[Federal Register Volume 77, Number 30 (Tuesday, February 14, 2012)]
[Proposed Rules]
[Pages 8332-8447]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-935]



[[Page 8331]]

Vol. 77

Tuesday,

No. 30

February 14, 2012

Part II





Commodity Futures Trading Commission





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17 CFR Part 75





 Prohibitions and Restrictions on Proprietary Trading and Certain 
Interests in, and Relationships With, Hedge Funds and Covered Funds; 
Proposed Rule

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

[[Page 8332]]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 75

RIN 3038-AD05


Prohibitions and Restrictions on Proprietary Trading and Certain 
Interests in, and Relationships With, Hedge Funds and Covered Funds

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of proposed rulemaking.

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SUMMARY: The Commodity Futures Trading Commission (``CFTC'' or 
``Commission'') is requesting comment on a proposed rule that would 
implement Section 619 of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (``Dodd-Frank Act'') which contains certain prohibitions 
and restrictions on the ability of a banking entity and nonbank 
financial company supervised by the Board of Governors of the Federal 
Reserve System (the ``Board'') to engage in proprietary trading and 
have certain interests in, or relationships with, a hedge fund or 
private equity fund (``CFTC Rule'').
    On November 7, 2011, the Office of the Comptroller of the Currency, 
Treasury (``OCC''); the Board; the Federal Deposit Insurance 
Corporation (``FDIC''); and the Securities and Exchange Commission 
(``SEC'') published a joint proposed rule implementing Section 619 of 
the Dodd-Frank Act (the ``Joint Release'').\1\ The CFTC is adopting the 
entire text of the proposed common rules section from the Joint Release 
(the ``Joint Rule'') as part of its proposed rule.\2\ Similar to the 
OCC, the Board, the FDIC, and the SEC in the Joint Release, the CFTC is 
modifying the Joint Rule with CFTC-specific rule text. The CFTC Rule 
also contains additional questions specific to the CFTC in Section III 
and does not include Subpart E of the Joint Release because Subpart E 
deals exclusively with the Board. The Commission solicits comments on 
all aspects of this proposed rule.
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    \1\ See Prohibitions and Restrictions on Proprietary Trading and 
Certain Interests in, and Relationships With, Hedge Funds and 
Private Equity Funds, 76 FR 68846, (Nov. 7, 2011).
    \2\ See 76 FR 68944-68967 for the Joint Rule text adopted by the 
Board, the OCC, the FDIC, and the SEC.

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DATES: Comments should be received on or before April 16, 2012.

ADDRESSES: Interested parties are encouraged to submit written comments 
to either the CFTC individually or jointly to the OCC, Board, FDIC 
(collectively, the ``Federal Banking Agencies'' or ``FBA''); SEC, and 
together with the CFTC, (the ``Agencies'').\3\ Commenters are 
encouraged to use the title ``Restrictions on Proprietary Trading and 
Certain Interests in, and Relationships with, Hedge Funds and Private 
Equity Funds'' to facilitate the organization and distribution of 
comments to the CFTC and among the Agencies. Commenters are also 
encouraged to identify the number of the specific question for comment 
to which they are responding.
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    \3\ See id. at 68846 for instructions on submitting comments to 
the OCC, the Board, the FDIC, and the SEC.
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    You may submit comments, identified by RIN number 3038-AD05, by any 
of the following methods:
    <bullet> Agency Web site, via its Comments Online process: http://comments.cftc.gov. Follow the instructions for submitting comments 
through the Web site.
    <bullet> Mail: David A. Stawick, Secretary of the Commission, 
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st 
Street NW., Washington, DC 20581.
    <bullet> Hand Delivery/Courier: Same as mail above.
    <bullet> Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments. Please submit comments 
by only one method.
    All comments must be submitted in English, or if not, accompanied 
by an English translation. Comments will be posted as received to 
http://www.cftc.gov. You should submit only information that you wish 
to make available publicly. If you wish the Commission to consider 
information that may be exempt from disclosure under the Freedom of 
Information Act (``FOIA''), a petition for confidential treatment of 
the exempt information may be submitted according to the procedures 
established in 17 CFR 145.9. The Commission reserves the right, but 
shall have no obligation, to review, prescreen, filter, redact, refuse, 
or remove any or all of your submission from http://www.cftc.gov that 
it may deem to be inappropriate for publication, such as obscene 
language. All submissions that have been redacted or removed that 
contain comments on the merits of the rulemaking will be retained in 
the public comment file and will be considered as required under the 
Administrative Procedure Act and other applicable laws, and may be 
accessible under FOIA.

FOR FURTHER INFORMATION CONTACT: Steven E. Seitz, Counsel, Office of 
the General Counsel, 202-418-5615, <a href="/cdn-cgi/l/email-protection#f58686909c818fb596938196db929a83"><span class="__cf_email__" data-cfemail="5d2e2e383429271d3e3b293e733a322b">[email protected]</span></a>; Gary Barnett, 
Director, Division of Swap and Intermediary Oversight, (202) 418-5977, 
<a href="/cdn-cgi/l/email-protection#5c3b3e3d2e323928281c3f3a283f723b332a"><span class="__cf_email__" data-cfemail="dcbbbebdaeb2b9a8a89cbfbaa8bff2bbb3aa">[email protected]</span></a>; Beverly Loew, Assistant General Counsel, Office of 
the General Counsel, (202) 418-5648, <a href="/cdn-cgi/l/email-protection#c6a4aaa9a3b186a5a0b2a5e8a1a9b0"><span class="__cf_email__" data-cfemail="385a54575d4f785b5e4c5b165f574e">[email protected]</span></a>; Adedayo Banwo, 
Counsel, Office of the General Counsel, (202) 418-6249, 
<a href="/cdn-cgi/l/email-protection#86e7e4e7e8f1e9c6e5e0f2e5a8e1e9f0"><span class="__cf_email__" data-cfemail="eb8a898a859c84ab888d9f88c58c849d">[email protected]</span></a>; Mathew Hargrow, Attorney Advisor, Office of the 
General Counsel, (202) 418-5267, <a href="/cdn-cgi/l/email-protection#c5a8ada4b7a2b7aab285a6a3b1a6eba2aab3"><span class="__cf_email__" data-cfemail="3f52575e4d584d50487f5c594b5c11585049">[email protected]</span></a>; Todd Prono, 
Financial Economist, Office of the Chief Economist, (202) 418-5640, 
<a href="/cdn-cgi/l/email-protection#2d595d5f4243426d4e4b594e034a425b"><span class="__cf_email__" data-cfemail="502420223f3e3f10333624337e373f26">[email protected]</span></a>; Commodity Futures Trading Commission, Three Lafayette 
Centre, 1155 21st Street NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION: 

I. Background

    The Dodd-Frank Act was enacted on July 21, 2010.\4\ Section 619 of 
the Dodd-Frank Act added a new section 13 to the Bank Holding Company 
Act of 1956 (``BHC Act'') (to be codified at 12 U.S.C. 1851) that 
generally prohibits any banking entity \5\ from engaging in proprietary 
trading or from acquiring or retaining an ownership interest in, 
sponsoring, or having certain relationships with a hedge fund or 
private equity fund (``covered fund''), subject to certain 
exemptions.\6\ New section 13 of the BHC Act also provides for nonbank 
financial companies supervised by the Board that engage in such 
activities or have such interests or relationships to be subject to 
additional capital requirements, quantitative limits, or other 
restrictions.\7\
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    \4\ Dodd-Frank Wall Street Reform and Consumer Protection Act, 
Public Law 111-203, 124 Stat. 1376 (2010).
    \5\ Application of the proposed rule to smaller, less-complex 
banking entities is discussed below in Part II.G of this 
Supplemental Information.
    \6\ The term ``banking entity'' is defined in section 13(h)(1) 
of the BHC Act, as amended by section 619 of the Dodd-Frank Act. See 
12 U.S.C. 1851(h)(1). The statutory definition includes any insured 
depository institution (other than certain limited purpose trust 
institutions), any company that controls an insured depository 
institution, any company that is treated as a bank holding company 
for purposes of section 8 of the International Banking Act of 1978 
(12 U.S.C. 3106), and any affiliate or subsidiary of any of the 
foregoing. Section 13 of the BHC Act defines the terms ``hedge 
fund'' and ``private equity fund'' as an issuer that would be an 
investment company, as defined under the Investment Company Act of 
1940 (15 U.S.C. 80a-1 et seq.), but for section 3(c)(1) or 3(c)(7) 
of that Act, or any such similar funds as the appropriate Federal 
banking agencies (i.e., the Board, OCC, and FDIC), the SEC, and the 
CFTC may, by rule, determine should be treated as a hedge fund or 
private equity fund. See 12 U.S.C. 1851(h)(2). The term banking 
entity that is used throughout this Supplemental Information only 
pertains to those banking entities that are relevant to the CFTC 
under the CFTC Rule.
    \7\ See 12 U.S.C. 1851(a)(2) and (f)(4). A ``nonbank financial 
company supervised by the Board'' is a nonbank financial company or 
other company that the Financial Stability Oversight Council 
(``Council'') has determined, under section 113 of the Dodd-Frank 
Act, shall be subject to supervision by the Board and prudential 
standards. The Board is not proposing at this time any additional 
capital requirements, quantitative limits, or other restrictions on 
nonbank financial companies pursuant to section 13 of the BHC Act, 
as it believes doing so would be premature in light of the fact that 
the Council has not yet finalized the criteria for designation of, 
nor yet designated, any nonbank financial company.

