companies, SEC-regulated business 

development companies and foreign 

public funds. For purposes of paragraph 

(b)(1)(i) of this section, a registered 

investment company, SEC-regulated 

business development companies or 

foreign public fund as described in 

§ 75.10(c)(1) will not be considered to be 

an affiliate of the banking entity so long 

as the banking entity: 

(A) Does not own, control, or hold 

with the power to vote 25 percent or 

more of the voting shares of the 

company or fund; and 

(B) Provides investment advisory, 

commodity trading advisory, 

administrative, and other services to the 

company or fund in compliance with 

the limitations under applicable 

regulation, order, or other authority. 

(iii) Covered funds. For purposes of 

paragraph (b)(1)(i) of this section, a 

covered fund will not be considered to 

be an affiliate of a banking entity so long 

as the covered fund is held in 

compliance with the requirements of 

this subpart. 

(iv) Treatment of employee and 

director investments financed by the 

banking entity. For purposes of 

paragraph (b)(1)(i) of this section, an 

investment by a director or employee of 

a banking entity who acquires an 

ownership interest in his or her 

personal capacity in a covered fund 

sponsored by the banking entity will be 

attributed to the banking entity if the 

banking entity, directly or indirectly, 

extends financing for the purpose of 

enabling the director or employee to 

acquire the ownership interest in the 

fund and the financing is used to 

acquire such ownership interest in the 

covered fund. 

(2) Calculation of permitted 

ownership interests in a single covered 

fund. Except as provided in paragraphs 

(b)(3) or (4) of this section, for purposes 

of determining whether an investment 

in a single covered fund complies with 

the restrictions on ownership interests 

under paragraphs (a)(2)(i)(B) and (ii)(A) 

of this section: 

(i) The aggregate number of the 

outstanding ownership interests held by 

the banking entity shall be the total 

number of ownership interests held 

under this section by the banking entity 

in a covered fund divided by the total 

number of ownership interests held by 

all entities in that covered fund, as of 

the last day of each calendar quarter 

(both measured without regard to 

committed funds not yet called for 

investment); 

(ii) The aggregate value of the 

outstanding ownership interests held by 

the banking entity shall be the aggregate 

fair market value of all investments in 

and capital contributions made to the 

covered fund by the banking entity, 

divided by the value of all investments 

in and capital contributions made to 

that covered fund by all entities, as of 

the last day of each calendar quarter (all 

measured without regard to committed 

funds not yet called for investment). If 

fair market value cannot be determined, 

then the value shall be the historical 

cost basis of all investments in and 

contributions made by the banking 

entity to the covered fund; 

(iii) For purposes of the calculation 

under paragraph (b)(2)(ii) of this section, 

once a valuation methodology is chosen, 

the banking entity must calculate the 

value of its investment and the 

investments of all others in the covered 

fund in the same manner and according 

to the same standards. 

(3) Issuing entities of asset-backed 

securities. In the case of an ownership 

interest in an issuing entity of assetbacked securities, for purposes of 

determining whether an investment in a 

single covered fund complies with the 

restrictions on ownership interests 

under paragraphs (a)(2)(i)(B) and 

(a)(2)(ii)(B) of this section: 

(i) For securitizations subject to the 

requirements of section 15G of the 

Exchange Act (15 U.S.C. 78o–11), the 

calculations shall be made as of the date 

and according to the valuation 

methodology applicable pursuant to the 

requirements of section 15G of the 

Exchange Act (15 U.S.C. 78o–11) and 

the implementing regulations issued 

thereunder; or 

(ii) For securitization transactions 

completed prior to the compliance date 

of such implementing regulations (or as 

to which such implementing regulations 

do not apply), the calculations shall be 

made as of the date of establishment as 

defined in paragraph (a)(2)(iv)(B) of this 

section or such earlier date on which 

the transferred assets have been valued 

for purposes of transfer to the covered 


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fund, and thereafter only upon the date 

on which additional securities of the 

issuing entity of asset-backed securities 

are priced for purposes of the sales of 

ownership interests to unaffiliated 

investors. 

(iii) For securitization transactions 

completed prior to the compliance date 

of such implementing regulations (or as 

to which such implementing regulations 

do not apply), the aggregate value of the 

outstanding ownership interests in the 

covered fund shall be the fair market 

value of the assets transferred to the 

issuing entity of the securitization and 

any other assets otherwise held by the 

issuing entity at such time, determined 

in a manner that is consistent with its 

determination of the fair market value of 

those assets for financial statement 

purposes. 

(iv) For purposes of the calculation 

under paragraph (b)(3)(iii) of this 

section, the valuation methodology used 

to calculate the fair market value of the 

ownership interests must be the same 

for both the ownership interests held by 

a banking entity and the ownership 

interests held by all others in the 

covered fund in the same manner and 

according to the same standards. 

(4) Multi-tier fund investments—(i) 

Master-feeder fund investments. If the 

principal investment strategy of a 

covered fund (the ‘‘feeder fund’’) is to 

invest substantially all of its assets in 

another single covered fund (the 

‘‘master fund’’), then for purposes of the 

investment limitations in paragraphs 

(a)(2)(i)(B) and (a)(2)(ii) of this section, 

the banking entity’s permitted 

investment in such funds shall be 

measured only by reference to the value 

of the master fund. The banking entity’s 

permitted investment in the master fund 

shall include any investment by the 

banking entity in the master fund, as 

well as the banking entity’s pro-rata 

share of any ownership interest of the 

master fund that is held through the 

feeder fund; and 

(ii) Fund-of-funds investments. If a 

banking entity organizes and offers a 

covered fund pursuant to § 75.11 for the 

purpose of investing in other covered 

funds (a ‘‘fund of funds’’) and that fund 

of funds itself invests in another 

covered fund that the banking entity is 

permitted to own, then the banking 

entity’s permitted investment in that 

other fund shall include any investment 

by the banking entity in that other fund, 

as well as the banking entity’s pro-rata 

share of any ownership interest of the 

fund that is held through the fund of 

funds. The investment of the banking 

entity may not represent more than 3 

percent of the amount or value of any 

single covered fund. 

(c) Aggregate permitted investments 

in all covered funds. (1) For purposes of 

paragraph (a)(2)(iii) of this section, the 

aggregate value of all ownership 

interests held by a banking entity shall 

be the sum of all amounts paid or 

contributed by the banking entity in 

connection with acquiring or retaining 

an ownership interest in covered funds 

(together with any amounts paid by the 

entity (or employee thereof) in 

connection with obtaining a restricted 

profit interest under § 75.10(d)(6)(ii)), on 

a historical cost basis. 

(2) Calculation of tier 1 capital. For 

purposes of paragraph (a)(2)(iii) of this 

section: 

(i) Entities that are required to hold 

and report tier 1 capital. If a banking 

entity is required to calculate and report 

tier 1 capital, the banking entity’s tier 1 

capital shall be equal to the amount of 

tier 1 capital of the banking entity as of 

the last day of the most recent calendar 

quarter, as reported to its primary 

financial regulatory agency; and 

(ii) If a banking entity is not required 

to calculate and report tier 1 capital, the 

banking entity’s tier 1 capital shall be 

determined to be equal to: 

(A) In the case of a banking entity that 

is controlled, directly or indirectly, by a 

depository institution that calculates 

and reports tier 1 capital, be equal to the 

amount of tier 1 capital reported by 

such controlling depository institution 

in the manner described in paragraph 

(c)(2)(i) of this section; 

(B) In the case of a banking entity that 

is not controlled, directly or indirectly, 

by a depository institution that 

calculates and reports tier 1 capital: 

(1) Bank holding company 

subsidiaries. If the banking entity is a 

subsidiary of a bank holding company 

or company that is treated as a bank 

holding company, be equal to the 

amount of tier 1 capital reported by the 

top-tier affiliate of such covered banking 

entity that calculates and reports tier 1 

capital in the manner described in 

paragraph (c)(2)(i) of this section; and 

(2) Other holding companies and any 

subsidiary or affiliate thereof. If the 

banking entity is not a subsidiary of a 

bank holding company or a company 

that is treated as a bank holding 

company, be equal to the total amount 

of shareholders’ equity of the top-tier 

affiliate within such organization as of 

the last day of the most recent calendar 

quarter that has ended, as determined 

under applicable accounting standards. 

(iii) Treatment of foreign banking 

entities—(A) Foreign banking entities. 

Except as provided in paragraph 

(c)(2)(iii)(B) of this section, with respect 

to a banking entity that is not itself, and 

is not controlled directly or indirectly 

by, a banking entity that is located or 

organized under the laws of the United 

States or of any State, the tier 1 capital 

of the banking entity shall be the 

consolidated tier 1 capital of the entity 

as calculated under applicable home 

country standards. 

(B) U.S. affiliates of foreign banking 

entities. With respect to a banking entity 

that is located or organized under the 

laws of the United States or of any State 

and is controlled by a foreign banking 

entity identified under paragraph 

(c)(2)(iii)(A) of this section, the banking 

entity’s tier 1 capital shall be as 

calculated under paragraphs (c)(2)(i) or 

(ii) of this section. 

(d) Capital treatment for a permitted 

investment in a covered fund. For 

purposes of calculating compliance with 

the applicable regulatory capital 

requirements, a banking entity shall 

deduct from the banking entity’s tier 1 

capital (as determined under paragraph 

(c)(2) of this section) the greater of: 

(1) The sum of all amounts paid or 

contributed by the banking entity in 

connection with acquiring or retaining 

an ownership interest (together with any 

amounts paid by the entity (or employee 

thereof) in connection with obtaining a 

restricted profit interest under 

§ 75.10(d)(6)(ii)), on a historical cost 

basis, plus any earnings received; and 

(2) The fair market value of the 

banking entity’s ownership interests in 

the covered fund as determined under 

paragraph (b)(2)(ii) or (3) of this section 

(together with any amounts paid by the 

entity (or employee thereof) in 

connection with obtaining a restricted 

profit interest under § 75.10(d)(6)(ii)), if 

the banking entity accounts for the 

profits (or losses) of the fund investment 

in its financial statements. 

(e) Extension of time to divest an 

ownership interest. (1) Upon application 

by a banking entity, the Board may 

extend the period under paragraph 

(a)(2)(i) of this section for up to 2 

additional years if the Board finds that 

an extension would be consistent with 

safety and soundness and not 

detrimental to the public interest. An 

application for extension must: 

(i) Be submitted to the Board at least 

90 days prior to the expiration of the 

applicable time period; 

(ii) Provide the reasons for 

application, including information that 

addresses the factors in paragraph (e)(2) 

of this section; and 

(iii) Explain the banking entity’s plan 

for reducing the permitted investment 

in a covered fund through redemption, 

sale, dilution or other methods as 

required in paragraph (a)(2) of this 

section. 


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(2) Factors governing Board 

determinations. In reviewing any 

application under paragraph (e)(1) of 

this section, the Board may consider all 

the facts and circumstances related to 

the permitted investment in a covered 

fund, including: 

(i) Whether the investment would 

result, directly or indirectly, in a 

material exposure by the banking entity 

to high-risk assets or high-risk trading 

strategies; 

(ii) The contractual terms governing 

the banking entity’s interest in the 

covered fund; 

(iii) The date on which the covered 

fund is expected to have attracted 

sufficient investments from investors 

unaffiliated with the banking entity to 

enable the banking entity to comply 

with the limitations in paragraph 

(a)(2)(i) of this section; 

(iv) The total exposure of the covered 

banking entity to the investment and the 

risks that disposing of, or maintaining, 

the investment in the covered fund may 

pose to the banking entity and the 

financial stability of the United States; 

(v) The cost to the banking entity of 

divesting or disposing of the investment 

within the applicable period; 

(vi) Whether the investment or the 

divestiture or conformance of the 

investment would involve or result in a 

material conflict of interest between the 

banking entity and unaffiliated parties, 

including clients, customers or 

counterparties to which it owes a duty; 

(vii) The banking entity’s prior efforts 

to reduce through redemption, sale, 

dilution, or other methods its ownership 

interests in the covered fund, including 

activities related to the marketing of 

interests in such covered fund; 

(viii) Market conditions; and 

(ix) Any other factor that the Board 

believes appropriate. 

(3) Authority to impose restrictions on 

activities or investment during any 

extension period. The Board may 

impose such conditions on any 

extension approved under paragraph 

(e)(1) of this section as the Board 

determines are necessary or appropriate 

to protect the safety and soundness of 

the banking entity or the financial 

stability of the United States, address 

material conflicts of interest or other 

unsound banking practices, or otherwise 

further the purposes of section 13 of the 

BHC Act and this part. 

(4) Consultation. In the case of a 

banking entity that is primarily 

regulated by another Federal banking 

agency, the SEC, or the CFTC, the Board 

will consult with such agency prior to 

acting on an application by the banking 

entity for an extension under paragraph 

(e)(1) of this section. 

§ 75.13 Other permitted covered fund 

activities and investments. 

(a) Permitted risk-mitigating hedging 

activities. (1) The prohibition contained 

in § 75.10(a) does not apply with respect 

to an ownership interest in a covered 

fund acquired or retained by a banking 

entity that is designed to demonstrably 

reduce or otherwise significantly 

mitigate the specific, identifiable risks 

to the banking entity in connection with 

a compensation arrangement with an 

employee of the banking entity or an 

affiliate thereof that directly provides 

investment advisory, commodity trading 

advisory or other services to the covered 

fund. 

(2) Requirements. The risk-mitigating 

hedging activities of a banking entity are 

permitted under paragraph (a) of this 

section only if: 

(i) The banking entity has established 

and implements, maintains and enforces 

an internal compliance program 

required by subpart D of this part that 

is reasonably designed to ensure the 

banking entity’s compliance with the 

requirements of this section, including: 

(A) Reasonably designed written 

policies and procedures; and 

(B) Internal controls and ongoing 

monitoring, management, and 

authorization procedures, including 

relevant escalation procedures; and 

(ii) The acquisition or retention of the 

ownership interest: 

(A) Is made in accordance with the 

written policies, procedures and 

internal controls required under this 

section; 

(B) At the inception of the hedge, is 

designed to reduce or otherwise 

significantly mitigate and demonstrably 

reduces or otherwise significantly 

mitigates one or more specific, 

identifiable risks arising in connection 

with the compensation arrangement 

with the employee that directly 

provides investment advisory, 

commodity trading advisory, or other 

services to the covered fund; 

(C) Does not give rise, at the inception 

of the hedge, to any significant new or 

additional risk that is not itself hedged 

contemporaneously in accordance with 

this section; and 

(D) Is subject to continuing review, 

monitoring and management by the 

banking entity. 

(iii) The compensation arrangement 

relates solely to the covered fund in 

which the banking entity or any affiliate 

has acquired an ownership interest 

pursuant to this paragraph and such 

compensation arrangement provides 

that any losses incurred by the banking 

entity on such ownership interest will 

be offset by corresponding decreases in 

amounts payable under such 

compensation arrangement. 

(b) Certain permitted covered fund 

activities and investments outside of the 

United States. (1) The prohibition 

contained in § 75.10(a) does not apply to 

the acquisition or retention of any 

ownership interest in, or the 

sponsorship of, a covered fund by a 

banking entity only if: 

(i) The banking entity is not organized 

or directly or indirectly controlled by a 

banking entity that is organized under 

the laws of the United States or of one 

or more States; 

(ii) The activity or investment by the 

banking entity is pursuant to paragraph 

(9) or (13) of section 4(c) of the BHC Act; 

(iii) No ownership interest in the 

covered fund is offered for sale or sold 

to a resident of the United States; and 

(iv) The activity or investment occurs 

solely outside of the United States. 

(2) An activity or investment by the 

banking entity is pursuant to paragraph 

(9) or (13) of section 4(c) of the BHC Act 

for purposes of paragraph (b)(1)(ii) of 

this section only if: 

(i) The activity or investment is 

conducted in accordance with the 

requirements of this section; and 

(ii)(A) With respect to a banking 

entity that is a foreign banking 

organization, the banking entity meets 

the qualifying foreign banking 

organization requirements of 

§ 211.23(a), (c) or (e) of the Board’s 

Regulation K (12 CFR 211.23(a), (c) or 

(e)), as applicable; or 

(B) With respect to a banking entity 

that is not a foreign banking 

organization, the banking entity is not 

organized under the laws of the United 

States or of one or more States and the 

banking entity, on a fully-consolidated 

basis, meets at least two of the following 

requirements: 

(1) Total assets of the banking entity 

held outside of the United States exceed 

total assets of the banking entity held in 

the United States; 

(2) Total revenues derived from the 

business of the banking entity outside of 

the United States exceed total revenues 

derived from the business of the 

banking entity in the United States; or 

(3) Total net income derived from the 

business of the banking entity outside of 

the United States exceeds total net 

income derived from the business of the 

banking entity in the United States. 

(3) An ownership interest in a covered 

fund is not offered for sale or sold to a 

resident of the United States for 

purposes of paragraph (b)(1)(iii) of this 

section only if it is sold or has been sold 

pursuant to an offering that does not 

target residents of the United States. 


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(4) An activity or investment occurs 

solely outside of the United States for 

purposes of paragraph (b)(1)(iv) of this 

section only if: 

(i) The banking entity acting as 

sponsor, or engaging as principal in the 

acquisition or retention of an ownership 

interest in the covered fund, is not itself, 

and is not controlled directly or 

indirectly by, a banking entity that is 

located in the United States or 

organized under the laws of the United 

States or of any State; 

(ii) The banking entity (including 

relevant personnel) that makes the 

decision to acquire or retain the 

ownership interest or act as sponsor to 

the covered fund is not located in the 

United States or organized under the 

laws of the United States or of any State; 

(iii) The investment or sponsorship, 

including any transaction arising from 

risk-mitigating hedging related to an 

ownership interest, is not accounted for 

as principal directly or indirectly on a 

consolidated basis by any branch or 

affiliate that is located in the United 

States or organized under the laws of 

the United States or of any State; and 

(iv) No financing for the banking 

entity’s ownership or sponsorship is 

provided, directly or indirectly, by any 

branch or affiliate that is located in the 

United States or organized under the 

laws of the United States or of any State. 

(5) For purposes of this section, a U.S. 

branch, agency, or subsidiary of a 

foreign bank, or any subsidiary thereof, 

is located in the United States; however, 

a foreign bank of which that branch, 

agency, or subsidiary is a part is not 

considered to be located in the United 

States solely by virtue of operation of 

the U.S. branch, agency, or subsidiary. 

(c) Permitted covered fund interests 

and activities by a regulated insurance 

company. The prohibition contained in 

§ 75.10(a) does not apply to the 

acquisition or retention by an insurance 

company, or an affiliate thereof, of any 

ownership interest in, or the 

sponsorship of, a covered fund only if: 

(1) The insurance company or its 

affiliate acquires and retains the 

ownership interest solely for the general 

account of the insurance company or for 

one or more separate accounts 

established by the insurance company; 

(2) The acquisition and retention of 

the ownership interest is conducted in 

compliance with, and subject to, the 

insurance company investment laws, 

regulations, and written guidance of the 

State or jurisdiction in which such 

insurance company is domiciled; and 

(3) The appropriate Federal banking 

agencies, after consultation with the 

Financial Stability Oversight Council 

and the relevant insurance 

commissioners of the States and foreign 

jurisdictions, as appropriate, have not 

jointly determined, after notice and 

comment, that a particular law, 

regulation, or written guidance 

described in paragraph (c)(2) of this 

section is insufficient to protect the 

safety and soundness of the banking 

entity, or the financial stability of the 

United States. 

§ 75.14 Limitations on relationships with a 

covered fund. 

(a) Relationships with a covered fund. 

(1) Except as provided for in paragraph 

(a)(2) of this section, no banking entity 

that serves, directly or indirectly, as the 

investment manager, investment 

adviser, commodity trading advisor, or 

sponsor to a covered fund, that 

organizes and offers a covered fund 

pursuant to § 75.11, or that continues to 

hold an ownership interest in 

accordance with § 75.11(b), and no 

affiliate of such entity, may enter into a 

transaction with the covered fund, or 

with any other covered fund that is 

controlled by such covered fund, that 

would be a covered transaction as 

defined in section 23A of the Federal 

Reserve Act (12 U.S.C. 371c(b)(7)), as if 

such banking entity and the affiliate 

thereof were a member bank and the 

covered fund were an affiliate thereof. 

(2) Notwithstanding paragraph (a)(1) 

of this section, a banking entity may: 

(i) Acquire and retain any ownership 

interest in a covered fund in accordance 

with the requirements of §§ 75.11, 

75.12, or 75.13; and 

(ii) Enter into any prime brokerage 

transaction with any covered fund in 

which a covered fund managed, 

sponsored, or advised by such banking 

entity (or an affiliate thereof) has taken 

an ownership interest, if: 

(A) The banking entity is in 

compliance with each of the limitations 

set forth in § 75.11 with respect to a 

covered fund organized and offered by 

such banking entity (or an affiliate 

thereof); 

(B) The chief executive officer (or 

equivalent officer) of the banking entity 

certifies in writing annually to the 

Commission (with a duty to update the 

certification if the information in the 

certification materially changes) that the 

banking entity does not, directly or 

indirectly, guarantee, assume, or 

otherwise insure the obligations or 

performance of the covered fund or of 

any covered fund in which such 

covered fund invests; and 

(C) The Board has not determined that 

such transaction is inconsistent with the 

safe and sound operation and condition 

of the banking entity. 

(b) Restrictions on transactions with 

covered funds. A banking entity that 

serves, directly or indirectly, as the 

investment manager, investment 

adviser, commodity trading advisor, or 

sponsor to a covered fund, or that 

organizes and offers a covered fund 

pursuant to § 75.11, or that continues to 

hold an ownership interest in 

accordance with § 75.11(b), shall be 

subject to section 23B of the Federal 

Reserve Act (12 U.S.C. 371c–1), as if 

such banking entity were a member 

bank and such covered fund were an 

affiliate thereof. 

(c) Restrictions on prime brokerage 

transactions. A prime brokerage 

transaction permitted under paragraph 

(a)(2)(ii) of this section shall be subject 

to section 23B of the Federal Reserve 

Act (12 U.S.C. 371c–1) as if the 

counterparty were an affiliate of the 

banking entity. 

§ 75.15 Other limitations on permitted 

covered fund activities. 

(a) No transaction, class of 

transactions, or activity may be deemed 

permissible under §§ 75.11 through 

75.13 if the transaction, class of 

transactions, or activity would: 

(1) Involve or result in a material 

conflict of interest between the banking 

entity and its clients, customers, or 

counterparties; 

(2) Result, directly or indirectly, in a 

material exposure by the banking entity 

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

strategy; or 

(3) Pose a threat to the safety and 

soundness of the banking entity or to 

the financial stability of the United 

States. 

(b) Definition of material conflict of 

interest. (1) For purposes of this section, 

a material conflict of interest between a 

banking entity and its clients, 

customers, or counterparties exists if the 

banking entity engages in any 

transaction, class of transactions, or 

activity that would involve or result in 

the banking entity’s interests being 

materially adverse to the interests of its 

client, customer, or counterparty with 

respect to such transaction, class of 

transactions, or activity, and the 

banking entity has not taken at least one 

of the actions in paragraph (b)(2) of this 

section. 

(2) Prior to effecting the specific 

transaction or class or type of 

transactions, or engaging in the specific 

activity, the banking entity: 

(i) Timely and effective disclosure. (A) 

Has made clear, timely, and effective 

disclosure of the conflict of interest, 

together with other necessary 

information, in reasonable detail and in 

a manner sufficient to permit a 


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reasonable client, customer, or 

counterparty to meaningfully 

understand the conflict of interest; and 

(B) Such disclosure is made in a 

manner that provides the client, 

customer, or counterparty the 

opportunity to negate, or substantially 

mitigate, any materially adverse effect 

on the client, customer, or counterparty 

created by the conflict of interest; or 

(ii) Information barriers. Has 

established, maintained, and enforced 

information barriers that are 

memorialized in written policies and 

procedures, such as physical separation 

of personnel, or functions, or limitations 

on types of activity, that are reasonably 

designed, taking into consideration the 

nature of the banking entity’s business, 

to prevent the conflict of interest from 

involving or resulting in a materially 

adverse effect on a client, customer, or 

counterparty. A banking entity may not 

rely on such information barriers if, in 

the case of any specific transaction, 

class or type of transactions or activity, 

the banking entity knows or should 

reasonably know that, notwithstanding 

the banking entity’s establishment of 

information barriers, the conflict of 

interest may involve or result in a 

materially adverse effect on a client, 

customer, or counterparty. 

(c) Definition of high-risk asset and 

high-risk trading strategy. For purposes 

of this section: 

(1) High-risk asset means an asset or 

group of related assets that would, if 

held by a banking entity, significantly 

increase the likelihood that the banking 

entity would incur a substantial 

financial loss or would pose a threat to 

the financial stability of the United 

States. 

(2) High-risk trading strategy means a 

trading strategy that would, if engaged 

in by a banking entity, significantly 

increase the likelihood that the banking 

entity would incur a substantial 

financial loss or would pose a threat to 

the financial stability of the United 

States. 

§§ 75.16–75.19 [Reserved] 

Subpart D—Compliance Program 

Requirement; Violations 

§ 75.20 Program for compliance; reporting. 

(a) Program requirement. Each 

banking entity shall develop and 

provide for the continued 

administration of a compliance program 

reasonably designed to ensure and 

monitor compliance with the 

prohibitions and restrictions on 

proprietary trading and covered fund 

activities and investments set forth in 

section 13 of the BHC Act and this part. 

The terms, scope and detail of the 

compliance program shall be 

appropriate for the types, size, scope 

and complexity of activities and 

business structure of the banking entity. 

(b) Contents of compliance program. 