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[[Page 8333]]

A. Rulemaking Framework

    Section 13 of the BHC Act requires that implementation of its 
provisions occur in several stages. First, the Council was required to 
conduct a study (``Council study'') and make recommendations by January 
21, 2011 on the implementation of section 13 of the BHC Act. The 
Council study was issued on January 18, 2011, and included a detailed 
discussion of key issues related to implementation of section 13 and 
recommended that the Agencies consider taking a number of specified 
actions in issuing rules under section 13 of the BHC Act.\8\ The 
Council study also recommended that the Agencies adopt a four-part 
implementation and supervisory framework for identifying and preventing 
prohibited proprietary trading, which included a programmatic 
compliance regime requirement for banking entities, analysis and 
reporting of quantitative metrics by banking entities, supervisory 
review and oversight by the Agencies, and enforcement procedures for 
violations.\9\ The CFTC has carefully considered the Council study and 
its recommendations, and has consulted with staff of the other 
Agencies, in formulating this proposal.\10\
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    \8\ See Financial Stability Oversight Counsel, Study and 
Recommendations on Prohibitions on Proprietary Trading and Certain 
Relationships with Hedge Funds and Private Equity Funds (Jan. 18, 
2011), available at http://www.treasury.gov/initiatives/Documents/Volcker%20sec%20619%20study%20final%201%2018%2011%20rg.pdf. See 12 
U.S.C. 1851(b)(1). Prior to publishing its study, the Council 
requested public comment on a number of issues to assist the Council 
in conducting its study. See 75 FR 61,758 (Oct. 6, 2010). 
Approximately 8,000 comments were received from the public, 
including from members of Congress, trade associations, individual 
banking entities, consumer groups, and individuals. As noted in the 
issuing release for the Council Study, these comments were carefully 
considered by the Council when drafting the Council study.
    \9\ See Council study at 5-6. The CFTC has implemented this 
recommendation through the proposed compliance program requirements 
contained in Subpart D of this proposal with respect to both 
proprietary trading and covered fund activities and investments.
    \10\ The CFTC also received a number of comment letters 
concerning implementation of section 13 of the BHC Act in advance of 
this proposal. The CFTC has carefully considered these comments in 
formulating this proposal.
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    The CFTC is adopting the entire text of the proposed common rules 
from the Joint Release (the ``Joint Rule'') as part of its proposed 
rule.\11\ Similar to the other Agencies in the Joint Release, the CFTC 
is modifying the text of proposed common rules section from the Joint 
Release with CFTC-specific rule text.
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    \11\ See 76 FR 68944 through 68967 for the Joint Rule.
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    Sections II and III of the CFTC Rule are substantively consistent 
with Sections II and III of the Joint Release, with the following 
exceptions: (a) Sections II of the CFTC Rule also includes the 
following additional questions: 8.1, 14.1, 30.1, 30.2, 64.1, 87.1, 
88.1, 168.1, 168.2, 177.1, 218.1, 227.1, 296.1, and 302.1 \12\ and (b) 
the CFTC Rule does not include Subpart E of the Joint Release because 
Subpart E only applies to the Board.\13\ The CFTC Rule includes these 
additional questions to ask whether certain provisions of the Joint 
Rule should be applicable to CFTC-regulated banking entities. In these 
questions, the CFTC generally asks whether the proposed CFTC Rule 
should adopt such provisions and requests an explanation of the 
rationale for either including or excluding such provision in the 
proposed CFTC Rule.
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    \12\ Section VI of the proposed CFTC Rule also contains the 
additional question 348.1.
    \13\ The CFTC believes that Sections II and III of both the CFTC 
Rule and the Joint Release are substantively consistent with the 
exception of the additional questions and the deletion of Subpart E. 
Any other discrepancies between Sections II and III of the CFTC Rule 
and the Joint Release are solely for stylistic purposes and are not 
intended to create any substantive differences between these 
sections of the CFTC Rule and the Joint Release.
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    Authority for developing and adopting regulations to implement the 
prohibitions and restrictions of section 13 of the BHC Act is divided 
between the Agencies in the manner provided in section 13(b)(2) of the 
BHC Act.\14\ The statute also requires the Agencies, in developing and 
issuing implementing rules, to consult and coordinate with each other, 
as appropriate, for the purposes of assuring, to the extent possible, 
that such rules are comparable and provide for consistent application 
and implementation of the applicable provisions of section 13 of the 
BHC Act.\15\ The CFTC believes that such coordination will assist in 
ensuring that advantages are not unduly provided to, and that 
disadvantages are not unduly imposed upon, companies affected by 
section 13 of the BHC Act and that the safety and soundness of banking 
entities and nonbank financial companies supervised by the Board are 
protected. The statute requires the CFTC to implement rules under 
section 13 not later than 9 months after the Council completes its 
study (i.e., not later than October 18, 2011).\16\ The restrictions and 
prohibitions of section 13 of the BHC Act become effective 12 months 
after issuance of final rules by the CFTC, or July 21, 2012, whichever 
is earlier.\17\
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    \14\ See 12 U.S.C. 1851(b)(2). Under section 13(b)(2)(B) of the 
BHC Act, rules implementing section 13's prohibitions and 
restrictions must be issued by: (i) the appropriate Federal banking 
agencies (i.e., the Board, the OCC, and the FDIC), jointly, with 
respect to insured depository institutions; (ii) the Board, with 
respect to any company that controls an insured depository 
institution, or that is treated as a bank holding company for 
purposes of section 8 of the International Banking Act, any nonbank 
financial company supervised by the Board, and any subsidiary of any 
of the foregoing (other than a subsidiary for which an appropriate 
Federal banking agency, the SEC, or the CFTC is the primary 
financial regulatory agency); (iii) the CFTC with respect to any 
entity for which it is the primary financial regulatory agency, as 
defined in section 2 of the Dodd-Frank Act; and (iv) the SEC with 
respect to any entity for which it is the primary financial 
regulatory agency, as defined in section 2 of the Dodd-Frank Act. 
See id.
    \15\ See 12 U.S.C. 1851(b)(2)(B)(ii). The Secretary of the 
Treasury, as Chairperson of the Council, is responsible for 
coordinating the Agencies' rulemakings under section 13 of the BHC 
Act. See id.
    \16\ See id. at 1851(b)(2)(A).
    \17\ See id. at 1851(c)(1).
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    In addition, the statute required the Board, acting alone, to adopt 
rules to implement the provisions of section 13 of the BHC Act that 
provide a banking entity or a nonbank financial company supervised by 
the Board a period of time after the effective date of section 13 of 
the BHC Act to bring the activities, investments, and relationships of 
the banking entity into compliance with that section and the Agencies' 
implementing regulations.\18\ The Board issued its final conformance 
rule as required under section 13(c)(6) of the BHC Act on February 8, 
2011 (``Board's Conformance Rule'').\19\ As noted in the issuing 
release for the Board's Conformance Rule, this period is intended to 
give markets and firms an opportunity to adjust to section 13 of the 
BHC Act.\20\
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    \18\ See id. at 1851(c)(6).
    \19\ See Conformance Period for Entities Engaged in Prohibited 
Proprietary Trading or Private Equity Fund or Hedge Fund Activities, 
76 FR 8265 (Feb. 14, 2011).
    \20\ See id. (citing 156 Cong. Rec. S5898 (daily ed. July 15, 
2010) (statement of Sen. Merkley)).
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B. Section 13 of the BHC Act

    Section 13 of the BHC Act generally prohibits banking entities from 
engaging in proprietary trading or from acquiring or retaining any 
ownership interest in, or sponsoring, a covered fund.\21\ However, 
section 13(d)(1) of that Act expressly includes exemptions from

[[Page 8334]]

these prohibitions for certain permitted activities, including:
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    \21\ 12 U.S.C. 1851(a)(1)(A) and (B).
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    <bullet> Trading in certain government obligations;
    <bullet> Underwriting and market making-related activities;
    <bullet> Risk-mitigating hedging activity;
    <bullet> Trading on behalf of customers;
    <bullet> Investments in Small Business Investment Companies 
(``SBICs'') and public interest investments;
    <bullet> Trading for the general account of insurance companies;
    <bullet> Organizing and offering a covered fund (including limited 
investments in such funds);
    <bullet> Foreign trading by non-U.S. banking entities; and
    <bullet> Foreign covered fund activities by non-U.S. banking 
entities.\22\
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    \22\ See id. at 1851(d)(1). As described in greater detail in 
Part III.B.4 of this SUPPLEMENTARY INFORMATION, the proposed rule 
applies some of these statutory exemptions only to the proprietary 
trading prohibition or the covered fund prohibitions and 
restrictions, but not both, where it appears either by plain 
language or by implication that the exemption was intended only to 
apply to one or the other.
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    For purposes of this Supplementary Information, trading activities 
subject to section 13 of the BHC Act, including those permitted under a 
relevant exemption, are sometimes referred to as ``covered trading 
activities.'' Similarly, activities and investments with respect to a 
covered fund that are subject to section 13 of the BHC Act, including 
those permitted under a relevant exemption, are sometimes referred to 
as ``covered fund activities or investments.''
    Additionally, section 13 of the BHC Act permits the CFTC to grant, 
by rule, other exemptions from the prohibitions on proprietary trading 
and acquiring or retaining an ownership interest in, or acting as 
sponsor to, a covered fund if the CFTC determines that the exemption 
would promote and protect the safety and soundness of the banking 
entity and the financial stability of the United States.\23\ 
Furthermore, under the statute, no banking entity may engage in a 
permitted activity if that activity would (i) involve or result in a 
material conflict of interest or material exposure of the banking 
entity to high-risk assets or high-risk trading strategies, or (ii) 
pose a threat to the safety and soundness of the banking entity or to 
the financial stability of the United States.\24\
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    \23\ Id. at 1851(d)(1)(J).
    \24\ See id. at 1851(d)(2).
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    Section 13(f) of the BHC Act separately prohibits a banking entity 
that serves, directly or indirectly, as the investment manager, 
investment adviser, or sponsor to a covered fund, and any affiliate of 
such a banking entity, from entering into any transaction with the 
fund, or any other covered fund controlled by such fund, that would be 
a ``covered transaction'' as defined in section 23A of the Federal 
Reserve Act (``FR Act''),\25\ as if such banking entity or affiliate 
were a member bank and the covered fund were an affiliate thereof, 
subject to certain exceptions.\26\ Section 13(f) also provides that a 
banking entity may enter into certain prime brokerage transactions with 
any covered fund in which a covered fund managed, sponsored, or advised 
by the banking entity has taken an equity, partnership, or other 
ownership interest, but any such transaction (and any other permitted 
transaction with such funds) must be on market terms in accordance with 
the provisions of section 23B of the FR Act.\27\
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    \25\ See 12 U.S.C. 371c.
    \26\ 12 U.S.C. 1851(f).
    \27\ 12 U.S.C. 371c-1.
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    Section 13 of the BHC Act does not prohibit a nonbank financial 
company supervised by the Board from engaging in proprietary trading, 
or from having the types of ownership interests in or relationships 
with a covered fund that a banking entity is prohibited or restricted 
from having under section 13 of the BHC Act. However, section 13 of the 
BHC Act provides for the Board or other appropriate Agency to impose 
additional capital charges, quantitative limits, or other restrictions 
on a nonbank financial company supervised by the Board or their 
subsidiaries and affiliates that are engaged in such activities or 
maintain such relationships.\28\
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    \28\ See 12 U.S.C. 1851(a)(2), (d)(4).
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II. Overview of Proposed Rule

A. General Approach

    In formulating the proposed rule, the CFTC attempted to reflect the 
structure of section 13 of the BHC Act, which is to prohibit a banking 
entity from engaging in proprietary trading or acquiring or retaining 
an ownership interest in, or having certain relationships with, a 
covered fund, while permitting such entities to continue to provide 
client-oriented financial services. However, the delineation of what 
constitutes a prohibited or permitted activity under section 13 of the 
BHC Act often involves subtle distinctions that are difficult both to 
describe comprehensively within regulation and to evaluate in practice. 
The CFTC appreciates that while it is crucial that rules under section 
13 of the BHC Act clearly define and implement its requirements, any 
rule must also preserve the ability of a banking entity to continue to 
structure its businesses and manage its risks in a safe and sound 
manner, as well as to effectively deliver to its clients the types of 
financial services that section 13 expressly protects and permits. 
These client-oriented financial services, which include underwriting, 
market making, and traditional asset management services, are important 
to the U.S. financial markets and the participants in those markets, 
and the CFTC endeavored to develop a proposed rule that does not unduly 
constrain banking entities in their efforts to safely provide such 
services. At the same time, providing appropriate latitude to banking 
entities to provide such client-oriented services need not and should 
not conflict with clear, robust, and effective implementation of the 
statute's prohibitions and restrictions. Given these complexities, the 
CFTC requests comment on the potential impacts the proposed approach 
may have on banking entities and the businesses in which they engage. 
In particular, and as discussed further in Part VII of this 
Supplemental Information, the CFTC recognizes that there are economic 
impacts that may arise from the proposed rule and its implementation of 
section 13 of the BHC Act, and the CFTC requests comment on such 
impacts, including quantitative data or studies, where possible.
    In light of these larger challenges and goals, the CFTC's proposal 
takes a multi-faceted approach to implementing section 13 of the BHC 
Act. In particular, the proposed rule includes a framework that: (i) 
Clearly describes the key characteristics of both prohibited and 
permitted activities; (ii) requires banking entities to establish a 
comprehensive programmatic compliance regime designed to ensure 
compliance with the requirements of the statute and rule in a way that 
takes into account and reflects the unique nature of a banking entity's 
businesses; and (iii) with respect to proprietary trading, requires 
certain banking entities to calculate and report meaningful 
quantitative data that will assist both banking entities and the CFTC 
in identifying particular activity that warrants additional scrutiny to 
distinguish prohibited proprietary trading from otherwise permissible 
activities. This multi-faceted approach, which is consistent with the 
implementation and supervisory framework recommended in the Council 
study, is intended to strike an appropriate balance between 
accommodating prudent risk

[[Page 8335]]

management and the continued provision of client-oriented financial 
services by banking entities while ensuring that such entities do not 
engage in prohibited proprietary trading or restricted covered fund 
activities or investments.\29\
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    \29\ In recognition of economic impacts that may arise from the 
proposed rule and its implementation of section 13 of the BHC Act, 
the CFTC is requesting comment on the relative costs and benefits of 
the proposal in Part VI of this Supplemental Information.
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    In addition, and consistent with the statutory requirement that the 
CFTC's rule under section 13 of the BHC Act be, to the extent possible, 
comparable and provide for consistent application and implementation, 
the CFTC is proposing the Joint Rule (i.e., common rule and appendices) 
that was proposed by the other Agencies. This uniform approach to 
implementation is intended to provide the maximum degree of clarity to 
banking entities and market participants and ensure that section 13's 
prohibitions and restrictions are applied consistently across different 
types of regulated entities.\30\
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    \30\ Under this uniform approach, the CFTC is proposing the same 
rule provisions under section 13 of the BHC Act as the Joint Rule. 
The CFTC's proposed rule would apply only to banking entities for 
which it has regulatory authority under section 13(b)(2)(B) of the 
BHC Act.
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    As a matter of structure, the proposed rule is generally divided 
into four subparts and contains three appendices, as follows:
    <bullet> Subpart A of the proposed rule describes the authority, 
scope, purpose, and relationship to other authorities of the rule and 
defines terms used commonly throughout the rule;
    <bullet> Subpart B of the proposed rule prohibits proprietary 
trading, defines terms relevant to covered trading activity, 
establishes exemptions from the prohibition on proprietary trading and 
limitations on those exemptions, and requires certain banking entities 
to report quantitative measurements with respect to their trading 
activities;
    <bullet> Subpart C of the proposed rule prohibits or restricts 
acquiring or retaining an ownership interest in, and certain 
relationships with, a covered fund, defines terms relevant to covered 
fund activities and investments, as well as establishes exemptions from 
the restrictions on covered fund activities and investments and 
limitations on those exemptions;
    <bullet> Subpart D of the proposed rule generally requires banking 
entities to establish an enhanced compliance program regarding 
compliance with section 13 of the BHC Act and the proposed rule, 
including written policies and procedures, internal controls, a 
management framework, independent testing of the compliance program, 
training, and recordkeeping;
    <bullet> Appendix A of the proposed rule details the quantitative 
measurements that certain banking entities may be required to compute 
and report with respect to their trading activities;\31\
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    \31\ A banking entity must comply with proposed Appendix A's 
reporting and recordkeeping requirements only if it has, together 
with its affiliates and subsidiaries, trading assets and liabilities 
the average gross sum of which (on a worldwide consolidated basis) 
is, as measured as of the last day of each of the four prior 
calendar quarters, equal to or greater than $1 billion.
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    <bullet> Appendix B of the proposed rule provides commentary 
regarding the factors the Agencies propose to use to help distinguish 
permitted market making-related activities from prohibited proprietary 
trading; and
    <bullet> Appendix C of the proposed rule details the minimum 
requirements and standards that certain banking entities must meet with 
respect to their compliance program, as required under subpart D.\32\
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    \32\ In particular, a banking entity must comply with the 
minimum standards specified in Appendix C of the proposed rule (i) 
with respect to its covered trading activities, if it engages in any 
covered trading activities and has, together with its affiliates and 
subsidiaries, trading assets and liabilities the average gross sum 
of which (on a worldwide consolidated basis), as measured as of the 
last day of each of the four prior calendar quarters, (X) is equal 
to or greater than $1 billion or (Y) equals 10 percent or more of 
its total assets; and (ii) with respect to its covered fund 
activities and investments, if it engages in any covered fund 
activities and investments and either (X) has, together with its 
affiliates and subsidiaries, aggregate investments in covered funds 
the average value of which is, as measured as of the last day of 
each of the four prior calendar quarters, equal to or greater than 
$1 billion or (Y) sponsors and advises, together with its affiliates 
and subsidiaries, covered funds the average total assets of which 
are, as measured as of the last day of each of the four prior 
calendar quarters, equal to or greater than $1 billion.
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B. Proprietary Trading Restrictions

    Subpart B of the proposed rule implements the statutory prohibition 
on proprietary trading and the various exemptions to this prohibition 
included in the statute. Section ----.3 of the proposed rule contains 
the core prohibition on proprietary trading and defines a number of 
related terms, including ``proprietary trading'' and ``trading 
account.'' The proposed rule's definition of proprietary trading 
generally parallels the statutory definition, and includes engaging as 
principal for the trading account of a banking entity in any 
transaction to purchase or sell certain types of financial 
positions.\33\
---------------------------------------------------------------------------

    \33\ See proposed rule Sec.  ----.3(b)(1).
---------------------------------------------------------------------------

    The proposed rule's definition of trading account generally 
parallels the statutory definition, and provides further guidance 
regarding the circumstances in which a position will be considered to 
have been taken principally for the purpose of short-term resale or 
benefiting from actual or expected short-term price movements, 
recognizing the importance of providing as much clarity as possible 
regarding this term, which ultimately defines the scope of accounts 
subject to the prohibition on proprietary trading.\34\ In particular, 
the proposed definition of trading account identifies three classes of 
positions that would cause an account to be a trading account. First, 
the definition includes positions taken principally for the purpose of 
short-term resale, benefitting from short-term price movements, 
realizing short-term arbitrage profits, or hedging another trading 
account position.\35\ As described in this notice, this language is 
substantially similar to language for a ``trading position'' used in 
the Federal banking agencies' current market risk capital rules, as 
proposed to be revised (``Market Risk Capital Rules''),\36\ and the 
CFTC proposes to interpret this language in a similar manner. Second, 
with respect to a banking entity subject to the Federal banking 
agencies' Market Risk Capital Rules, the definition includes all 
positions in financial instruments subject to the prohibition on 
proprietary trading that are treated as ``covered positions'' under 
those capital rules, other than certain foreign exchange and 
commodities positions. Third, the definition includes all positions 
acquired or taken by certain registered securities and derivatives 
dealers (or, in the case of financial institutions \37\ that are 
government securities dealers, that have filed notice with an 
appropriate regulatory agency) in connection with their activities that 
require such registration or notice.\38\ The definition of trading 
account also contains clarifying exclusions for certain positions that 
do not appear to involve the requisite short-term trading intent, such 
as positions arising under certain repurchase and reverse repurchase 
arrangements or securities lending transactions, positions acquired or 
taken for bona fide liquidity

[[Page 8336]]

management purposes, and certain positions of derivatives clearing 
organizations or clearing agencies.\39\
---------------------------------------------------------------------------

    \34\ See proposed rule Sec.  ----.3(b)(2).
    \35\ See proposed rule Sec.  ----.3(b)(2)(i)(A).
    \36\ See 76 FR 1890 (Jan. 11, 2011).
    \37\ In the context of regulation of government securities 
dealers under the Securities Exchange Act of 1934 (``Exchange 
Act''), the term ``financial institution'' as defined in section 
3(a)(46) of the Exchange Act includes a bank (as defined in section 
3(a)(36) of the Exchange Act) and a foreign bank (as defined in the 
International Banking Act of 1978). See 15 U.S.C. 78c(a)(46).
    \38\ See proposed rule Sec.  ----.3(b)(2)(i)(B).
    \39\ See proposed rule Sec.  ----.3(b)(2)(iii).
---------------------------------------------------------------------------