Except as provided in paragraph (f) of 

this section, the compliance program 

required by paragraph (a) of this section, 

at a minimum, shall include: 

(1) Written policies and procedures 

reasonably designed to document, 

describe, monitor and limit trading 

activities subject to subpart B of this 

part (including those permitted under 

§§ 75.3 to 75.6), including setting, 

monitoring and managing required 

limits set out in §§ 75.4 and 75.5, and 

activities and investments with respect 

to a covered fund subject to subpart C 

of this part (including those permitted 

under §§ 75.11 through 75.14) 

conducted by the banking entity to 

ensure that all activities and 

investments conducted by the banking 

entity that are subject to section 13 of 

the BHC Act and this part comply with 

section 13 of the BHC Act and this part; 

(2) A system of internal controls 

reasonably designed to monitor 

compliance with section 13 of the BHC 

Act and this part and to prevent the 

occurrence of activities or investments 

that are prohibited by section 13 of the 

BHC Act and this part; 

(3) A management framework that 

clearly delineates responsibility and 

accountability for compliance with 

section 13 of the BHC Act and this part 

and includes appropriate management 

review of trading limits, strategies, 

hedging activities, investments, 

incentive compensation and other 

matters identified in this part or by 

management as requiring attention; 

(4) Independent testing and audit of 

the effectiveness of the compliance 

program conducted periodically by 

qualified personnel of the banking 

entity or by a qualified outside party; 

(5) Training for trading personnel and 

managers, as well as other appropriate 

personnel, to effectively implement and 

enforce the compliance program; and 

(6) Records sufficient to demonstrate 

compliance with section 13 of the BHC 

Act and this part, which a banking 

entity must promptly provide to the 

Commission upon request and retain for 

a period of no less than 5 years or such 

longer period as required by the 

Commission. 

(c) Additional standards. In addition 

to the requirements in paragraph (b) of 

this section, the compliance program of 

a banking entity must satisfy the 

requirements and other standards 

contained in Appendix B of this part, if: 

(1) The banking entity engages in 

proprietary trading permitted under 

subpart B of this part and is required to 

comply with the reporting requirements 

of paragraph (d) of this section; 

(2) The banking entity has reported 

total consolidated assets as of the 

previous calendar year end of $50 

billion or more or, in the case of a 

foreign banking entity, has total U.S. 

assets as of the previous calendar year 

end of $50 billion or more (including all 

subsidiaries, affiliates, branches and 

agencies of the foreign banking entity 

operating, located or organized in the 

United States); or 

(3) The Commission notifies the 

banking entity in writing that it must 

satisfy the requirements and other 

standards contained in Appendix B of 

this part. 

(d) Reporting requirements under 

Appendix A of this Part. (1) A banking 

entity engaged in proprietary trading 

activity permitted under subpart B of 

this part shall comply with the reporting 

requirements described in Appendix A 

of this part, if: 

(i) The banking entity (other than a 

foreign banking entity as provided in 

paragraph (d)(1)(ii) of this section) has, 

together with its affiliates and 

subsidiaries, trading assets and 

liabilities (excluding trading assets and 

liabilities involving obligations of or 

guaranteed by the United States or any 

agency of the United States) the average 

gross sum of which (on a worldwide 

consolidated basis) over the previous 

consecutive four quarters, as measured 

as of the last day of each of the four 

prior calendar quarters, equals or 

exceeds the threshold established in 

paragraph (d)(2) of this section; 

(ii) In the case of a foreign banking 

entity, the average gross sum of the 

trading assets and liabilities of the 

combined U.S. operations of the foreign 

banking entity (including all 

subsidiaries, affiliates, branches and 

agencies of the foreign banking entity 

operating, located or organized in the 

United States and excluding trading 

assets and liabilities involving 

obligations of or guaranteed by the 

United States or any agency of the 

United States) over the previous 

consecutive four quarters, as measured 

as of the last day of each of the four 

prior calendar quarters, equals or 

exceeds the threshold established in 

paragraph (d)(2) of this section; or 

(iii) The Commission notifies the 

banking entity in writing that it must 

satisfy the reporting requirements 

contained in Appendix A of this part. 

(2) The threshold for reporting under 

paragraph (d)(1) of this section shall be 

$50 billion beginning on June 30, 2014; 


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$25 billion beginning on April 30, 2016; 

and $10 billion beginning on December 

31, 2016. 

(3) Frequency of reporting. Unless the 

Commission notifies the banking entity 

in writing that it must report on a 

different basis, a banking entity with 

$50 billion or more in trading assets and 

liabilities (as calculated in accordance 

with paragraph (d)(1) of this section) 

shall report the information required by 

Appendix A of this part for each 

calendar month within 30 days of the 

end of the relevant calendar month; 

beginning with information for the 

month of January 2015, such 

information shall be reported within 10 

days of the end of each calendar month. 

Any other banking entity subject to 

Appendix A of this part shall report the 

information required by Appendix A of 

this part for each calendar quarter 

within 30 days of the end of that 

calendar quarter unless the Commission 

notifies the banking entity in writing 

that it must report on a different basis. 

(e) Additional documentation for 

covered funds. Any banking entity that 

has more than $10 billion in total 

consolidated assets as reported on 

December 31 of the previous two 

calendar years shall maintain records 

that include: 

(1) Documentation of the exclusions 

or exemptions other than sections 

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

Company Act of 1940 relied on by each 

fund sponsored by the banking entity 

(including all subsidiaries and affiliates) 

in determining that such fund is not a 

covered fund; 

(2) For each fund sponsored by the 

banking entity (including all 

subsidiaries and affiliates) for which the 

banking entity relies on one or more of 

the exclusions from the definition of 

covered fund provided by § 75.10(c)(1), 

(5), (8), (9), or (10), documentation 

supporting the banking entity’s 

determination that the fund is not a 

covered fund pursuant to one or more 

of those exclusions; 

(3) For each seeding vehicle described 

in § 75.10(c)(12)(i) or (iii) that will 

become a registered investment 

company or SEC-regulated business 

development company, a written plan 

documenting the banking entity’s 

determination that the seeding vehicle 

will become a registered investment 

company or SEC-regulated business 

development company; the period of 

time during which the vehicle will 

operate as a seeding vehicle; and the 

banking entity’s plan to market the 

vehicle to third-party investors and 

convert it into a registered investment 

company or SEC-regulated business 

development company within the time 

period specified in § 75.12(a)(2)(i)(B); 

(4) For any banking entity that is, or 

is controlled directly or indirectly by a 

banking entity that is, located in or 

organized under the laws of the United 

States or of any State, if the aggregate 

amount of ownership interests in 

foreign public funds that are described 

in § 75.10(c)(1) owned by such banking 

entity (including ownership interests 

owned by any affiliate that is controlled 

directly or indirectly by a banking entity 

that is located in or organized under the 

laws of the United States or of any State) 

exceeds $50 million at the end of two 

or more consecutive calendar quarters, 

beginning with the next succeeding 

calendar quarter, documentation of the 

value of the ownership interests owned 

by the banking entity (and such 

affiliates) in each foreign public fund 

and each jurisdiction in which any such 

foreign public fund is organized, 

calculated as of the end of each calendar 

quarter, which documentation must 

continue until the banking entity’s 

aggregate amount of ownership interests 

in foreign public funds is below $50 

million for two consecutive calendar 

quarters; and 

(5) For purposes of paragraph (e)(4) of 

this section, a U.S. branch, agency, or 

subsidiary of a foreign banking entity is 

located in the United States; however, 

the foreign bank that operates or 

controls that branch, agency, or 

subsidiary is not considered to be 

located in the United States solely by 

virtue of operating or controlling the 

U.S. branch, agency, or subsidiary. 

(f) Simplified programs for less active 

banking entities—(1) Banking entities 

with no covered activities. A banking 

entity that does not engage in activities 

or investments pursuant to subpart B or 

subpart C of this part (other than trading 

activities permitted pursuant to 

§ 75.6(a)) may satisfy the requirements 

of this section by establishing the 

required compliance program prior to 

becoming engaged in such activities or 

making such investments (other than 

trading activities permitted pursuant to 

§ 75.6(a)). 

(2) Banking entities with modest 

activities. A banking entity with total 

consolidated assets of $10 billion or less 

as reported on December 31 of the 

previous two calendar years that 

engages in activities or investments 

pursuant to subpart B or subpart C of 

this part (other than trading activities 

permitted under § 75.6(a)) may satisfy 

the requirements of this section by 

including in its existing compliance 

policies and procedures appropriate 

references to the requirements of section 

13 of the BHC Act and this part and 

adjustments as appropriate given the 

activities, size, scope and complexity of 

the banking entity. 

§ 75.21 Termination of activities or 

investments; penalties for violations. 

(a) Any banking entity that engages in 

an activity or makes an investment in 

violation of section 13 of the BHC Act 

or this part, or acts in a manner that 

functions as an evasion of the 

requirements of section 13 of the BHC 

Act or this part, including through an 

abuse of any activity or investment 

permitted under subparts B or C of this 

part, or otherwise violates the 

restrictions and requirements of section 

13 of the BHC Act or this part, shall, 

upon discovery, promptly terminate the 

activity and, as relevant, dispose of the 

investment. 

(b) Whenever the Commission finds 

reasonable cause to believe any banking 

entity has engaged in an activity or 

made an investment in violation of 

section 13 of the BHC Act or this part, 

or engaged in any activity or made any 

investment that functions as an evasion 

of the requirements of section 13 of the 

BHC Act or this part, the Commission 

may take any action permitted by law to 

enforce compliance with section 13 of 

the BHC Act and this part, including 

directing the banking entity to restrict, 

limit, or terminate any or all activities 

under this part and dispose of any 

investment. 

Appendix A to Part 75—Reporting and 

Recordkeeping Requirements for 

Covered Trading Activities 

I. Purpose 

a. This appendix sets forth reporting and 

recordkeeping requirements that certain 

banking entities must satisfy in connection 

with the restrictions on proprietary trading 

set forth in subpart B of this part 

(‘‘proprietary trading restrictions’’). Pursuant 

to § 75.20(d), this appendix generally applies 

to a banking entity that, together with its 

affiliates and subsidiaries, has significant 

trading assets and liabilities. These entities 

are required to (i) furnish periodic reports to 

the Commission regarding a variety of 

quantitative measurements of their covered 

trading activities, which vary depending on 

the scope and size of covered trading 

activities, and (ii) create and maintain 

records documenting the preparation and 

content of these reports. The requirements of 

this appendix must be incorporated into the 

banking entity’s internal compliance program 

under § 75.20 and Appendix B of this part. 

b. The purpose of this appendix is to assist 

banking entities and the Commission in: 

(i) Better understanding and evaluating the 

scope, type, and profile of the banking 

entity’s covered trading activities; 

(ii) Monitoring the banking entity’s covered 

trading activities; 

(iii) Identifying covered trading activities 

that warrant further review or examination 


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by the banking entity to verify compliance 

with the proprietary trading restrictions; 

(iv) Evaluating whether the covered trading 

activities of trading desks engaged in market 

making-related activities subject to § 75.4(b) 

are consistent with the requirements 

governing permitted market making-related 

activities; 

(v) Evaluating whether the covered trading 

activities of trading desks that are engaged in 

permitted trading activity subject to § 75.4, 

75.5, or 75.6(a) and (b) (i.e., underwriting and 

market making-related related activity, riskmitigating hedging, or trading in certain 

government obligations) are consistent with 

the requirement that such activity not result, 

directly or indirectly, in a material exposure 

to high-risk assets or high-risk trading 

strategies; 

(vi) Identifying the profile of particular 

covered trading activities of the banking 

entity, and the individual trading desks of 

the banking entity, to help establish the 

appropriate frequency and scope of 

examination by the Commission of such 

activities; and 

(vii) Assessing and addressing the risks 

associated with the banking entity’s covered 

trading activities. 

c. The quantitative measurements that 

must be furnished pursuant to this appendix 

are not intended to serve as a dispositive tool 

for the identification of permissible or 

impermissible activities. 

d. In order to allow banking entities and 

the Agencies to evaluate the effectiveness of 

these metrics, banking entities must collect 

and report these metrics for all trading desks 

beginning on the dates established in § 75.20. 

The Agencies will review the data collected 

and revise this collection requirement as 

appropriate based on a review of the data 

collected prior to September 30, 2015. 

e. In addition to the quantitative 

measurements required in this appendix, a 

banking entity may need to develop and 

implement other quantitative measurements 

in order to effectively monitor its covered 

trading activities for compliance with section 

13 of the BHC Act and this part and to have 

an effective compliance program, as required 

by § 75.20 and Appendix B of this part. The 

effectiveness of particular quantitative 

measurements may differ based on the profile 

of the banking entity’s businesses in general 

and, more specifically, of the particular 

trading desk, including types of instruments 

traded, trading activities and strategies, and 

history and experience (e.g., whether the 

trading desk is an established, successful 

market maker or a new entrant to a 

competitive market). In all cases, banking 

entities must ensure that they have robust 

measures in place to identify and monitor the 

risks taken in their trading activities, to 

ensure that the activities are within risk 

tolerances established by the banking entity, 

and to monitor and examine for compliance 

with the proprietary trading restrictions in 

this part. 

f. On an ongoing basis, banking entities 

must carefully monitor, review, and evaluate 

all furnished quantitative measurements, as 

well as any others that they choose to utilize 

in order to maintain compliance with section 

13 of the BHC Act and this part. All 

measurement results that indicate a 

heightened risk of impermissible proprietary 

trading, including with respect to otherwisepermitted activities under §§ 75.4 through 

75.6(a) and (b), or that result in a material 

exposure to high-risk assets or high-risk 

trading strategies, must be escalated within 

the banking entity for review, further 

analysis, explanation to the Commission, and 

remediation, where appropriate. The 

quantitative measurements discussed in this 

appendix should be helpful to banking 

entities in identifying and managing the risks 

related to their covered trading activities. 

II. Definitions 

The terms used in this appendix have the 

same meanings as set forth in §§ 75.2 and 

75.3. In addition, for purposes of this 

appendix, the following definitions apply: 

Calculation period means the period of 

time for which a particular quantitative 

measurement must be calculated. 