    Section ----.3 of the proposed rule also defines a number of other 
relevant terms, including the term ``covered financial position.'' This 
term is used to define the scope of financial instruments subject to 
the prohibition on proprietary trading. Consistent with the statutory 
language, such covered financial positions include positions (including 
long, short, synthetic and other positions) in securities, derivatives, 
commodity futures, and options on such instruments, but do not include 
positions in loans, spot foreign exchange or spot commodities.\40\
---------------------------------------------------------------------------

    \40\ See proposed rule Sec.  ----.3(b)(3).
---------------------------------------------------------------------------

    Section ----.4 of the proposed rule implements the statutory 
exemptions for underwriting and market making-related activities. For 
each of these permitted activities, the proposed rule provides a number 
of requirements that must be met in order for a banking entity to rely 
on the applicable exemption. These requirements are generally designed 
to ensure that the activities, revenues and other characteristics of 
the banking entity's trading activity are consistent with underwriting 
and market making-related activities, respectively, and not prohibited 
proprietary trading.\41\ These requirements are intended to support and 
augment other parts of the proposed rule's approach to implementing the 
prohibition on proprietary trading, including the compliance program 
requirement and the reporting of quantitative measurements, in order to 
assist banking entities and the CFTC in identifying prohibited trading 
activities that may be conducted in the context of, or mischaracterized 
as, permitted underwriting or market making-related activities.
---------------------------------------------------------------------------

    \41\ See proposed rule Sec.  ----.4(a), (b).
---------------------------------------------------------------------------

    Section ----.5 of the proposed rule implements the statutory 
exemption for risk-mitigating hedging. As with the underwriting and 
market-making exemptions, proposed Sec.  ----.5 contains a number of 
requirements that must be met in order for a banking entity to rely on 
the exemption. These requirements are generally designed to ensure that 
the banking entity's trading activity is truly risk-mitigating hedging 
in purpose and effect.\42\ Proposed Sec.  ----.5 also requires banking 
entities to document, at the time the transaction is executed, the 
hedging rationale for certain transactions that present heightened 
compliance risks.\43\ As with the exemptions for underwriting and 
market making-related activity, these requirements form part of a 
broader implementation approach that also includes the compliance 
program requirement and the reporting of quantitative measurements.
---------------------------------------------------------------------------

    \42\ See proposed rule Sec. Sec.  ----.5(b)(1), (2).
    \43\ See proposed rule Sec.  ----.5(b)(3).
---------------------------------------------------------------------------

    Section ----.6 of the proposed rule implements statutory exemptions 
for trading in certain government obligations, trading on behalf of 
customers, trading by a regulated insurance company, and trading by 
certain foreign banking entities outside the United States. Section --
--.6(a) of the proposed rule describes the government obligations in 
which a banking entity may trade notwithstanding the prohibition on 
proprietary trading, which include U.S. government and agency 
obligations, obligations and other instruments of certain government 
sponsored entities, and State and municipal obligations.\44\ Section --
--.6(b) of the proposed rule describes permitted trading on behalf of 
customers and identifies three categories of transactions that would 
qualify for the exemption.\45\ These categories include: (i) 
Transactions conducted by a banking entity as investment adviser, 
commodity trading advisor, trustee, or in a similar fiduciary capacity 
for the account of a customer where the customer, and not the banking 
entity, has beneficial ownership of the related positions; (ii) 
riskless principal transactions; and (iii) transactions conducted by a 
banking entity that is a regulated insurance company for the separate 
account of insurance policyholders, subject to certain conditions. 
Section ----.6(c) of the proposed rule describes permitted trading by a 
regulated insurance company for its general account, and generally 
parallels the statutory language governing this exemption.\46\ Finally, 
Sec.  ----.6(d) of the proposed rule describes permitted trading 
outside of the United States by a foreign banking entity.\47\ The 
proposed exemption clarifies when a foreign banking entity will be 
considered to engage in such trading pursuant to sections 4(c)(9) or 
4(c)(13) of the BHC Act, as required by the statute, including with 
respect to a foreign banking entity not currently subject to section 4 
of the BHC Act. The exemption also clarifies when trading will be 
considered to have occurred solely outside of the United States, as 
required by the statute, and provides a number of specific criteria for 
determining whether that standard is met.
---------------------------------------------------------------------------

    \44\ See proposed rule Sec.  ----.6(a).
    \45\ See proposed rule Sec.  ----.6(b).
    \46\ See proposed rule Sec.  ----.6(c).
    \47\ See proposed rule Sec.  ----.6(d).
---------------------------------------------------------------------------

    Section ----.7 of the proposed rule requires certain banking 
entities with significant covered trading activities to comply with the 
reporting and recordkeeping requirements specified in Appendix A of the 
proposed rule. In addition, Sec.  ----.7 requires that a banking entity 
comply with the recordkeeping requirements in Sec.  ----.20 of the 
proposed rule, including, where applicable, the recordkeeping 
requirements in Appendix C of the proposed rule. Section ----.7 of the 
proposed rule also requires a banking entity to comply with any other 
reporting or recordkeeping requirements that the CFTC may impose to 
evaluate the banking entity's compliance with the proposed rule.\48\ 
Proposed Appendix A requires those relevant banking entities with 
significant covered trading activities to furnish periodic reports to 
the CFTC regarding a variety of quantitative measurements of its 
covered trading activities and maintain records documenting the 
preparation and content of these reports. These proposed reporting and 
recordkeeping requirements vary depending on the scope and size of 
covered trading activities, and a banking entity must comply with 
proposed Appendix A's reporting and recordkeeping requirements only if 
it has, together with its affiliates and subsidiaries, trading assets 
and liabilities the average gross sum of which (on a worldwide 
consolidated basis) is, as measured as of the last day of each of the 
four prior calendar quarters, equal to or greater than $1 billion. 
These thresholds are designed to reduce the burden on smaller, less 
complex banking entities, which generally engage in limited market-
making and other trading activities. Other provisions of the proposal, 
and in particular the compliance program requirement in Sec.  ----.20 
of the proposed rule, are likely to be less burdensome and equally 
effective methods for ensuring compliance with section 13 of the BHC 
Act by smaller, less complex banking entities.
---------------------------------------------------------------------------

    \48\ See proposed rule Sec.  ----.7.
---------------------------------------------------------------------------

    The quantitative measurements that must be furnished under the 
proposed rule are generally designed to reflect, and provide meaningful 
information regarding, certain characteristics of trading activities 
that appear to be particularly useful to help differentiate permitted 
market making-related activities from prohibited proprietary trading 
and to identify whether certain trading activities result in a material

[[Page 8337]]

exposure to high-risk assets or high-risk trading strategies. In 
addition, proposed Appendix B contains a detailed commentary regarding 
identification of permitted market making-related activities and 
distinguishing such activities from trading activities that constitute 
prohibited proprietary trading.
    As described in Part II.B.5 of the Supplementary Information below, 
the CFTC expects to utilize the conformance period provided in section 
13(c)(2) of the BHC Act to further refine and finalize the reporting 
requirements, reflecting the substantial public comment, practical 
experience, and revision that will likely be required to ensure 
appropriate, effective use of reported quantitative data in practice.
    Section ----.8 of the proposed rule prohibits a banking entity from 
relying on any exemption to the prohibition on proprietary trading if 
the permitted activity would involve or result in a material conflict 
of interest, result in a material exposure to high-risk assets or high-
risk trading strategies, or pose a threat to the safety and soundness 
of the banking entity or to the financial stability of the United 
States.\49\ This section also defines material conflict of interest, 
high-risk asset, and high-risk trading strategy for these purposes.
---------------------------------------------------------------------------

    \49\ See proposed rule Sec.  ----.8.
---------------------------------------------------------------------------

C. Covered Fund Activities and Investments

    Subpart C of the proposed rule implements the statutory prohibition 
on, as principal, directly or indirectly, acquiring and retaining an 
ownership interest in, or having certain relationships with, a covered 
fund, as well as the various exemptions to this prohibition included in 
the statute. Section ----.10 of the proposed rule contains the core 
prohibition on covered fund activities and investments and defines a 
number of related terms, including ``covered fund'' and ``ownership 
interest.'' The proposed rule's definition of covered fund generally 
parallels the statutory definition of ``hedge fund'' and ``private 
equity fund,'' and explains the universe of entities that would be 
considered a ``covered fund'' (including those entities determined by 
the CFTC to be ``such similar funds'') and, thus, subject to the 
general prohibition.\50\
---------------------------------------------------------------------------

    \50\ See proposed rule Sec.  ----.10(b)(1).
---------------------------------------------------------------------------

    The definition of ``ownership interest'' provides further guidance 
regarding the types of interests that would be considered to be an 
ownership interest in a covered fund.\51\ As described in this 
Supplementary Information, these interests may take various forms. The 
definition of ownership interest also explicitly excludes from the 
definition ``carried interest'' whereby a banking entity may share in 
the profits of the covered fund solely as performance compensation for 
services provided to the covered fund by the banking entity (or an 
affiliate, subsidiary, or employee thereof).\52\
---------------------------------------------------------------------------

    \51\ See proposed rule Sec.  ----.10(b)(3).
    \52\ See proposed rule Sec.  ----.10(b)(3)(ii).
---------------------------------------------------------------------------

    Section ----.10 of the proposed rule also defines a number of other 
relevant terms, including the terms ``prime brokerage transaction,'' 
``sponsor,'' and ``trustee.''
    Section ----.11 of the proposed rule implements the exemption for 
organizing and offering a covered fund provided for under section 
13(d)(1)(G) of the BHC Act. Section ----.11(a) of the proposed rule 
outlines the conditions that must be met in order for a banking entity 
to organize and offer a covered fund under this authority. These 
requirements are contained in the statute and are intended to allow a 
banking entity to engage in certain traditional asset management and 
advisory businesses in compliance with section 13 of the BHC Act.\53\ 
The requirements are discussed in detail in Part III.C.2 of this 
Supplementary Information.
---------------------------------------------------------------------------