Comprehensive profit and loss means the 

net profit or loss of a trading desk’s material 

sources of trading revenue over a specific 

period of time, including, for example, any 

increase or decrease in the market value of 

a trading desk’s holdings, dividend income, 

and interest income and expense. 

Covered trading activity means trading 

conducted by a trading desk under § 75.4, 

75.5, or 75.6(a) or (b). A banking entity may 

include trading under § 75.3(d) or 75.6(c), (d) 

or (e). 

Measurement frequency means the 

frequency with which a particular 

quantitative metric must be calculated and 

recorded. 

Trading desk means the smallest discrete 

unit of organization of a banking entity that 

purchases or sells financial instruments for 

the trading account of the banking entity or 

an affiliate thereof. 

III. Reporting and Recordkeeping of 

Quantitative Measurements 

a. Scope of Required Reporting 

General scope. Each banking entity made 

subject to this part by § 75.20 must furnish 

the following quantitative measurements for 

each trading desk of the banking entity, 

calculated in accordance with this appendix: 

• Risk and Position Limits and Usage; 

• Risk Factor Sensitivities; 

• Value-at-Risk and Stress VaR; 

• Comprehensive Profit and Loss 

Attribution; 

• Inventory Turnover; 

• Inventory Aging; and 

• Customer Facing Trade Ratio 

b. Frequency of Required Calculation and 

Reporting 

A banking entity must calculate any 

applicable quantitative measurement for each 

trading day. A banking entity must report 

each applicable quantitative measurement to 

the Commission on the reporting schedule 

established in § 75.20 unless otherwise 

requested by the Commission. All 

quantitative measurements for any calendar 

month must be reported within the time 

period required by § 75.20. 

c. Recordkeeping 

A banking entity must, for any quantitative 

measurement furnished to the Commission 

pursuant to this appendix and § 75.20(d), 

create and maintain records documenting the 

preparation and content of these reports, as 

well as such information as is necessary to 

permit the Commission to verify the accuracy 

of such reports, for a period of 5 years from 

the end of the calendar year for which the 

measurement was taken. 

IV. Quantitative Measurements 

a. Risk-Management Measurements 

1. Risk and Position Limits and Usage 

i. Description: For purposes of this 

appendix, Risk and Position Limits are the 

constraints that define the amount of risk that 

a trading desk is permitted to take at a point 

in time, as defined by the banking entity for 

a specific trading desk. Usage represents the 

portion of the trading desk’s limits that are 

accounted for by the current activity of the 

desk. Risk and position limits and their usage 

are key risk management tools used to 

control and monitor risk taking and include, 

but are not limited, to the limits set out in 

§§ 75.4 and 75.5. A number of the metrics 

that are described below, including ‘‘Risk 

Factor Sensitivities’’ and ‘‘Value-at-Risk and 

Stress Value-at-Risk,’’ relate to a trading 

desk’s risk and position limits and are useful 

in evaluating and setting these limits in the 

broader context of the trading desk’s overall 

activities, particularly for the market making 

activities under § 75.4(b) and hedging activity 

under § 75.5. Accordingly, the limits required 

under §§ 75.4(b)(2)(iii) and 75.5(b)(1)(i) must 

meet the applicable requirements under 

§§ 75.4(b)(2)(iii) and 75.5(b)(1)(i) and also 

must include appropriate metrics for the 

trading desk limits including, at a minimum, 

the ‘‘Risk Factor Sensitivities’’ and ‘‘Value-atRisk and Stress Value-at-Risk’’ metrics except 

to the extent any of the ‘‘Risk Factor 

Sensitivities’’ or ‘‘Value-at-Risk and Stress 

Value-at-Risk’’ metrics are demonstrably 

ineffective for measuring and monitoring the 

risks of a trading desk based on the types of 

positions traded by, and risk exposures of, 

that desk. 

ii. General Calculation Guidance: Risk and 

Position Limits must be reported in the 

format used by the banking entity for the 

purposes of risk management of each trading 

desk. Risk and Position Limits are often 

expressed in terms of risk measures, such as 

VaR and Risk Factor Sensitivities, but may 

also be expressed in terms of other 

observable criteria, such as net open 

positions. When criteria other than VaR or 

Risk Factor Sensitivities are used to define 

the Risk and Position Limits, both the value 

of the Risk and Position Limits and the value 

of the variables used to assess whether these 

limits have been reached must be reported. 

iii. Calculation Period: One trading day. 

iv. Measurement Frequency: Daily. 

2. Risk Factor Sensitivities 

i. Description: For purposes of this 

appendix, Risk Factor Sensitivities are 

changes in a trading desk’s Comprehensive 

Profit and Loss that are expected to occur in 

the event of a change in one or more 


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underlying variables that are significant 

sources of the trading desk’s profitability and 

risk. 

ii. General Calculation Guidance: A 

banking entity must report the Risk Factor 

Sensitivities that are monitored and managed 

as part of the trading desk’s overall risk 

management policy. The underlying data and 

methods used to compute a trading desk’s 

Risk Factor Sensitivities will depend on the 

specific function of the trading desk and the 

internal risk management models employed. 

The number and type of Risk Factor 

Sensitivities that are monitored and managed 

by a trading desk, and furnished to the 

Commission, will depend on the explicit 

risks assumed by the trading desk. In general, 

however, reported Risk Factor Sensitivities 

must be sufficiently granular to account for 

a preponderance of the expected price 

variation in the trading desk’s holdings. 

A. Trading desks must take into account 

any relevant factors in calculating Risk Factor 

Sensitivities, including, for example, the 

following with respect to particular asset 

classes: 

• Commodity derivative positions: risk 

factors with respect to the related 

commodities set out in § 20.2 of this chapter, 

the maturity of the positions, volatility and/ 

or correlation sensitivities (expressed in a 

manner that demonstrates any significant 

non-linearities), and the maturity profile of 

the positions; 

• Credit positions: risk factors with respect 

to credit spreads that are sufficiently granular 

to account for specific credit sectors and 

market segments, the maturity profile of the 

positions, and risk factors with respect to 

interest rates of all relevant maturities; 

• Credit-related derivative positions: risk 

factor sensitivities, for example credit 

spreads, shifts (parallel and non-parallel) in 

credit spreads—volatility, and/or correlation 

sensitivities (expressed in a manner that 

demonstrates any significant non-linearities), 

and the maturity profile of the positions; 

• Equity derivative positions: risk factor 

sensitivities such as equity positions, 

volatility, and/or correlation sensitivities 

(expressed in a manner that demonstrates 

any significant non-linearities), and the 

maturity profile of the positions; 

• Equity positions: risk factors for equity 

prices and risk factors that differentiate 

between important equity market sectors and 

segments, such as a small capitalization 

equities and international equities; 

• Foreign exchange derivative positions: 

risk factors with respect to major currency 

pairs and maturities, exposure to interest 

rates at relevant maturities, volatility, and/or 

correlation sensitivities (expressed in a 

manner that demonstrates any significant 

non-linearities), as well as the maturity 

profile of the positions; and 

• Interest rate positions, including interest 

rate derivative positions: risk factors with 

respect to major interest rate categories and 

maturities and volatility and/or correlation 

sensitivities (expressed in a manner that 

demonstrates any significant non-linearities), 

and shifts (parallel and non-parallel) in the 

interest rate curve, as well as the maturity 

profile of the positions. 

B. The methods used by a banking entity 

to calculate sensitivities to a common factor 

shared by multiple trading desks, such as an 

equity price factor, must be applied 

consistently across its trading desks so that 

the sensitivities can be compared from one 

trading desk to another. 

iii. Calculation Period: One trading day. 

iv. Measurement Frequency: Daily. 

3. Value-at-Risk and Stress Value-at-Risk 

i. Description: For purposes of this 

appendix, Value-at-Risk (‘‘VaR’’) is the 

commonly used percentile measurement of 

the risk of future financial loss in the value 

of a given set of aggregated positions over a 

specified period of time, based on current 

market conditions. For purposes of this 

appendix, Stress Value-at-Risk (‘‘Stress VaR’’) 

is the percentile measurement of the risk of 

future financial loss in the value of a given 

set of aggregated positions over a specified 

period of time, based on market conditions 

during a period of significant financial stress. 

ii. General Calculation Guidance: Banking 

entities must compute and report VaR and 

Stress VaR by employing generally accepted 

standards and methods of calculation. VaR 

should reflect a loss in a trading desk that is 

expected to be exceeded less than one 

percent of the time over a one-day period. 

For those banking entities that are subject to 

regulatory capital requirements imposed by a 

Federal banking agency, VaR and Stress VaR 

must be computed and reported in a manner 

that is consistent with such regulatory capital 

requirements. In cases where a trading desk 

does not have a standalone VaR or Stress VaR 

calculation but is part of a larger aggregation 

of positions for which a VaR or Stress VaR 

calculation is performed, a VaR or Stress VaR 

calculation that includes only the trading 

desk’s holdings must be performed consistent 

with the VaR or Stress VaR model and 

methodology used for the larger aggregation 

of positions. 

iii. Calculation Period: One trading day. 

iv. Measurement Frequency: Daily. 

b. Source-of-Revenue Measurements 

1. Comprehensive Profit and Loss Attribution 

i. Description: For purposes of this 

appendix, Comprehensive Profit and Loss 

Attribution is an analysis that attributes the 

daily fluctuation in the value of a trading 

desk’s positions to various sources. First, the 

daily profit and loss of the aggregated 

positions is divided into three categories: (i) 

Profit and loss attributable to a trading desk’s 

existing positions that were also positions 

held by the trading desk as of the end of the 

prior day (‘‘existing positions’’); (ii) profit 

and loss attributable to new positions 

resulting from the current day’s trading 

activity (‘‘new positions’’); and (iii) residual 

profit and loss that cannot be specifically 

attributed to existing positions or new 

positions. The sum of (i), (ii), and (iii) must 

equal the trading desk’s comprehensive profit 

and loss at each point in time. In addition, 

profit and loss measurements must calculate 

volatility of comprehensive profit and loss 

(i.e., the standard deviation of the trading 

desk’s one-day profit and loss, in dollar 

terms) for the reporting period for at least a 

30-, 60- and 90-day lag period, from the end 

of the reporting period, and any other period 

that the banking entity deems necessary to 

meet the requirements of the rule. 

A. The comprehensive profit and loss 

associated with existing positions must 

reflect changes in the value of these positions 

on the applicable day. The comprehensive 

profit and loss from existing positions must 

be further attributed, as applicable, to 

changes in (i) the specific Risk Factors and 

other factors that are monitored and managed 

as part of the trading desk’s overall risk 

management policies and procedures; and (ii) 

any other applicable elements, such as cash 

flows, carry, changes in reserves, and the 

correction, cancellation, or exercise of a 

trade. 

B. The comprehensive profit and loss 

attributed to new positions must reflect 

commissions and fee income or expense and 

market gains or losses associated with 

transactions executed on the applicable day. 

New positions include purchases and sales of 

financial instruments and other assets/

liabilities and negotiated amendments to 

existing positions. The comprehensive profit 

and loss from new positions may be reported 

in the aggregate and does not need to be 

further attributed to specific sources. 

C. The portion of comprehensive profit and 

loss that cannot be specifically attributed to 

known sources must be allocated to a 

residual category identified as an 

unexplained portion of the comprehensive 

profit and loss. Significant unexplained 

profit and loss must be escalated for further 

investigation and analysis. 

ii. General Calculation Guidance: The 

specific categories used by a trading desk in 

the attribution analysis and amount of detail 

for the analysis should be tailored to the type 

and amount of trading activities undertaken 

by the trading desk. The new position 

attribution must be computed by calculating 

the difference between the prices at which 

instruments were bought and/or sold and the 

prices at which those instruments are marked 

to market at the close of business on that day 

multiplied by the notional or principal 

amount of each purchase or sale. Any fees, 

commissions, or other payments received 

(paid) that are associated with transactions 

executed on that day must be added 

(subtracted) from such difference. These 

factors must be measured consistently over 

time to facilitate historical comparisons. 

iii. Calculation Period: One trading day. 

iv. Measurement Frequency: Daily. 

c. Customer-Facing Activity Measurements 

1. Inventory Turnover 

i. Description: For purposes of this 

appendix, Inventory Turnover is a ratio that 

measures the turnover of a trading desk’s 

inventory. The numerator of the ratio is the 

absolute value of all transactions over the 

reporting period. The denominator of the 

ratio is the value of the trading desk’s 

inventory at the beginning of the reporting 

period. 

ii. General Calculation Guidance: For 

purposes of this appendix, for derivatives, 

other than options and interest rate 

derivatives, value means gross notional 

value, for options, value means delta 

adjusted notional value, and for interest rate 

derivatives, value means 10-year bond 

equivalent value. 

iii. Calculation Period: 30 days, 60 days, 

and 90 days. 


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iv. Measurement Frequency: Daily. 

2. Inventory Aging 

i. Description: For purposes of this 

appendix, Inventory Aging generally 

describes a schedule of the trading desk’s 

aggregate assets and liabilities and the 

amount of time that those assets and 

liabilities have been held. Inventory Aging 

should measure the age profile of the trading 

desk’s assets and liabilities. 

ii. General Calculation Guidance: In 

general, Inventory Aging must be computed 

using a trading desk’s trading activity data 

and must identify the value of a trading 

desk’s aggregate assets and liabilities. 