    \53\ See 156 Cong. Rec. S5889 (daily ed. July 15, 2010) 
(statement of Sen. Hagan).
---------------------------------------------------------------------------

    Section ----.12 of the proposed rule permits a banking entity to 
acquire and retain, as an investment in a covered fund, an ownership 
interest in a covered fund that the banking entity organizes and offers 
under Sec.  ----.11.\54\ This section implements section 13(d)(4) of 
the BHC Act and related provisions. Section 13(d)(4) of the BHC Act 
permits a banking entity to make an investment in a covered fund that 
the banking entity organizes and offers pursuant to section 
13(d)(1)(G), or for which it acts as sponsor, for the purposes of (i) 
establishing the covered fund and providing the fund with sufficient 
initial equity for investment to permit the fund to attract 
unaffiliated investors, or (ii) making a de minimis investment in the 
covered fund in compliance with applicable requirements. Section --
--.12 of the proposed rule implements this authority and related 
limitations, including limitations regarding the amount and value of 
any individual per-fund investment and the aggregate value of all such 
permitted investments.\55\ Proposed Sec.  ----.12 also clarifies how a 
banking entity must calculate its compliance with these investment 
limitations (including by deducting such investments from applicable 
capital, as relevant), as well as sets forth how a banking entity may 
request an extension of the period of time within which it must conform 
an investment in a single covered fund.\56\
---------------------------------------------------------------------------

    \54\ See proposed rule Sec.  ----.12.
    \55\ See proposed rule Sec.  ----.12(a)(2).
    \56\ See proposed rule Sec. Sec.  ----.12(b), (c), and (d).
---------------------------------------------------------------------------

    Section ----.13 of the proposed rule implements the statutory 
exemptions described in sections 13(d)(1)(C), (E), and (I) of the BHC 
Act that permit a banking entity: (i) to acquire and retain an 
ownership interest in, or act as sponsor to, one or more SBICs, a 
public welfare investment, or certain qualified rehabilitation 
expenditures; (ii) to acquire and retain an ownership interest in a 
covered fund as a risk-mitigating hedging activity; and (iii) in the 
case of a non-U.S. banking entity, to acquire and retain an ownership 
interest in, or act as sponsor to, a foreign covered fund.\57\ Section 
----.13(a) of the proposed rule permits a banking entity to acquire and 
retain an ownership interest in, or act as sponsor to, an SBIC or 
certain public interest investments, without limitation as to the 
amount of ownership interests it may own, hold, or control with the 
power to vote.\58\
---------------------------------------------------------------------------

    \57\ See proposed rule Sec.  ----.13(a)-(c).
    \58\ See proposed rule Sec.  ----.13(a).
---------------------------------------------------------------------------

    Section ----.13(b) of the proposed rule permits a banking entity to 
use an ownership interest in a covered fund to hedge, but only with 
respect to individual or aggregated obligations or liabilities of a 
banking entity that arise from: (i) The banking entity acting as 
intermediary on behalf of a customer that is not itself a banking 
entity to facilitate the customer's exposure to the profits and losses 
of the covered fund (similar to acting as a ``riskless principal''); or 
(ii) a compensation arrangement with an employee of the banking entity 
that directly provides investment advisory or other services to that 
fund.\59\ Additionally, Sec.  ----.13(b) of the proposed rule requires 
that the hedge represent a substantially similar offsetting exposure to 
the same covered fund and in the same amount of ownership interest in 
the covered fund arising out of the transaction that the acquisition or 
retention of an ownership interest in the covered fund is intended to 
hedge or otherwise mitigate.\60\ Proposed Sec.  ----.13(b) also 
requires a banking entity to document, at the time the transaction is 
executed, the hedging rationale for all hedging transactions

[[Page 8338]]

involving an ownership interest in a covered fund.\61\
---------------------------------------------------------------------------

    \59\ See proposed rule Sec.  ----.13(b)(1).
    \60\ See proposed rule Sec. Sec.  ----.13(b)(2)(ii)(C) and (D).
    \61\ See proposed rule Sec.  ----.13(b)(3).
---------------------------------------------------------------------------

    Section ----.13(c) of the proposed rule implements section 
13(d)(1)(I) of the BHC Act and permits certain foreign banking entities 
to acquire or retain an ownership interest in, or to act as sponsor to, 
a covered fund so long as such activity occurs solely outside of the 
United States and the entity meets the requirements of sections 4(c)(9) 
or 4(c)(13) of the BHC Act. This statutory exemption limits the 
extraterritorial application of the statutory restrictions on covered 
fund activities and investments to foreign firms that, in the course of 
operating outside of the United States, engage in activities permitted 
under relevant foreign law outside of the United States, while 
preserving national treatment and competitive equality among U.S. and 
foreign firms within the United States.\62\ The proposed rule defines 
both the type of foreign banking entities that are eligible for the 
exemption and the circumstances in which covered fund activities or 
investments by such an entity will be considered to have occurred 
solely outside of the United States (including clarifying when an 
ownership interest will be considered to have been offered for sale or 
sold to a resident of the United States). Section ----.13(d) of the 
proposed rule also implements in part the rule of construction 
contained in section 13(g)(2) of the BHC Act, which permits the sale 
and securitization of loans.\63\ Proposed Sec.  ----.13(d) clarifies 
that a banking entity may acquire and retain an ownership interest in, 
or act as sponsor to, a covered fund that is an issuer of asset-backed 
securities, the assets or holdings of which are solely comprised of: 
(i) Loans; (ii) contractual rights or assets directly arising from 
those loans supporting the asset-backed securities; and (iii) a limited 
amount of interest rate or foreign exchange derivatives that materially 
relate to such loans and that are used for hedging purposes with 
respect to the securitization structure.\64\ The authority contained in 
this section of the proposed rule would therefore allow a banking 
entity to acquire and retain an ownership interest in a loan 
securitization vehicle (which would be a covered fund for purposes of 
section 13(h)(2) of the BHC Act and the proposed rule) that the banking 
entity organizes and offers, or acts as sponsor to, in excess of the 
three percent limits specified in section 13(d)(4) of the BHC Act and 
Sec.  ----.12 of the proposed rule.
---------------------------------------------------------------------------

    \62\ See 156 Cong. Rec. S5897 (daily ed. July 15, 2010) 
(statement of Sen. Merkley).
    \63\ See 12 U.S.C. 1851(g)(2).
    \64\ See proposed rule Sec.  ----.13(d).
---------------------------------------------------------------------------

    Section ----.14 of the proposed rule implements section 13(d)(1)(J) 
of the BHC Act \65\ and permits a banking entity to engage in any 
covered fund activity or investment that the CFTC and the Agencies 
determine promotes and protects the safety and soundness of banking 
entities and the financial stability of the United States.\66\ The CFTC 
has proposed to permit three activities at this time under this 
authority. These activities involve acquiring and retaining an 
ownership interest in, or acting as sponsor to, certain bank owned life 
insurance (``BOLI'') separate accounts, investments in and sponsoring 
of certain asset-backed securitizations, and investments in and 
sponsoring of certain entities that rely on the exclusion from the 
definition of investment company in section 3(c)(1) and/or 3(c)(7) of 
the Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.) 
(``Investment Company Act'') but that are, in fact, common corporate 
organizational vehicles.\67\ Additionally, the CFTC has proposed to 
permit a banking entity to acquire and retain an ownership interest in, 
or act as sponsor to, a covered fund, if such acquisition or retention 
is done (i) in the ordinary course of collecting a debt previously 
contracted, or (ii) pursuant to and in compliance with the conformance 
or extended transition periods implemented under section 13(c)(6) of 
the BHC Act.\68\
---------------------------------------------------------------------------

    \65\ Section 13(d)(1)(J) of the BHC Act provides the Agencies 
discretion to determine that activities not specifically identified 
by sections 13(d)(1)(A)-(I) of the BHC Act are also exempted from 
the general prohibitions contained in section 13(a) of that Act, and 
are thus permitted activities. In order to make such a 
determination, the Agencies must find that such activity or 
activities promote and protect the safety and soundness of banking 
entities, as well as promote and protect the financial stability of 
the United States. See 12 U.S.C. 1851(d)(1)(J).
    \66\ See 12 U.S.C. 1851(d)(1)(J).
    \67\ See proposed rule Sec.  ----.13(a)(1)-(2).
    \68\ See proposed rule at Sec.  ----.14(b).
---------------------------------------------------------------------------

    Section ----.15 of the proposed rule, which implements section 
13(e)(1) of the BHC Act,\69\ requires a relevant banking entity engaged 
in covered fund activities and investments to comply with (i) the 
internal controls, reporting, and recordkeeping requirements required 
under Sec.  ----.20 and Appendix C of the proposed rule, as applicable 
and (ii) such other reporting and recordkeeping requirements as the 
CFTC may deem necessary to appropriately evaluate the banking entity's 
compliance with subpart C.\70\
---------------------------------------------------------------------------

    \69\ Section 13(e)(1) of the BHC Act requires the CFTC to issue 
regulations regarding internal controls and recordkeeping to ensure 
compliance with section 13. See 12 U.S.C. 1851(e)(1).
    \70\ See proposed rule Sec.  ----.15.
---------------------------------------------------------------------------

    Section ----.16 of the proposed rule implements section 13(f) of 
the BHC Act and generally prohibits a banking entity from entering into 
certain transactions with a covered fund that would be a covered 
transaction as defined in section 23A of the FR Act.\71\ Section --
--.16(a)(2) of the proposed rule clarifies that, for reasons explained 
in part III.C.7 of this SUPPLEMENTARY INFORMATION, certain transactions 
between a banking entity and a covered fund remain permissible. Section 
----.16(b) of the proposed rule implements the statute's requirement 
that any transaction permitted under section 13(f) of the BHC Act 
(including a prime brokerage transaction) between the banking entity 
and a covered fund is subject to section 23B of the FR Act,\72\ which, 
in general, requires that the transaction be on market terms or on 
terms at least as favorable to the banking entity as a comparable 
transaction by the banking entity with an unaffiliated third party.
---------------------------------------------------------------------------

    \71\ See proposed rule Sec.  ----.16.
    \72\ 12 U.S.C. 371c-1.
---------------------------------------------------------------------------

    Section ----.17 of the proposed rule prohibits a banking entity 
from relying on any exemption to the prohibition on acquiring and 
retaining an ownership interest in, acting as sponsor to, or having 
certain relationships with, a covered fund, if the permitted activity 
or investment would involve or result in a material conflict of 
interest, result in a material exposure to high-risk assets or high-
risk trading strategies, or pose a threat to the safety and soundness 
of the banking entity or to the financial stability of the United 
States.\73\ This section also defines material conflict of interest, 
high-risk asset, and high-risk trading strategy for these purposes.
---------------------------------------------------------------------------

    \73\ See proposed rule Sec.  ----.17.
---------------------------------------------------------------------------

D. Compliance Program Requirement

    Subpart D of the proposed rule requires a banking entity engaged in 
covered trading activities or covered fund activities to develop and 
implement a program reasonably designed to ensure and monitor 
compliance with the prohibitions and restrictions on covered trading 
activities and covered fund activities and investments set forth in 
section 13 of the BHC Act and the proposed rule.\74\

[[Page 8339]]

Section ----.20(b) of the proposed rule specifies six elements that 
each compliance program established under subpart D must, at a minimum, 
include:
---------------------------------------------------------------------------

    \74\ See proposed rule Sec.  ----.20. If a banking entity does 
not engage in covered trading activities and/or covered fund 
activities and investments, it need only ensure that its existing 
compliance policies and procedures include measures that are 
designed to prevent the banking entity from becoming engaged in such 
activities and making such investments, and which require the 
banking entity to develop and provide for the required compliance 
program prior to engaging in such activities or making such 
investments.
---------------------------------------------------------------------------

    <bullet> Internal written policies and procedures reasonably 
designed to document, describe, and monitor the covered trading 
activities and covered fund activities and investments of the banking 
entity to ensure that such activities comply with section 13 of the BHC 
Act and the proposed rule;
    <bullet> A system of internal controls reasonably designed to 
monitor and identify potential areas of noncompliance with section 13 
of the BHC Act and the proposed rule in the banking entity's covered 
trading and covered fund activities and to prevent the occurrence of 
activities that are prohibited by section 13 of the BHC Act and the 
proposed rule;
    <bullet> A management framework that clearly delineates 
responsibility and accountability for compliance with section 13 of the 
BHC Act and the proposed rule;
    <bullet> Independent testing for the effectiveness of the 
compliance program, conducted by qualified banking entity personnel or 
a qualified outside party;
    <bullet> Training for trading personnel and managers, as well as 
other appropriate personnel, to effectively implement and enforce the 
compliance program; and
    <bullet> Making and keeping records sufficient to demonstrate 
compliance with section 13 of the BHC Act and the proposed rule, which 
a relevant banking entity must promptly provide to the CFTC upon 
request and retain for a period of no less than 5 years.
    For a banking entity with significant covered trading activities or 
covered fund activities and investments, the compliance program must 
also meet a number of minimum standards that are specified in Appendix 
C of the proposed rule.\75\ The application of detailed minimum 
standards for these types of banking entities is intended to reflect 
the heightened compliance risks of large covered trading activities and 
covered fund activities and investments and to provide clear, specific 
guidance to such banking entities regarding the compliance measures 
that would be required for purposes of the proposed rule. For banking 
entities with smaller, less complex covered trading activities and 
covered fund activities and investments, these detailed minimum 
standards are not applicable, though the CFTC expects that such smaller 
entities will consider these minimum standards as guidance in designing 
an appropriate compliance program.
---------------------------------------------------------------------------

    \75\ A banking entity must comply with the minimum standards 
specified in Appendix C of the proposed rule (i) with respect to its 
covered trading activities, if it engages in any covered trading 
activities and has, together with its affiliates and subsidiaries, 
trading assets and liabilities the average gross sum of which (on a 
worldwide consolidated basis), as measured as of the last day of 
each of the four prior calendar quarters, (X) is equal to or greater 
than $1 billion or (Y) equals 10 percent or more of its total 
assets; and (ii) with respect to its covered fund activities and 
investment, if it engages in any covered fund activities and 
investments and either (X) has, together with its affiliates and 
subsidiaries, aggregate investments in covered funds the average 
value of which is, as measured as of the last day of each of the 
four prior calendar quarters, equal to or greater than $1 billion or 
(Y) sponsors and advises, together with its affiliates and 
subsidiaries, covered funds the average total assets of which are, 
as measured as of the last day of each of the four prior calendar 
quarters, equal to or greater than $1 billion.
---------------------------------------------------------------------------

E. Conformance Provisions

    Subpart E of the Board's proposed rule, as set forth in the Joint 
Release, is not included in the proposed CFTC Rule because this Subpart 
E only applies to the Board.

F. Treatment of Smaller, Less-Complex Banking Entities

    In formulating the proposed rule, the CFTC has carefully considered 
and taken into account the potential impact of the proposed rule on 
small banking entities and banking entities that engage in little or no 
covered trading activities or covered fund activities and investments, 
including the burden and cost that might be associated with such 
banking entities' compliance with the proposed rule. In particular, the 
CFTC has proposed to reduce the effect of the proposed rule on such 
banking entities by limiting the application of certain requirements, 
such as the reporting and recordkeeping requirements of Sec.  ----.7 
and Appendix A of the proposed rule and the compliance program 
requirements contained in subpart D and Appendix C of the proposed 
rule, to those banking entities that engage in little or no covered 
trading activities or covered fund activities and investments. The CFTC 
also requested comment (i) throughout this SUPPLEMENTARY INFORMATION on 
a number of questions related to the costs and burdens associated with 
particular aspects of the proposal, as well as (ii) in Part VII.B of 
this Supplementary Information on any significant alternatives that 
would minimize the impact of the proposal on small banking entities.

G. Application of Section 13 of the BHC Act to Securitization Vehicles 
or Issuers of Asset-Backed Securities

    Many issuers of asset-backed securities may be included within the 
definition of covered fund since they would be an investment company 
but for the exclusions contained in section 3(c)(1) or 3(c)(7) of the 
Investment Company Act.\76\ If an issuer of asset-backed securities is 
considered to be a covered fund, then a banking entity would not be 
permitted to acquire or retain any ownership interest issued by such 
issuer except as otherwise permitted under section 13 of the BHC Act 
and the proposed rule.\77\ Separately, issuers of asset-backed 
securities may be included within the definition of banking entity, as 
noted in Part III.A.2 of this Supplementary Information. Although the 
proposed definition of banking entity would not include any entity that 
is a covered fund, an issuer of asset-backed securities that is both 
(i) an affiliate or subsidiary of a banking entity,\78\ and (ii) does 
not rely on an exclusion contained in section 3(c)(1) of 3(c)(7) of the 
Investment Company Act, would be a banking entity and thus subject to 
the requirements of section 13

[[Page 8340]]

of the BHC Act and the proposed rule, including: (i) the prohibition on 
proprietary trading; (ii) limitations on investments in and 
relationships with a covered fund; (iii) the establishment and 
implementation of a compliance program as required under the proposed 
rule; and (iv) recordkeeping and reporting requirements. Given the 
breadth of the definition of ``affiliate,'' these requirements may 
apply to a significant portion of the outstanding securitization 
market, including issuers of asset-backed securities that rely on rule 
3a-7 or section 3(c)(5) of the Investment Company Act.
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    \76\ For purposes of the proposed rule, any securitization 
entity that meets the requirements for an exclusion under Rule 3a-7 
or section 3(c)(5) of the Investment Company Act, or any other 
exclusion or exemption from the definition of ``investment company'' 
under the Investment Company Act (other than sections 3(c)(1) or 
3(c)(7) of the Investment Company Act), would not be a covered fund 
under the proposed definition. Additionally, an issuer of asset-
backed securities that is subject to legal documents mandating 
compliance with the conditions of section 3(c)(1) of 3(c)(7) of the 
Investment Company Act would not be a covered fund if such issuer 
also can satisfy all the conditions of an alternative exclusion or 
exemption for which it is eligible.
    \77\ For example, under the proposed rule, a banking entity 
would be able to acquire or retain an interest or security of an 
issuer of asset-backed securities that is a covered fund if: (i) The 
interest or security of the issuer does not qualify as an 
``ownership interest'' under Sec.  ----.10(b)(3) of the proposed 
rule; (ii) the issuer of asset-backed securities is comprised solely 
of loans, contractual rights or assets directly arising from those 
loans, and certain specified interest rate or foreign exchange 
derivatives used for hedging purposes, as permitted under Sec.  --
--.13(d) or ----.14(a)(2)(v) of the proposed rule; (iii) the banking 
entity is a ``securitizer'' or ``originator'' and acquires and 
retains such interest in compliance with the minimum requirements of 
section 15G of the Exchange Act and any implementing regulations 
issued thereunder, as provided under Sec.  ----.14(a)(2)(iii) of the 
proposed rule; or (v) the banking entity organizes and offers the 
issuer and the ownership interest is a permitted investment under 
Sec.  ----.12 of the proposed rule. The circumstances where a 
banking entity may acquire or retain an ownership interest in a 
covered fund are discussed in detail in Part III.C of this 
SUPPLEMENTAL INFORMATION.
    \78\ The definitions of ``affiliate'' and ``subsidiary'' are 
discussed in detail in Part III.A.2 of this Supplemental 
Information.
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    In recognition of these concerns, the CFTC, similar to the Agencies 
in the Joint Rule, has requested comment throughout this Supplementary 
Information on the potential effects of section 13 of the BHC Act and 
the proposed rule on the securitization industry and issuers of asset-
backed securities.