Inventory Aging must include two schedules, 

an asset-aging schedule and a liability-aging 

schedule. Each schedule must record the 

value of assets or liabilities held over all 

holding periods. For derivatives, other than 

options, and interest rate derivatives, value 

means gross notional value, for options, 

value means delta adjusted notional value 

and, for interest rate derivatives, value means 

10-year bond equivalent value. 

iii. Calculation Period: One trading day. 

iv. Measurement Frequency: Daily. 

3. Customer-Facing Trade Ratio—Trade 

Count Based and Value Based 

i. Description: For purposes of this 

appendix, the Customer-Facing Trade Ratio 

is a ratio comparing (i) the transactions 

involving a counterparty that is a customer 

of the trading desk to (ii) the transactions 

involving a counterparty that is not a 

customer of the trading desk. A trade count 

based ratio must be computed that records 

the number of transactions involving a 

counterparty that is a customer of the trading 

desk and the number of transactions 

involving a counterparty that is not a 

customer of the trading desk. A value based 

ratio must be computed that records the 

value of transactions involving a 

counterparty that is a customer of the trading 

desk and the value of transactions involving 

a counterparty that is not a customer of the 

trading desk. 

ii. General Calculation Guidance: For 

purposes of calculating the Customer-Facing 

Trade Ratio, a counterparty is considered to 

be a customer of the trading desk if the 

counterparty is a market participant that 

makes use of the banking entity’s market 

making-related services by obtaining such 

services, responding to quotations, or 

entering into a continuing relationship with 

respect to such services. However, a trading 

desk or other organizational unit of another 

banking entity would not be a client, 

customer, or counterparty of the trading desk 

if the other entity has trading assets and 

liabilities of $50 billion or more as measured 

in accordance with § 75.20(d)(1) unless the 

trading desk documents how and why a 

particular trading desk or other 

organizational unit of the entity should be 

treated as a client, customer, or counterparty 

of the trading desk. Transactions conducted 

anonymously on an exchange or similar 

trading facility that permits trading on behalf 

of a broad range of market participants would 

be considered transactions with customers of 

the trading desk. For derivatives, other than 

options, and interest rate derivatives, value 

means gross notional value, for options, 

value means delta adjusted notional value, 

and for interest rate derivatives, value means 

10-year bond equivalent value. 

iii. Calculation Period: 30 days, 60 days, 

and 90 days. 

iv. Measurement Frequency: Daily. 

Appendix B to Part 75—Enhanced 

Minimum Standards for Compliance 

Programs 

I. Overview 

Section 75.20(c) requires certain banking 

entities to establish, maintain, and enforce an 

enhanced compliance program that includes 

the requirements and standards in this 

Appendix as well as the minimum written 

policies and procedures, internal controls, 

management framework, independent 

testing, training, and recordkeeping 

provisions outlined in § 75.20. This 

Appendix sets forth additional minimum 

standards with respect to the establishment, 

oversight, maintenance, and enforcement by 

these banking entities of an enhanced 

internal compliance program for ensuring 

and monitoring compliance with the 

prohibitions and restrictions on proprietary 

trading and covered fund activities and 

investments set forth in section 13 of the 

BHC Act and this part. 

a. This compliance program must: 

1. Be reasonably designed to identify, 

document, monitor, and report the permitted 

trading and covered fund activities and 

investments of the banking entity; identify, 

monitor and promptly address the risks of 

these covered activities and investments and 

potential areas of noncompliance; and 

prevent activities or investments prohibited 

by, or that do not comply with, section 13 of 

the BHC Act and this part; 

2. Establish and enforce appropriate limits 

on the covered activities and investments of 

the banking entity, including limits on the 

size, scope, complexity, and risks of the 

individual activities or investments 

consistent with the requirements of section 

13 of the BHC Act and this part; 

3. Subject the effectiveness of the 

compliance program to periodic independent 

review and testing, and ensure that the 

entity’s internal audit, corporate compliance 

and internal control functions involved in 

review and testing are effective and 

independent; 

4. Make senior management, and others as 

appropriate, accountable for the effective 

implementation of the compliance program, 

and ensure that the board of directors and 

chief executive officer (or equivalent) of the 

banking entity review the effectiveness of the 

compliance program; and 

5. Facilitate supervision and examination 

by the Agencies of the banking entity’s 

permitted trading and covered fund activities 

and investments. 

II. Enhanced Compliance Program 

a. Proprietary Trading Activities 

A banking entity must establish, maintain 

and enforce a compliance program that 

includes written policies and procedures that 

are appropriate for the types, size, and 

complexity of, and risks associated with, its 

permitted trading activities. The compliance 

program may be tailored to the types of 

trading activities conducted by the banking 

entity, and must include a detailed 

description of controls established by the 

banking entity to reasonably ensure that its 

trading activities are conducted in 

accordance with the requirements and 

limitations applicable to those trading 

activities under section 13 of the BHC Act 

and this part, and provide for appropriate 

revision of the compliance program before 

expansion of the trading activities of the 

banking entity. A banking entity must devote 

adequate resources and use knowledgeable 

personnel in conducting, supervising and 

managing its trading activities, and promote 

consistency, independence and rigor in 

implementing its risk controls and 

compliance efforts. The compliance program 

must be updated with a frequency sufficient 

to account for changes in the activities of the 

banking entity, results of independent testing 

of the program, identification of weaknesses 

in the program, and changes in legal, 

regulatory or other requirements. 

1. Trading Desks: The banking entity must 

have written policies and procedures 

governing each trading desk that include a 

description of: 

i. The process for identifying, authorizing 

and documenting financial instruments each 

trading desk may purchase or sell, with 

separate documentation for market makingrelated activities conducted in reliance on 

§ 75.4(b) and for hedging activity conducted 

in reliance on § 75.5; 

ii. A mapping for each trading desk to the 

division, business line, or other 

organizational structure that is responsible 

for managing and overseeing the trading 

desk’s activities; 

iii. The mission (i.e., the type of trading 

activity, such as market-making, trading in 

sovereign debt, etc.) and strategy (i.e., 

methods for conducting authorized trading 

activities) of each trading desk; 

iv. The activities that the trading desk is 

authorized to conduct, including (i) 

authorized instruments and products, and (ii) 

authorized hedging strategies, techniques and 

instruments; 

v. The types and amount of risks allocated 

by the banking entity to each trading desk to 

implement the mission and strategy of the 

trading desk, including an enumeration of 

material risks resulting from the activities in 

which the trading desk is authorized to 

engage (including but not limited to price 

risks, such as basis, volatility and correlation 

risks, as well as counterparty credit risk). 

Risk assessments must take into account both 

the risks inherent in the trading activity and 

the strength and effectiveness of controls 

designed to mitigate those risks; 

vi. How the risks allocated to each trading 

desk will be measured; 

vii. Why the allocated risks levels are 

appropriate to the activities authorized for 

the trading desk; 

viii. The limits on the holding period of, 

and the risk associated with, financial 

instruments under the responsibility of the 

trading desk; 

ix. The process for setting new or revised 

limits, as well as escalation procedures for 


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granting exceptions to any limits or to any 

policies or procedures governing the desk, 

the analysis that will be required to support 

revising limits or granting exceptions, and 

the process for independently reviewing and 

documenting those exceptions and the 

underlying analysis; 

x. The process for identifying, 

documenting and approving new products, 

trading strategies, and hedging strategies; 

xi. The types of clients, customers, and 

counterparties with whom the trading desk 

may trade; and 

xii. The compensation arrangements, 

including incentive arrangements, for 

employees associated with the trading desk, 

which may not be designed to reward or 

incentivize prohibited proprietary trading or 

excessive or imprudent risk-taking. 

2. Description of risks and risk 

management processes: The compliance 

program for the banking entity must include 

a comprehensive description of the risk 

management program for the trading activity 

of the banking entity. The compliance 

program must also include a description of 

the governance, approval, reporting, 

escalation, review and other processes the 

banking entity will use to reasonably ensure 

that trading activity is conducted in 

compliance with section 13 of the BHC Act 

and this part. Trading activity in similar 

financial instruments should be subject to 

similar governance, limits, testing, controls, 

and review, unless the banking entity 

specifically determines to establish different 

limits or processes and documents those 

differences. Descriptions must include, at a 

minimum, the following elements: 

i. A description of the supervisory and risk 

management structure governing all trading 

activity, including a description of processes 

for initial and senior-level review of new 

products and new strategies; 

ii. A description of the process for 

developing, documenting, testing, approving 

and reviewing all models used for valuing, 

identifying and monitoring the risks of 

trading activity and related positions, 

including the process for periodic 

independent testing of the reliability and 

accuracy of those models; 

iii. A description of the process for 

developing, documenting, testing, approving 

and reviewing the limits established for each 

trading desk; 

iv. A description of the process by which 

a security may be purchased or sold pursuant 

to the liquidity management plan, including 

the process for authorizing and monitoring 

such activity to ensure compliance with the 

banking entity’s liquidity management plan 

and the restrictions on liquidity management 

activities in this part; 

v. A description of the management review 

process, including escalation procedures, for 

approving any temporary exceptions or 

permanent adjustments to limits on the 

activities, positions, strategies, or risks 

associated with each trading desk; and 

vi. The role of the audit, compliance, risk 

management and other relevant units for 

conducting independent testing of trading 

and hedging activities, techniques and 

strategies. 

3. Authorized risks, instruments, and 

products. The banking entity must 

implement and enforce limits and internal 

controls for each trading desk that are 

reasonably designed to ensure that trading 

activity is conducted in conformance with 

section 13 of the BHC Act and this part and 

with the banking entity’s written policies and 

procedures. The banking entity must 

establish and enforce risk limits appropriate 

for the activity of each trading desk. These 

limits should be based on probabilistic and 

non-probabilistic measures of potential loss 

(e.g., Value-at-Risk and notional exposure, 

respectively), and measured under normal 

and stress market conditions. At a minimum, 

these internal controls must monitor, 

establish and enforce limits on: 

i. The financial instruments (including, at 

a minimum, by type and exposure) that the 

trading desk may trade; 

ii. The types and levels of risks that may 

be taken by each trading desk; and 

iii. The types of hedging instruments used, 

hedging strategies employed, and the amount 

of risk effectively hedged. 

4. Hedging policies and procedures. The 

banking entity must establish, maintain, and 

enforce written policies and procedures 

regarding the use of risk-mitigating hedging 

instruments and strategies that, at a 

minimum, describe: 

i. The positions, techniques and strategies 

that each trading desk may use to hedge the 

risk of its positions; 

ii. The manner in which the banking entity 

will identify the risks arising in connection 

with and related to the individual or 

aggregated positions, contracts or other 

holdings of the banking entity that are to be 

hedged and determine that those risks have 

been properly and effectively hedged; 

iii. The level of the organization at which 

hedging activity and management will occur; 

iv. The manner in which hedging strategies 

will be monitored and the personnel 

responsible for such monitoring; 

v. The risk management processes used to 

control unhedged or residual risks; and 

vi. The process for developing, 

documenting, testing, approving and 

reviewing all hedging positions, techniques 

and strategies permitted for each trading desk 

and for the banking entity in reliance on 

§ 75.5. 

5. Analysis and quantitative 

measurements. The banking entity must 

perform robust analysis and quantitative 

measurement of its trading activities that is 

reasonably designed to ensure that the 

trading activity of each trading desk is 

consistent with the banking entity’s 

compliance program; monitor and assist in 

the identification of potential and actual 

prohibited proprietary trading activity; and 

prevent the occurrence of prohibited 

proprietary trading. Analysis and models 

used to determine, measure and limit risk 

must be rigorously tested and be reviewed by 

management responsible for trading activity 

to ensure that trading activities, limits, 

strategies, and hedging activities do not 

understate the risk and exposure to the 

banking entity or allow prohibited 

proprietary trading. This review should 

include periodic and independent backtesting and revision of activities, limits, 

strategies and hedging as appropriate to 

contain risk and ensure compliance. In 

addition to the quantitative measurements 

reported by any banking entity subject to 

Appendix A of this part, each banking entity 

must develop and implement, to the extent 

appropriate to facilitate compliance with this 

part, additional quantitative measurements 

specifically tailored to the particular risks, 

practices, and strategies of its trading desks. 

The banking entity’s analysis and 

quantitative measurements must incorporate 

the quantitative measurements reported by 

the banking entity pursuant to Appendix A 

of this part (if applicable) and include, at a 

minimum, the following: 

i. Internal controls and written policies and 

procedures reasonably designed to ensure the 

accuracy and integrity of quantitative 

measurements; 

ii. Ongoing, timely monitoring and review 

of calculated quantitative measurements; 

iii. The establishment of numerical 

thresholds and appropriate trading measures 

for each trading desk and heightened review 

of trading activity not consistent with those 

thresholds to ensure compliance with section 

13 of the BHC Act and this part, including 

analysis of the measurement results or other 

information, appropriate escalation 

procedures, and documentation related to the 

review; and 

iv. Immediate review and compliance 

investigation of the trading desk’s activities, 

escalation to senior management with 

oversight responsibilities for the applicable 

trading desk, timely notification to the 

Commission, appropriate remedial action 

(e.g., divesting of impermissible positions, 

cessation of impermissible activity, 

disciplinary actions), and documentation of 

the investigation findings and remedial 

action taken when quantitative 

measurements or other information, 

considered together with the facts and 

circumstances, or findings of internal audit, 

independent testing or other review suggest 

a reasonable likelihood that the trading desk 

has violated any part of section 13 of the BHC 

Act or this part. 