III. Section by Section Summary of Proposed Rule

A. Subpart A--Authority and Definitions

1. Section ----.1: Authority, Purpose, Scope, and Relationship to Other 
Authorities
a. Authority and Scope
    Section ----.1 of the proposed rule describes the authority under 
which the CFTC is issuing the proposed rule, the purpose of the 
proposed rule, and the banking entities to which the CFTC's rule 
applies. In addition, Sec.  ----.1(d) of the proposed rule implements 
section 13(g)(1) of the BHC Act, which provides that the prohibitions 
and restrictions of section 13 apply to the activities of a banking 
entity regardless of whether such activities are authorized for a 
banking entity under other applicable provisions of law.\79\
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    \79\ See proposed rule Sec.  ----.1(d).
---------------------------------------------------------------------------

b. Effective Date
    Section 13(c)(1) of the BHC Act provides that section 13 will take 
effect on the earlier of (i) 12 months after the date of issuance of 
final rules implementing that section, or (ii) 2 years after the date 
of enactment of section 13, which is July 21, 2012.\80\ Because the 
CFTC did not issue final rules implementing section 13 of the BHC Act 
by July 21, 2011, Sec.  ----.1 of the proposed rule specifies that the 
effective date for its provisions will be July 21, 2012.
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    \80\ See 12 U.S.C. 1851(c)(1).
---------------------------------------------------------------------------

    The CFTC notes that the proposed effective date will impact not 
only the date on which the proposed rule's prohibitions and 
restrictions on proprietary trading and covered fund activities and 
investments go into effect (subject to the conformance period or 
extended transition period provided by section 13(c) of the BHC 
Act),\81\ but also the date on which a banking entity must comply with 
(i) the reporting and recordkeeping requirements of Sec.  ----.7 and 
Appendix A of the proposed rule and (ii) the compliance program mandate 
of Sec.  ----.20 and Appendix C of the proposed rule. As proposed, 
Sec.  ----.1 would require a banking entity subject to either the 
reporting and recordkeeping or compliance program requirements to begin 
complying with these requirements as of July 21, 2012.\82\ With respect 
to the compliance program requirement of the proposed rule, Sec.  --
--.1 would require a banking entity to have developed and implemented 
the required program by the proposed effective date, though the CFTC 
notes that prohibited activities and investments may not be fully 
conformed by that date. The CFTC expects a banking entity to fully 
conform all investments and activities to the requirements of the 
proposed rule as soon as practicable within the conformance periods 
provided in section 13 of the BHC Act and the Board's rules thereunder, 
which define the conformance periods. With respect to the reporting and 
recordkeeping requirements of the proposed rule, Sec.  ----.1 of the 
proposed rule would require a banking entity to begin furnishing these 
reports for all trading units or asset management units as of the 
effective date, though the quantitative measurements furnished for 
proprietary trading activities that are conducted in reliance on the 
authority provided by the conformance period would not be used to 
identify prohibited proprietary trading until such time as the relevant 
trading activities must be conformed.
---------------------------------------------------------------------------

    \81\ See id. at 1851(c)(2)--(6).
    \82\ See proposed rule Sec.  ----.1.
---------------------------------------------------------------------------

    The CFTC expects that a banking entity may need a period of time to 
prepare for effectiveness of the proposed rule and, in particular, to 
implement both the compliance program and the reporting and 
recordkeeping requirements provided under the proposed rule. 
Accordingly, in order to help assess the effects and impact of the 
proposed effective date and any alternative compliance dates, the CFTC 
requests comment on the following questions:
    Question 1. Does the proposed effective date provide banking 
entities with sufficient time to prepare to comply with the 
prohibitions and restrictions on proprietary trading and covered fund 
activities and investments? If not, what other period of time is needed 
and why? \83\
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    \83\ Note that each additional question asked by the CFTC in the 
CFTC Rule retains the same base question number as in the Joint 
Release (e.g. when the CFTC has included a question on whether 
question number 168 may be applicable to the CFTC, the new 
additional question is listed as question 168.1).
---------------------------------------------------------------------------

    Question 2. Does the proposed effective date provide banking 
entities with sufficient time to implement the proposal's compliance 
program requirement? If not, what are the impediments to implementing 
specific elements of the compliance program and what would be a more 
effective time period for implementing each element and why?
    Question 3. Does the proposed effective date provide banking 
entities sufficient time to implement the proposal's reporting and 
recordkeeping requirements? If not, what are the impediments to 
implementing specific elements of the proposed reporting and 
recordkeeping requirements and what would be a more effective time 
period for implementing each element and why?
    Question 4. Should the CFTC use a gradual, phased in approach to 
implement the statute rather than having the implementing rules become 
effective at one time? If so, what prohibitions and restrictions should 
be implemented first? Please explain.
2. Section ----.2: Definitions
    Section ----.2 of the proposed rule defines a variety of terms used 
throughout the proposed rule, including ``banking entity,'' which 
defines the scope of entities to which the proposed rule applies. 
Consistent with the statutory definition of that term, Sec.  ----.2(e) 
of the proposed rule provides that a ``banking entity'' includes: (i) 
Any insured depository institution; (ii) any company that controls an 
insured depository institution; (iii) any company that is treated as a 
bank holding company for purposes of section 8 of the International 
Banking Act of 1978 (12 U.S.C. 3106); and (iv) any affiliate or 
subsidiary of any of the foregoing.\84\ In addition, in order to avoid 
application of section 13 of the BHC Act in a way that appears 
unintended by the statute and would create internal inconsistencies in 
the statutory scheme,

[[Page 8341]]

the proposed rule also clarifies that the term ``banking entity'' does 
not include any affiliate or subsidiary of a banking entity, if that 
affiliate or subsidiary is (i) a covered fund, or (ii) any entity 
controlled by such a covered fund.\85\ This clarification is proposed 
because the definition of ``affiliate'' and ``subsidiary'' under the 
BHC Act is broad, and could include a covered fund that a banking 
entity has permissibly sponsored or made an investment in because, for 
example, the banking entity acts as general partner or managing member 
of the covered fund as part of its permitted sponsorship 
activities.\86\ If such a covered fund were considered a ``banking 
entity'' for purposes of the proposed rule, the fund itself would 
become subject to all of the restrictions and limitations of section 13 
of the BHC Act and the proposed rule, which would be inconsistent with 
the purpose and intent of the statute. For example, such a covered fund 
would then generally be prohibited from investing in other covered 
funds, notwithstanding the fact that section 13(f)(3) of the BHC Act 
specifically contemplates such investments. Accordingly, the proposed 
rule would exclude from the definition of banking entity any fund that 
a banking entity may invest in or sponsor as permitted by the proposed 
rule.
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    \84\ See proposed rule Sec.  ----.2(e). Sections ----.2(a) and 
(bb) of the proposed rule clarify that the terms ``affiliate'' and 
``subsidiary'' have the same meaning as in sections 2(d) and (k) of 
the BHC Act (12 U.S.C. 1841(d) and (k)).
    \85\ The CFTC notes that since the proposed rule implements 
section 13 of the BHC Act, it incorporates that Act's definition of 
``affiliate'' and ``subsidiary.'' See proposed rule Sec. Sec.  --
--.2(a) and (bb). The terms affiliate and subsidiary are generally 
defined in section 2 of the BHC Act according to whether such entity 
controls or is controlled by another relevant entity. See 12 U.S.C. 
1841(d), (k). The concept of control under the proposed rule, in 
turn, is as defined in section 2 of the BHC Act and as implemented 
by the Board. See 12 U.S.C. 1841(a)(2); 12 CFR 225.2(e).
    \86\ Under section 2 of the BHC Act and the Board's Regulation Y 
(12 CFR part 225), a banking entity acting as general partner or 
managing member of another company would be deemed to control that 
company and, as such, the company would be both an ``affiliate'' and 
``subsidiary'' of the banking entity for purposes of the BHC Act. 
See 12 U.S.C. 1841(d), (k).
---------------------------------------------------------------------------

    An entity such as a mutual fund would generally not be a subsidiary 
or affiliate of a banking entity under this definition if the banking 
entity only provides advisory or administrative services to, has 
certain limited investments in, or organizes, sponsors, and manages a 
mutual fund (which includes a registered investment company) in 
accordance with BHC Act rules.\87\
---------------------------------------------------------------------------

    \87\ See, e.g., 12 U.S.C. 1483(c)(6), (c)(8), and (k); 12 CFR 
225.28(b)(6), 225.86(b)(3).
---------------------------------------------------------------------------

    Section ----.2(j) of the proposed rule defines the term ``covered 
banking entity,'' which is used to describe the specific types of 
banking entities to which the CFTC's rule applies. In addition, a 
number of other definitions contained in Sec.  ----.2 are discussed in 
further detail below in connection with the separate sections of the 
proposed rule in which they are used.
    The proposed rule also defines the terms ``buy and purchase'' and 
``sell and sale,'' which are used throughout the proposed rule to 
describe the scope of transactions that are subject to subparts B and C 
of the proposed rule. These definitions are substantially similar to 
the definitions of the same terms under the Exchange Act, except that 
the proposed definitions provide additional clarity regarding the types 
of transactions that would be considered the purchase or sale of a 
commodity future or derivative or ownership interest in a covered 
fund.\88\ These definitions are purposefully broad in scope, and are 
intended to include a wide range of transaction types that would permit 
a banking entity to gain or eliminate, or increase or reduce, exposure 
to a covered financial position or ownership interest in a covered 
fund.
---------------------------------------------------------------------------

    \88\ See proposed rule Sec. Sec.  ----.2(g), (v); 15 U.S.C. 
78c(a)(13), (14).
---------------------------------------------------------------------------

    Request for comment.
    The CFTC requests comment on the proposed rule's definition of 
``banking entity.'' In particular, the CFTC requests comment on the 
following questions:
    Question 5. Is the proposed rule's definition of banking entity 
effective? What alternative definitions might be more effective in 
light of the language and purpose of the statute?
    Question 6. Are there any entities that should not be included 
within the definition of banking entity since their inclusion would not 
be consistent with the language or purpose of the statute or could 
otherwise produce unintended results? Should a registered investment 
company be expressly excluded from the definition of banking entity? 
Why or why not?
    Question 7. Is the proposed rule's exclusion of a covered fund that 
is organized, offered and held by a banking entity from the definition 
of banking entity effective? Should the definition of banking entity be 
modified to exclude any covered fund? Why or why not?
    Question 8. Banking entities commonly structure their registered 
investment company relationships and investments such that the 
registered investment company is not considered an affiliate or 
subsidiary of the banking entity. Should a registered investment 
company be expressly excluded from the definition of banking entity? 
Why or why not? Are there circumstances in which such companies should 
be treated as banking entities subject to section 13 of the BHC Act? 
How many such companies would be covered by the proposed definition?
    Question 8.1. What is the best method for the CFTC and the other 
regulators to coordinate regarding the allocation of supervisory 
responsibilities under the proposed CFTC Rule?
    Question 9. Under the proposed rule, would issuers of asset-backed 
securities be captured by the proposed definition of ``banking 
entity''? If so, are issuers of asset-backed securities within certain 
asset classes particularly impacted? Are particular types of 
securitization vehicles (trusts, LLCs, etc.) more likely than others to 
be included in the definition of banking entity? Should issuers of 
asset-backed securities be excluded from the proposed definition of 
``banking entity,'' and if so, why? How would such an exclusion be 
consistent with the language and purpose of the statute?
    Question 10. What would be the potential impact of including 
existing issuers of asset-backed securities \89\ in the proposed 
definition of ``banking entity'' on existing issuers of asset-backed 
securities and the securitization market generally? How many existing 
issuers of asset-backed securities might be included in the proposed 
definition of ``banking entity''? Are there ways in which the proposed 
rule could be amended to mitigate or eliminate potential impact, if 
any, on existing asset-backed securities \90\ without compromising the 
intent of the statute?
---------------------------------------------------------------------------