6. Other Compliance Matters. In addition 

to the requirements specified above, the 

banking entity’s compliance program must: 

i. Identify activities of each trading desk 

that will be conducted in reliance on 

exemptions contained in §§ 75.4 through 

75.6, including an explanation of: 

A. How and where in the organization the 

activity occurs; and 

B. Which exemption is being relied on and 

how the activity meets the specific 

requirements for reliance on the applicable 

exemption; 

ii. Include an explanation of the process for 

documenting, approving and reviewing 

actions taken pursuant to the liquidity 

management plan, where in the organization 

this activity occurs, the securities permissible 

for liquidity management, the process for 

ensuring that liquidity management activities 

are not conducted for the purpose of 

prohibited proprietary trading, and the 

process for ensuring that securities 

purchased as part of the liquidity 

management plan are highly liquid and 

conform to the requirements of this part; 

iii. Describe how the banking entity 

monitors for and prohibits potential or actual 


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material exposure to high-risk assets or highrisk trading strategies presented by each 

trading desk that relies on the exemptions 

contained in §§ 75.3(d)(3) and 75.4 through 

75.6, which must take into account potential 

or actual exposure to: 

A. Assets whose values cannot be 

externally priced or, where valuation is 

reliant on pricing models, whose model 

inputs cannot be externally validated; 

B. Assets whose changes in value cannot 

be adequately mitigated by effective hedging; 

C. New products with rapid growth, 

including those that do not have a market 

history; 

D. Assets or strategies that include 

significant embedded leverage; 

E. Assets or strategies that have 

demonstrated significant historical volatility; 

F. Assets or strategies for which the 

application of capital and liquidity standards 

would not adequately account for the risk; 

and 

G. Assets or strategies that result in large 

and significant concentrations to sectors, risk 

factors, or counterparties; 

iv. Establish responsibility for compliance 

with the reporting and recordkeeping 

requirements of subpart B of this part and 

§ 75.20; and 

v. Establish policies for monitoring and 

prohibiting potential or actual material 

conflicts of interest between the banking 

entity and its clients, customers, or 

counterparties. 

7. Remediation of violations. The banking 

entity’s compliance program must be 

reasonably designed and established to 

effectively monitor and identify for further 

analysis any trading activity that may 

indicate potential violations of section 13 of 

the BHC Act and this part and to prevent 

actual violations of section 13 of the BHC Act 

and this part. The compliance program must 

describe procedures for identifying and 

remedying violations of section 13 of the 

BHC Act and this part, and must include, at 

a minimum, a requirement to promptly 

document, address and remedy any violation 

of section 13 of the BHC Act or this part, and 

document all proposed and actual 

remediation efforts. The compliance program 

must include specific written policies and 

procedures that are reasonably designed to 

assess the extent to which any activity 

indicates that modification to the banking 

entity’s compliance program is warranted 

and to ensure that appropriate modifications 

are implemented. The written policies and 

procedures must provide for prompt 

notification to appropriate management, 

including senior management and the board 

of directors, of any material weakness or 

significant deficiencies in the design or 

implementation of the compliance program 

of the banking entity. 

b. Covered Fund Activities or Investments 

A banking entity must establish, maintain 

and enforce a compliance program that 

includes written policies and procedures that 

are appropriate for the types, size, 

complexity and risks of the covered fund and 

related activities conducted and investments 

made, by the banking entity. 

1. Identification of covered funds. The 

banking entity’s compliance program must 

provide a process, which must include 

appropriate management review and 

independent testing, for identifying and 

documenting covered funds that each unit 

within the banking entity’s organization 

sponsors or organizes and offers, and covered 

funds in which each such unit invests. In 

addition to the documentation requirements 

for covered funds, as specified under 

§ 75.20(e), the documentation must include 

information that identifies all pools that the 

banking entity sponsors or has an interest in 

and the type of exemption from the 

Commodity Exchange Act (whether or not 

the pool relies on § 4.7 of the regulations 

under the Commodity Exchange Act (§ 4.7 of 

this chapter)), and the amount of ownership 

interest the banking entity has in those pools. 

2. Identification of covered fund activities 

and investments. The banking entity’s 

compliance program must identify, 

document and map each unit within the 

organization that is permitted to acquire or 

hold an interest in any covered fund or 

sponsor any covered fund and map each unit 

to the division, business line, or other 

organizational structure that will be 

responsible for managing and overseeing that 

unit’s activities and investments. 

3. Explanation of compliance. The banking 

entity’s compliance program must explain 

how: 

i. The banking entity monitors for and 

prohibits potential or actual material 

conflicts of interest between the banking 

entity and its clients, customers, or 

counterparties related to its covered fund 

activities and investments; 

ii. The banking entity monitors for and 

prohibits potential or actual transactions or 

activities that may threaten the safety and 

soundness of the banking entity related to its 

covered fund activities and investments; and 

iii. The banking entity monitors for and 

prohibits potential or actual material 

exposure to high-risk assets or high-risk 

trading strategies presented by its covered 

fund activities and investments, taking into 

account potential or actual exposure to: 

A. Assets whose values cannot be 

externally priced or, where valuation is 

reliant on pricing models, whose model 

inputs cannot be externally validated; 

B. Assets whose changes in values cannot 

be adequately mitigated by effective hedging; 

C. New products with rapid growth, 

including those that do not have a market 

history; 

D. Assets or strategies that include 

significant embedded leverage; 

E. Assets or strategies that have 

demonstrated significant historical volatility; 

F. Assets or strategies for which the 

application of capital and liquidity standards 

would not adequately account for the risk; 

and 

G. Assets or strategies that expose the 

banking entity to large and significant 

concentrations with respect to sectors, risk 

factors, or counterparties; 

4. Description and documentation of 

covered fund activities and investments. For 

each organizational unit engaged in covered 

fund activities and investments, the banking 

entity’s compliance program must document: 

i. The covered fund activities and 

investments that the unit is authorized to 

conduct; 

ii. The banking entity’s plan for actively 

seeking unaffiliated investors to ensure that 

any investment by the banking entity 

conforms to the limits contained in § 75.12 or 

registered in compliance with the securities 

laws and thereby exempt from those limits 

within the time periods allotted in § 75.12; 

and 

iii. How it complies with the requirements 

of subpart C of this part. 

5. Internal Controls. A banking entity must 

establish, maintain, and enforce internal 

controls that are reasonably designed to 

ensure that its covered fund activities or 

investments comply with the requirements of 

section 13 of the BHC Act and this part and 

are appropriate given the limits on risk 

established by the banking entity. These 

written internal controls must be reasonably 

designed and established to effectively 

monitor and identify for further analysis any 

covered fund activity or investment that may 

indicate potential violations of section 13 of 

the BHC Act or this part. The internal 

controls must, at a minimum require: 

i. Monitoring and limiting the banking 

entity’s individual and aggregate investments 

in covered funds; 

ii. Monitoring the amount and timing of 

seed capital investments for compliance with 

the limitations under subpart C of this part 

(including but not limited to the redemption, 

sale or disposition requirements of § 75.12), 

and the effectiveness of efforts to seek 

unaffiliated investors to ensure compliance 

with those limits; 

iii. Calculating the individual and 

aggregate levels of ownership interests in one 

or more covered fund required by § 75.12; 

iv. Attributing the appropriate instruments 

to the individual and aggregate ownership 

interest calculations above; 

v. Making disclosures to prospective and 

actual investors in any covered fund 

organized and offered or sponsored by the 

banking entity, as provided under 

§ 75.11(a)(8); 

vi. Monitoring for and preventing any 

relationship or transaction between the 

banking entity and a covered fund that is 

prohibited under § 75.14, including where 

the banking entity has been designated as the 

sponsor, investment manager, investment 

adviser, or commodity trading advisor to a 

covered fund by another banking entity; and 

vii. Appropriate management review and 

supervision across legal entities of the 

banking entity to ensure that services and 

products provided by all affiliated entities 

comply with the limitation on services and 

products contained in § 75.14. 

6. Remediation of violations. The banking 

entity’s compliance program must be 

reasonably designed and established to 

effectively monitor and identify for further 

analysis any covered fund activity or 

investment that may indicate potential 

violations of section 13 of the BHC Act or 

this part and to prevent actual violations of 

section 13 of the BHC Act and this part. The 

banking entity’s compliance program must 

describe procedures for identifying and 

remedying violations of section 13 of the 


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BHC Act and this part, and must include, at 

a minimum, a requirement to promptly 

document, address and remedy any violation 

of section 13 of the BHC Act or this part, 

including § 75.21, and document all 

proposed and actual remediation efforts. The 

compliance program must include specific 

written policies and procedures that are 

reasonably designed to assess the extent to 

which any activity or investment indicates 

that modification to the banking entity’s 

compliance program is warranted and to 

ensure that appropriate modifications are 

implemented. The written policies and 

procedures must provide for prompt 

notification to appropriate management, 

including senior management and the board 

of directors, of any material weakness or 

significant deficiencies in the design or 

implementation of the compliance program 

of the banking entity. 

III. Responsibility and Accountability for the 

Compliance Program 

a. A banking entity must establish, 

maintain, and enforce a governance and 

management framework to manage its 

business and employees with a view to 

preventing violations of section 13 of the 

BHC Act and this part. A banking entity must 

have an appropriate management framework 

reasonably designed to ensure that: 

Appropriate personnel are responsible and 

accountable for the effective implementation 

and enforcement of the compliance program; 

a clear reporting line with a chain of 

responsibility is delineated; and the 

compliance program is reviewed periodically 

by senior management. The board of 

directors (or equivalent governance body) 

and senior management should have the 

appropriate authority and access to personnel 

and information within the organizations as 

well as appropriate resources to conduct 

their oversight activities effectively. 

1. Corporate governance. The banking 

entity must adopt a written compliance 

program approved by the board of directors, 

an appropriate committee of the board, or 

equivalent governance body, and senior 

management. 

2. Management procedures. The banking 

entity must establish, maintain, and enforce 

a governance framework that is reasonably 

designed to achieve compliance with section 

13 of the BHC Act and this part, which, at 

a minimum, provides for: 

i. The designation of appropriate senior 

management or committee of senior 

management with authority to carry out the 

management responsibilities of the banking 

entity for each trading desk and for each 

organizational unit engaged in covered fund 

activities; 

ii. Written procedures addressing the 

management of the activities of the banking 

entity that are reasonably designed to achieve 

compliance with section 13 of the BHC Act 

and this part, including: 

A. A description of the management 

system, including the titles, qualifications, 

and locations of managers and the specific 

responsibilities of each person with respect 

to the banking entity’s activities governed by 

section 13 of the BHC Act and this part; and 

B. Procedures for determining 

compensation arrangements for traders 

engaged in underwriting or market makingrelated activities under § 75.4 or riskmitigating hedging activities under § 75.5 so 

that such compensation arrangements are 

designed not to reward or incentivize 

prohibited proprietary trading and 

appropriately balance risk and financial 

results in a manner that does not encourage 

employees to expose the banking entity to 

excessive or imprudent risk. 

3. Business line managers. Managers with 

responsibility for one or more trading desks 

of the banking entity are accountable for the 

effective implementation and enforcement of 

the compliance program with respect to the 

applicable trading desk(s). 

4. Board of directors, or similar corporate 

body, and senior management. The board of 

directors, or similar corporate body, and 

senior management are responsible for 

setting and communicating an appropriate 

culture of compliance with section 13 of the 

BHC Act and this part and ensuring that 

appropriate policies regarding the 

management of trading activities and covered 

fund activities or investments are adopted to 

comply with section 13 of the BHC Act and 

this part. The board of directors or similar 

corporate body (such as a designated 

committee of the board or an equivalent 

governance body) must ensure that senior 

management is fully capable, qualified, and 

properly motivated to manage compliance 

with this part in light of the organization’s 

business activities and the expectations of 

the board of directors. The board of directors 

or similar corporate body must also ensure 

that senior management has established 

appropriate incentives and adequate 

resources to support compliance with this 

part, including the implementation of a 

compliance program meeting the 

requirements of this appendix into 

management goals and compensation 

structures across the banking entity. 

5. Senior management. Senior management 

is responsible for implementing and 

enforcing the approved compliance program. 

Senior management must also ensure that 

effective corrective action is taken when 

failures in compliance with section 13 of the 

BHC Act and this part are identified. Senior 

management and control personnel charged 

with overseeing compliance with section 13 

of the BHC Act and this part should review 

the compliance program for the banking 

entity periodically and report to the board, or 

an appropriate committee thereof, on the 

effectiveness of the compliance program and 

compliance matters with a frequency 

appropriate to the size, scope, and risk 

profile of the banking entity’s trading 

activities and covered fund activities or 

investments, which shall be at least annually. 

6. CEO attestation. Based on a review by 

the CEO of the banking entity, the CEO of the 

banking entity must, annually, attest in 

writing to the Commission that the banking 

entity has in place processes to establish, 

maintain, enforce, review, test and modify 

the compliance program established under 

this appendix and § 75.20 in a manner 

reasonably designed to achieve compliance 

with section 13 of the BHC Act and this part. 

In the case of a U.S. branch or agency of a 

foreign banking entity, the attestation may be 

provided for the entire U.S. operations of the 

foreign banking entity by the senior 

management officer of the United States 

operations of the foreign banking entity who 

is located in the United States. 

IV. Independent Testing 

a. Independent testing must occur with a 

frequency appropriate to the size, scope, and 

risk profile of the banking entity’s trading 

and covered fund activities or investments, 

which shall be at least annually. This 

independent testing must include an 

evaluation of: 

1. The overall adequacy and effectiveness 

of the banking entity’s compliance program, 

including an analysis of the extent to which 

the program contains all the required 

elements of this appendix; 

2. The effectiveness of the banking entity’s 

internal controls, including an analysis and 

documentation of instances in which such 

internal controls have been breached, and 

how such breaches were addressed and 

resolved; and 

3. The effectiveness of the banking entity’s 

management procedures. 

b. A banking entity must ensure that 

independent testing regarding the 

effectiveness of the banking entity’s 

compliance program is conducted by a 

qualified independent party, such as the 

banking entity’s internal audit department, 

compliance personnel or risk managers 

independent of the organizational unit being 

tested, outside auditors, consultants, or other 

qualified independent parties. A banking 

entity must promptly take appropriate action 

to remedy any significant deficiencies or 

material weaknesses in its compliance 

program and to terminate any violations of 

section 13 of the BHC Act or this part. 

V. Training 

Banking entities must provide adequate 

training to personnel and managers of the 

banking entity engaged in activities or 

investments governed by section 13 of the 

BHC Act or this part, as well as other 

appropriate supervisory, risk, independent 

testing, and audit personnel, in order to 

effectively implement and enforce the 

compliance program. This training should 

occur with a frequency appropriate to the 

size and the risk profile of the banking 

entity’s trading activities and covered fund 

activities or investments. 

VI. Recordkeeping 

Banking entities must create and retain 

records sufficient to demonstrate compliance 

and support the operations and effectiveness 

of the compliance program. A banking entity 

must retain these records for a period that is 

no less than 5 years or such longer period as 

required by the Commission in a form that 

allows it to promptly produce such records 

to the Commission on request. 

Issued in Washington, DC, on December 

30, 2013, by the Commission. 

Melissa D. Jurgens, 

Secretary of the Commission. 

Note: The following appendices will not 

appear in the Code of Federal Regulations. 


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Appendices to Prohibitions and 

Restrictions on Proprietary Trading 

and Certain Interests in, and 

Relationships With, Hedge Funds and 

Private Equity Funds—Commission 

Voting Summary and Statements of 

Commissioners 

Appendix 1—Commission Voting 

Summary 

On this matter, Chairman Gensler and 

Commissioners Chilton and Wetjen voted in 

the affirmative. Commissioner O’Malia voted 

in the negative. 

Appendix 2—Statement of Chairman 

Gary Gensler 

I support the final ‘‘Volcker Rule’’ before 

the Commission today. It achieves the 

important balance, as directed by Congress, 

of prohibiting banking entities from 

proprietary trading while at the same time 

allowing banking entities to engage in 

permitted activities, including market 

making and risk mitigating hedging. 

Further, as directed by the Dodd-Frank 

Wall Street Reform and Consumer Protection 

Act (Dodd-Frank Act), the final rule strikes 

an appropriate balance regarding banking 

entities investment in hedge funds and 

private equity funds. As Congress directed— 

other than for de minimis investments— 

banking entities are prohibited from 

sponsoring, owning, and having certain 

relationships with hedge funds or private 

equity funds. The final rule focuses the 

prohibition on entities formed for investing 

or trading in securities or derivatives and that 

are typically offered to institutional investors 

and high-net-worth individuals. The final 

definition was tailored to exclude entities 

that are offered more broadly to retail 

investors or have a more general corporate 

purpose, such as loan securitizations. 

The Commodity Futures Trading 

Commission (CFTC) consulted and 

coordinated with the Federal Reserve, the 

Federal Deposit Insurance Corporation, the 

Comptroller of the Currency and the 

Securities and Exchange Commission in 

developing this rule. Based on this 

collaboration, the CFTC’s final rule mirrors 

the language being adopted by the other 

financial regulators. 

The CFTC authority to implement the 

Volcker Rule is for the banking entities for 

which we are the primary financial 

regulatory agency. As of today, the CFTC 

estimates that our authority primarily applies 

to approximately 110 registered swap dealers 

and futures commission merchants (FCMs) 

that would each individually be banking 

entities under the Volcker Rule. Grouped by 

corporate affiliation these represent about 45 

different business enterprises. 

As a foundation, the final Volcker Rule 

requires banking entities to have a robust 

compliance program, including defined 

limits on market making, underwriting and 

hedging activities as well as continuous 

monitoring and management of such 

activities. It also requires reporting to 

regulators on specific metrics and trading 

details. This transparency will enhance the 

CFTC’s ability to oversee swap dealers and 

FCMs. 

Banking entities’ customers and 

counterparties will continue to be provided 

liquidity through the banking entities’ 

permitted market making. The banking 

entities are permitted to do so as long as each 

trading desk’s market-maker inventory is 

designed not to exceed, on an ongoing basis, 

the reasonably expected near-term demands 

of clients, customers or counterparties. The 

banking entities will be required to maintain 

an ongoing compliance program and follow 

the rule’s limits on market-maker inventory 

and financial exposure. For instance, banking 

entities would not be able to stockpile or 

accumulate positions over time that do not 

meet expected near-term customer demand. 

The final Volcker Rule also permits 

hedging to reduce identified, specific risks 

from the banking entity’s individual or 

aggregated positions. Permitted hedging 

activity will be required to (1) be designed to 

and (2) demonstrably reduce or otherwise 

significantly mitigate one or more specific, 

identifiable risks. The final rule’s preamble 

further states that this activity is not intended 

to be hedging of generalized risks based on 

non-position specific modeling or other 

considerations. Hedging of the general assets 

and liabilities of the banking entity or a guess 

as to the direction of the economy will no 

longer be permitted. 

Hedging strategies and positions are 

subject to analysis, including required 

correlation analysis, as well as an ongoing 

recalibration requirement to ensure it is not 

prohibited proprietary trading. 

The Commission also has the legal 

authority to enforce the Volcker Rule. If the 

Commission believes there is a violation, 

Dodd-Frank Section 619 and the final rule 

state that it can, after providing an 

opportunity to respond, order the registrant 

to stop that activity. The Commission also 

can use existing authority to discipline 

registrants, including FCMs, swap dealers, 

and others. The CEA and Commission rules 

provide that we may restrict, suspend or 

revoke a registration for good cause. 

Depending on the facts and circumstances, 

violation of Dodd-Frank Section 619 may rise 

to that level. 

The talented CFTC staff working along 

with my fellow Commissioners—Mike Dunn, 

Jill Sommers, Bart Chilton, Scott O’Malia and 

Mark Wetjen—really have delivered for the 

American public. 

With this action, the staff of this small but 

remarkably effective agency will have 

completed 68 rulemakings, orders and 

guidances. Though lacking adequate 

resources, the CFTC staff has diligently 

sorted through nearly 60,000 public comment 

letters. They have met with members of the 

public more than 2,200 times to discuss 

reform. 

These common-sense reforms have been 

truly transformative. 

Bright lights of transparency now are 

shining on the $380 trillion swaps market. 

The public can see the price and volume of 

every transaction, like a modern-day 

tickertape. Transparent, regulated trading 

platforms are trading a quarter of a trillion 

dollars in swaps each day. 

A majority of the swaps market is now 

being centrally cleared—lowering risk and 

bringing access to anyone wishing to 

compete. 

Ninety-one swap dealers have registered 

and—for the first time—are being overseen 

for their swaps activity. 

I couldn’t be more proud of this dedicated 

group of public servants. 

I am honored to have served along with 

them during such a remarkable time in the 

history of this agency. 

Appendix 3—Statement of 

Commissioner Bart Chilton 

High Roller’s Room 

I’m pleased to be voting on a final Volcker 

Rule. Frankly, two-and-a-half weeks ago, I 

had grave doubts about getting this done in 

a meaningful fashion. It had become weaker 

than the original proposal. But, thankfully, 

and I thank the Chairman for his tireless 

efforts, we have a rigorous and robust rule 

before us. 

If you’ve ever been to a casino, many of 

them have a high roller’s room. There’s 

usually a sign about a $1000 minimum bet. 

Many have ornate gaming tables and heavy 

draperies. If you walk around, you can catch 

a glimpse inside. But other than betting a lot 

of money, I’m not sure what goes on in there. 

And, that’s fine . . . some high rollers lose 

and some win. 

But, what if what the high rollers did in 

that room impacted all of us? What if it 

impacted consumers, our economy and our 

country? What if what the high rollers did in 

that room cost us $417 billion dollars (in a 

big bank bailout) because the games they 

were playing were tanking the economy? 

That’s why we need a strong Volcker Rule. 

We should never again be put in a 

circumstance where too big to fail high 

rollers play games of chance with our nation. 

This rule takes a heavy velvet rope with brass 

ends across the doorway and closes the high 

roller’s room. (Maybe they’ll put in more 

Blazing 7s or Wheel of Fortunes.) 

The dilemma in drafting the final rule has 

been that there are certain permitted forms of 

trading that have been difficult to define. 

Fortunately, the language has been solidified 

tightly to avoid loopholes. 

First, the key parts of the law, and what I 

have focused on for a very long time, are the 

words surrounding hedging. Proprietary 

hedging is allowed under the law, but 

speculative trading—risky gambles for the 

house—are exactly what Volcker sought to 

end. This rule does that by requiring hedges 

be designed to mitigate and reduce actual 

risk, and not just by an accidental or 

collateral effect of the trade. We also have 

better correlation language in the rule, 

correlation that shows that the hedging 

‘‘activity demonstrably reduces or otherwise 

significantly mitigates the specific, 

identifiable risk(s) being hedged.’’ This is 

key—the risk has to be specific and 

identifiable. You can’t just say, ‘‘Ah, oh, that? 

Hmm, it was a hedge.’’ Nope, we aren’t going 

to let ya play that game. The position needs 

to be correlated with the risk. 

Furthermore, there is now an ongoing 

requirement to recalibrate the position, the 


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6074 Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 

1 Dodd-Frank Wall Street Reform and Consumer 

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

(2010). 

2 12 U.S.C. 1851. 

3 5 U.S.C. 500 et seq. 

4 Gina Chon, ‘‘CFTC Goes Its Own Way Over 

Volcker Rule,’’ Fin. Times, November 23, 2013. 

5See SIFMA, ISDA & IIB v. CFTC, No. 13–CV– 

1916 (D.D.C.). 

6 Dodd-Frank Act § 2(12). 

7Senators Carl Levin and Jeff Merkley, co-authors 

of § 619 of the Dodd-Frank Act, emphasized the 

importance of enforcement to the success of the 

Volcker Rule by urging the five responsible agencies 

to ‘‘provide coordinated and consistent 

enforcement, including data sharing by regulators’’ 

in their implementation of a final rule. Letter from 

Hon. Jeff Merkley, Member, United States Senate, 

and Hon. Carl Levin, Member, United States Senate, 

to Hon. Ben Bernanke, Chairman, Board of 

Governors of the Federal Reserve System, Hon. 

Thomas Curry, Comptroller of the Currency, 

Department of the Treasury, Hon. Gary Gensler, 

Chairman, Commodity Futures Trading 

Commission, Hon. Martin Gruenberg, Acting 

Chairman, Federal Deposit Insurance Commission, 

and Hon. Mary Shapiro, Chairman, Securities and 

Exchange Commission (Apr. 26, 2012) (on file with 

the Commission). 

hedge, in order to ensure that the position 

remains a hedge and does not become 

speculative. When people say this version of 

the Volcker Rule will stop circumstances like 

the London Whale, this ongoing recalibration 

provision is exactly what will help avoid 

similar debacles. 

Second, the same goes for market making. 

Yes, market making is allowed, but only for 

the benefit of the banks’ customers—for their 

customers and not solely in order to collect 

market maker fees provided by the exchange 

or for any proprietary speculative reason. 

Full stop. 

Third, on portfolio hedging: One of the 

changes that has been made is that we have 

defined what a portfolio is NOT—it can’t be 

some amorphous set of excuses for doing a 

trade. You can’t call deuces and one-eyed 

jacks wild after the hand has been dealt. You 

can’t do an after-the-fact extract of a set of 

trades as a rationale for a hedge. 

Fourth, I’ve spoken many times about 

perverse bonus structures that reward the 

macho macho men traders. The idea, and it 

is contained in actual rule text language, is 

that big bonuses and rewards in banking 

should not be tied to flyer bets. Our first 

proposal was fairly poorly drafted on this. It 

didn’t differentiate between prohibited 

proprietary trading and permitted proprietary 

trading very well. My view of the language 

that compensation should be ‘‘designed’’ not 

to reward or incentivize prohibited trading is 

that this is a sufficiently narrow test. One of 

the ways we will determine if something is 

designed in this way is how, in fact, traders 

are paid. So we will look after-the-fact at the 

payouts. 

Finally, the Volcker Rule won’t be 

implemented until July of 2015. That’s ages 

in these morphing markets where new games 

seem to be played all the time. I guarantee 

there will be efforts to find loopholes, figure 

out ways around what has been written. 

That’s the way of the world. So, my final 

thought is that this rule must not be static. 

Regulators need to continue to monitor what 

is taking place. We need our regulatory eyes 

in the sky, but also to look around the corner 

for what’s coming next, and be nimble and 

quick, to ensure that what we do today holds 

up and that the high roller’s room isn’t reopened. 

While this may be the end of part of the 

rulemaking process, it is, and must be, the 

beginning of a process, that continues. 

Thank you. 

Appendix 4—Dissenting Statement of 

Commissioner Scott D. O’Malia 

I respectfully dissent from today’s 

Commission vote on the final rule 

implementing § 619 of the Dodd-Frank Act,1

commonly known as the ‘‘Volcker Rule.’’ I 

cannot support a rulemaking that 

undermines the regulatory process, nor 

clearly delineates the Commission’s new 

jurisdiction and enforcement authority under 

§ 13 of the Bank Holding Company Act of 

1956 (‘‘BHC Act’’) 2 and fails to include 

procedures that afford due process to market 

participants. 

Former Supreme Court Justice Louis D. 

Brandeis, who earlier in his career was 

instrumental in establishing the Federal 

Reserve System, stated: ‘‘If we desire respect 

for the law, we must first make the law 

respectable.’’ But respect—and integrity of 

process—is what has been most lacking in 

the Commission’s approach to rulemaking. 

I believe the Commission must get back to 

the basics of good government and proper 

rulemaking. I cannot vote for a final rule that 

is hardly the product of meaningful 

consideration by the full Commission, but 

instead was negotiated exclusively by the 

Chairman. In addition, I cannot vote for a 

final rule where the Commission has not 

devoted enough attention to providing 

sufficient clarity and due process in the 

enforcement of new and untested regulatory 

authority, but still imposes significant 

obligations upon market participants at an 

unknown—but surely considerable—cost. 

Abuse of Process 

Throughout the Commission’s rulemakings 

under the Dodd-Frank Act, I have urged the 

Commission to act faithfully in accordance 

with the applicable statutory authorities and 

the Administrative Procedure Act (‘‘APA’’).3

However, in the implementation of one of the 

most important mandates issued by Congress 

in response to the financial crisis, the 

Commission seems to have forgotten the 

basics of agency rulemaking. I am deeply 

troubled by the egregious abuse of process in 

this rulemaking. Without a doubt, it far 

surpasses all other previous transgressions to 

date. 

The first opportunity each Commissioner 

had to review a partial draft of the nearly 

1,000-page final rule came only three weeks 

prior to today’s vote. Further, because the 

Commission was operating in an information 

vacuum, the fact that the Commissioners 

were not reviewing the working interagency 

draft—but instead had the ‘‘CFTC-preferred’’ 

version of the rule—only came to light a few 

days later.4 The Commission did not receive 

a near-final draft of the rule (with language 

agreed to by all five agencies) until just six 

days prior to the vote, despite repeated 

requests by Commissioners for a version of 

the draft then in circulation amongst the 

responsible agencies. This six-day draft was 

not even accompanied by the courtesy of a 

summary or term sheet in order to aid the 

Commission in digesting, at the last minute, 

this incredibly complex and dense final rule. 

I am disappointed that today’s vote on the 

final rule is besmirched by the purposeful 

circumvention of measured review by each 

Commissioner’s office. It is simply not 

possible to carefully weigh a final rule— 

particularly one with as much detail and 

consequence as the Volcker Rule—in the 

briefest of timeframes. Accordingly, I am 

concerned that the lack of meaningful 

participation by the full Commission in the 

rulemaking process has therefore seriously 

impaired the ability of the Commission, as a 

deliberative body, to engage in reasoned 

decision-making. 

Congress established the CFTC as an 

independent agency led by a Commission— 

not a director—to act as steward to the 

futures and swaps markets. In doing so, 

Congress entrusted each of the 

Commissioners to independently use his or 

her experience and expertise to carefully 

review and deliberate upon all Commission 

action, including rulemaking. Final rules 

should reflect the input and collective 

opinion of the Commission as a whole, but 

today’s vote falls far short of that 

fundamental standard. 

It is imperative that the Commission 

respect the letter and spirit of the law and 

adhere faithfully to APA requirements in our 

implementation of this new statutory 

authority granted by Congress under the BHC 

Act. Unfortunately, the Commission’s 

rulemaking over the past three years has been 

aptly referred to as ‘‘regulation by fiat.’’ 5 We 

cannot continue down this path of reflexive, 

knee-jerk regulation that fails to provide 

clarity and certainty to market participants. 

The Commission must get back to the basics 

and return to a thoughtful, measured 

approach to regulating our markets in an 

open and transparent manner. 

Jurisdiction and Enforcement Authority 

I also believe that the basics of any 

rulemaking are jurisdiction and enforcement. 

However, the final rule fails to provide clear 

and consistent procedures for both (1) the 

Commission’s new enforcement authority 

under § 13 of the BHC Act and (2) due 

process for market participants. 

As a threshold matter, the Volcker Rule 

may give us concurrent, and potentially 

overlapping, jurisdiction as the ‘‘primary 

financial regulatory agency’’ 6 of a 

Commission registrant or registered entity, so 

long as there is some type of corporate 

relationship with a banking entity. It is 

essential that the Commission continue to 

work with the other responsible agencies on 

implementation to further outline the scope 

of each agency’s jurisdiction, maximize 

regulatory efficiency, and provide 

consistency for market participants, with a 

minimum of duplicative and costly 

requirements and wasted resources.7 The 

Commission must also be mindful of foreign 


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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations 6075 

8 7 U.S.C. 1 et seq. 

9 7 U.S.C. 19(a). 

10Section 619 of the Dodd-Frank Act, paragraph 

(e)(2), which is entitled Anti-evasion—Termination 

of Activities or Investment, provides that 

‘‘Notwithstanding any other provision of law, 

whenever an appropriate Federal banking agency, 

the Securities and Exchange Commission, or the 

Commodity Futures Trading Commission, as 

appropriate, has reasonable cause to believe that a 

banking entity or nonbank financial company 

supervised by the Board under the respective 

agency’s jurisdiction has made an investment or 

engaged in an activity in a manner that functions 

as an evasion of the requirements of this section 

(including through an abuse of any permitted 

activity) or otherwise violates the restrictions under 

this section, the appropriate Federal banking 

agency, the Securities and Exchange Commission, 

or the Commodity Futures Trading Commission, as 

appropriate, shall order, after due notice and 

opportunity for hearing, the banking entity or 

nonbank financial company supervised by the 

Board to terminate the activity and, as relevant, 

dispose of the investment. Nothing in this 

paragraph shall be construed to limit the inherent 

authority of any Federal agency or State regulatory 

authority to further restrict any investments or 

activities under otherwise applicable provisions of 

law.’’ 

11See, e.g., 12 U.S.C. 1818(i). 12 7 U.S.C. 9(c)(4)(A). 13 7 U.S.C. 6s. 

14 7 U.S.C. 12a. 

15 7 U.S.C. 8a(2)(E). 

16 7 U.S.C. 8a(2)(H). 

17 7 U.S.C. 8a(3). 

18 17 CFR 3.60. 

regulators and seek harmonization in the 

extraterritorial application of our 

jurisdiction, in accordance with principles of 

international comity. 

I am concerned that the Commission has 

not devoted enough attention to delineating 

our enforcement authority and procedures 

under the Volcker Rule, including the 

implications of not promulgating the final 

rule under the Commodity Exchange Act 

(‘‘CEA’’).8 This is important because the final 

rule is only being promulgated under the 

BHC Act. Consequently, the Commission is 

limited to only the enforcement measures 

provided for by § 13(e)(2) of the BHC Act. By 

not also promulgating the final rule under the 

CEA, the Commission cannot use its full 

suite of enforcement tools under the CEA to 

ensure compliance with the Volcker Rule. 

If the Commission wanted to use its 

enforcement powers under the CEA, the final 

rule must be promulgated under the CEA and 

undergo cost-benefit consideration pursuant 

to § 15(a) of the CEA.9 But, by choosing to 

forgo any cost-benefit analysis and 

promulgate the Volcker Rule solely under the 

BHC Act, the Commission has thus limited 

its enforcement powers. 

To illustrate this point, it is critical to 

emphasize that the Commission’s authority 

under the Volcker Rule is not derived from 

the CEA, which established the CFTC and its 

jurisdiction over the futures and swaps 

market. Section 619 of the Dodd-Frank Act 

amends the BHC Act, which is administered 

by the Federal Reserve Board. The Volcker 

Rule is codified as § 13 of the BHC Act and 

confers limited enforcement authority to the 

Commission under § 13(e)(2) to order an 

affected party to ‘‘terminate the [violative] 

activity’’ and ‘‘dispose of the investment.’’ 10

First, although the statutory text of 

§ 13(e)(2) suggests that the Commission may, 

essentially, issue a cease and desist order to 

a banking entity engaging in violative 

activity, the Commission has not 

promulgated any provisions in the final rule 

that would define and delineate such an 

order. 

The issue of enforcement action is not a 

problem for the banking agencies, who have 

broad supervisory powers over the safety and 

soundness of banking entities, and 

considerable enforcement powers under § 8 

of the BHC Act, or §§ 8 or 39 of the Federal 

Deposit Insurance Act 11 (as described in the 

preamble to the final rule). Those powers are 

conferred to the banking agencies as 

prudential regulators. The Commission, 

however, is not a prudential regulator of its 

registrants or registered entities and does not 

have the same powers as the banking 

agencies. 

Second, I have serious concerns that by not 

including specific procedures in the final 

rule for an enforcement action taken by the 

Commission pursuant to § 13(e)(2), the 

Commission is not affording due process to 

any party that might be the subject of a future 

enforcement action. The statutory text in 

§ 13(e)(2) explicitly states that ‘‘due notice 

and opportunity for hearing’’ must be 

provided. But, the final rule does not contain 

any procedures for notice or hearing, and in 

fact does not even mention that statutory 

requirement. 

Third, I am also concerned that the 

Commission may nevertheless try to read its 

enforcement powers under the CEA into its 

limited enforcement authority under the BHC 

Act. The final rule, in new § 75.21(b), states 

that ‘‘the Commission may take any action 

permitted by law to enforce compliance with 

section 13 of the BHC Act and this part, 

including directing the banking entity to 

restrict, limit, or terminate any or all 

activities under this part and dispose of any 

investment.’’ 

That provision, without being promulgated 

under the CEA and undergoing cost-benefit 

consideration, cannot permit the use of 

enforcement powers provided for in the CEA. 

The enforcement powers the Commission has 

under the CEA explicitly only apply to 

violations of ‘‘this Act’’ (the CEA), including 

‘‘any rule, regulation, or order of the 

Commission promulgated in accordance with 

. . . this Act’’ (emphasis added).12

Although it would be possible for the 

Commission to exercise its power over 

registration of a Commission registrant or 

registered entity as a matter of right, it is 

unclear to me whether the Commission has 

actually promulgated rules that permit the 

revocation of registration for a swap dealer. 

Section 4s of the CEA 13 governs the 

registration and regulation of swap dealers 

and major swap participants, but does not 

explicitly address revocation of registration. 

Section 8a of the CEA 14 explicitly applies to 

the registration of an exclusive list of 

Commission registrants (intermediaries), but 

does not include swap dealers. Section 8a of 

the CEA authorizes the Commission to 

revoke registration, but only in certain 

circumstances as described in, for example, 

§§ 8a(2)(A)–(H), 8a(3), and 8a(4). 

Although some of those provisions may 

permit the revocation of registration of a 

swap dealer, it is secondary to, for example, 

either a finding by a court of law or another 

Federal or State agency that a violation of the 

CEA occurred,15 or that the principal of a 

swap dealer was statutorily disqualified from 

registration,16 or that the swap dealer 

willfully aided or abetted in the violation of 

the CEA by another person, or failed to 

supervise a person that violated the CEA.17

Because these powers over registration only 

apply where there has been a violation of the 

CEA, I do not see how they can be applied 

to a violation of § 13 of the BHC Act. 

Commission regulation § 3.60 18 provides 

procedures for revocation of registration, but 

only pursuant to §§ 8a(2), 8a(3), and 8a(4), 

which do not directly apply to swap dealers 

as just discussed. 

I am concerned that, because there does 

not appear to be any Commission regulation 

that permits the revocation of registration for 

a swap dealer, and because § 75.21 of the 

final rule does not include any procedures 

for an enforcement action taken by the 

Commission pursuant to § 13(e)(2) of the 

BHC Act, the Commission would not able to 

effectively enforce the Volcker Rule. Further, 

the Commission’s enforcement powers under 

the CEA are not available to enforce the 

Volcker Rule because the final rule was not 

promulgated under the CEA. I also reiterate 

that I am deeply troubled by the omission of 

procedures to afford due process to market 

participants. 

Conclusion 

As the Commission moves towards 

finalizing the last of the rules mandated by 

the Dodd-Frank Act, I believe it’s about time 

that it got back to the basics of good 

government and proper rulemaking. The final 

rule does neither because of the abuse of 

process in its rulemaking and the lack of due 

process and clarity in its enforcement 

procedures. Because of these fundamental 

flaws in the final rule, I cannot support it. 

[FR Doc. 2013–31476 Filed 1–30–14; 8:45 am] 

BILLING CODE 6351–01–P 


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