    \89\ For purposes of this SUPPLEMENTAL INFORMATION, ``existing 
issuers of asset-backed securities'' means issuers that issued 
asset-backed securities prior to the effective date of the proposed 
rule.
    \90\ For purposes of this SUPPLEMENTAL INFORMATION, ``existing 
asset-backed securities'' means asset-backed securities that were 
issued prior to the effective date of the proposed rule.
---------------------------------------------------------------------------

    Question 11. What would be the legal and economic impact to an 
issuer of asset-backed securities of being considered a ``banking 
entity''? What additional costs would be incurred in the establishment 
and implementation of a compliance program related to the provisions of 
the proposed rule as required by Sec.  ----.20 of the proposed rule 
(including Appendix C, where applicable)? Who would pay those 
additional costs?
    Question 12. If the ownership requirement under the proposed rule 
for credit risk retention (section 15G of the Exchange Act) combined 
with the control inherent in the position of servicer or investment 
manager means that more securitization vehicles would be considered 
affiliates of banking

[[Page 8342]]

entities, would fewer banking entities be willing to (i) serve as the 
servicer or investment manager of securitization transactions and/or 
(ii) serve as the originator or securitizer (as defined in section 15G 
of the Exchange Act) of securitization transactions? What other impact 
might the potential interplay between these rules have on future 
securitization transactions? Could there be other potential unintended 
consequences?
    Question 13. Are the proposed rule's definitions of buy and 
purchase and sale and sell appropriate? If not, what alternative 
definitions would be more appropriate? Should any other terms be 
defined? If so, are there existing definitions in other rules or 
regulations that could be used in this context? Why would the use of 
such other definitions be appropriate?

B. Subpart B--Proprietary Trading Restrictions

1. Section ----.3: Prohibition on Proprietary Trading
    Section ----.3 of the proposed rule describes the scope of the 
prohibition on proprietary trading and defines a number of terms 
related to proprietary trading. The CFTC notes that the definition of 
``proprietary trading'' in the statute and under the proposed rule is 
broad. This definition must be viewed in light of the exemptions 
described later in the proposed rule, which reflect statutory 
provisions permitting a number of activities.
a. Prohibition on Proprietary Trading
    Section ----.3(a) of the proposed rule implements section 
13(a)(1)(A) of the BHC Act and prohibits a banking entity from engaging 
in proprietary trading unless otherwise permitted under Sec. Sec.  --
--.4 through ----.6 of the proposed rule. Section ----.3(b)(1) of the 
proposed rule defines proprietary trading in accordance with section 
13(h)(4) of the BHC Act.\91\ This definition is a key element of the 
proposal because, unless an activity covered by the definition is 
specifically permitted under one of the exemptions contained in 
Sec. Sec.  ----.4 through ----.6 of the proposed rule, a banking entity 
is prohibited from engaging in that activity. Specifically, the 
proposal largely restates the statutory definition of proprietary 
trading, defining that term to mean engaging in the purchase or sale of 
one or more covered financial positions as principal for the trading 
account of the banking entity.\92\ The terms ``trading account'' and 
``covered financial position'' are defined in Sec. Sec.  ----.3(b)(2) 
and ----.3(b)(3) of the proposed rule, respectively. The proposed 
definition of proprietary trading also clarifies that proprietary 
trading does not include acting as agent, broker, or custodian for an 
unaffiliated third party, because acting in these types of capacities 
does not involve trading as principal, which is one of the requisite 
aspects of the statutory definition.
---------------------------------------------------------------------------

    \91\ See proposed rule Sec.  ----.3(b)(1).
    \92\ See 12 U.S.C. 1851(h)(4); see also proposed rule Sec.  --
--.3(b)(1). Although the statutory definition refers to the 
``purchase, sale, acquisition, or disposition of'' covered financial 
positions, the proposed rule uses the simpler terms ``purchase'' and 
``sale,'' which are defined broadly in Sec. Sec.  ----.2(g) and (v) 
of the proposed rule.
---------------------------------------------------------------------------

b. ``Trading Account''
i. Definition of ``Trading Account''
    Section 13(h)(6) of the BHC Act defines the term ``trading 
account'' as ``any account used for acquiring or taking positions in 
securities [or other enumerated instruments] principally for the 
purpose of selling in the near-term (or otherwise with the intent to 
resell in order to profit from short-term price movements),'' as well 
as any such other accounts that the CFTC by rule determine.\93\ As an 
initial matter, the CFTC notes that it is often difficult to clearly 
identify the purpose for which a position is acquired or taken and 
whether that purpose is short-term in nature, particularly since 
identification of that purpose generally depends on the intent with 
which the position is acquired or taken. Moreover, the statute does not 
define the terms ``near-term'' or ``short-term'' for these purposes.
---------------------------------------------------------------------------

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

    In implementing the statutory definition of trading account, the 
proposed rule generally restates the statutory definition, with the 
addition of certain details intended to provide banking entities with 
greater clarity regarding the scope of positions that fall within the 
definition of trading account.\94\ The proposed definition of trading 
account has three prongs. First, under the proposed rule, a trading 
account includes any account that is used by a banking entity to 
acquire or take one or more covered financial positions for the purpose 
of: (i) 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 such positions.\95\ Second, the 
proposed definition of trading account also includes any account used 
by a banking entity that is subject to the Market Risk Capital Rules to 
acquire or take one or more covered financial positions that are 
subject to those rules, other than certain foreign exchange and 
commodity positions.\96\ Third, the proposed definition of trading 
account also includes any account used by a banking entity that is a 
securities dealer, swap dealer, or security-based swap dealer to 
acquire or take positions in connection with its dealing 
activities.\97\ To provide additional clarity and guidance regarding 
the trading account definition, the proposed rule also includes a 
rebuttable presumption that any account used to acquire or take a 
covered financial position that is held for sixty days or less is a 
trading account under the first prong, unless the banking entity can 
demonstrate that the position was not acquired principally for short-
term trading purposes. The proposed definition also clarifies that no 
account will be a trading account to the extent that it is used to 
acquire or take certain positions under repurchase or reverse 
repurchase arrangements or securities lending transactions, positions 
for bona fide liquidity management purposes, or certain positions held 
by derivatives clearing organizations or clearing agencies. Each of the 
three definitional prongs is independent of the others--any one prong 
would, if met, cause the relevant account to fall within the definition 
of ``trading account.''
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    \94\ The CFTC notes that the structure of the proposed 
definition, which defines a trading account by reference to the 
positions that the account is used to acquire or take, is consistent 
with the structure of the statutory language used in section 
13(h)(6) of the BHC Act.
    \95\ See proposed rule Sec.  ----.3(b)(2)(i)(A).
    \96\ See proposed rule Sec.  ----.3(b)(2)(i)(B).
    \97\ See proposed rule Sec.  --.3(b)(2)(i)(C).
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    The CFTC has drawn on existing rules, in particular the Market Risk 
Capital Rules and various securities and commodities laws, in 
identifying trading accounts and defining related terms in the 
proposal.
ii. Positions Acquired or Taken for Short-Term Trading Purposes
    The first prong of the proposed trading account definition refers 
to positions that a banking entity acquires or takes principally for 
short-term purposes--that is, for one of the following enumerated 
purposes described in Sec. Sec.  ----.3(b)(2)(i)(A)(1) through (4) of 
the proposed rule:
    <bullet> Short-term resale;
    <bullet> Benefitting from actual or expected short-term price 
movements;
    <bullet> Realizing short-term arbitrage profits; or
    <bullet> Hedging one or more such positions.
    This prong reflects the statutory definition's reference to 
positions acquired or taken ``principally for the

[[Page 8343]]

purpose of selling in the near-term (or otherwise with the intent to 
resell in order to profit from short-term price movements).'' \98\
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    \98\ See 12 U.S.C. 1851(h)(6); see also proposed rule Sec.  --
--.3(b)(2)(i).
---------------------------------------------------------------------------

    Section ----.3(b)(2)(i)(A)(1) of the proposed rule's definition of 
trading account includes covered financial positions acquired or taken 
principally for the purpose of short-term resale.\99\ This part of the 
trading account definition restates language contained in the statutory 
definition of trading account and describes one class of positions that 
are acquired or taken for short-term trading purposes.
---------------------------------------------------------------------------

    \99\ See proposed rule Sec.  ----.3(b)(2)(i)(A)(1).
---------------------------------------------------------------------------

    Section ----.3(b)(2)(i)(A)(2) of the proposed rule includes covered 
financial positions acquired or taken principally for the purpose of 
benefitting from actual or expected short-term price movements.\100\ 
This part of the trading account definition does not require the resale 
of the position; rather, it requires only an intent to engage in any 
form of transaction on a short-term basis (including a transaction 
separate from, but related to, the initial acquisition of the position) 
for the purpose of benefitting from a short-term movement in the price 
of the underlying position. This part of the proposed definition would, 
for example, include a derivative or other position where the banking 
entity enters into (or intends to enter into) a subsequent transaction 
in the near-term to simply offset or ``close out,'' rather than sell, 
all or a portion of the risks of the initial position, in order to 
benefit from a price movement occurring between the acquisition of the 
underlying position and the subsequent offsetting transaction. 
Similarly, it would also include a derivative, commodity future, or 
other position that, regardless of the term of that position, is 
subject to the exchange of short-term variation margin through which 
the banking entity intends to benefit from short-term price movements. 
The proposed definition would also capture the acquisition of a debt 
instrument where the banking entity intends to enter into a short-term 
transaction to simply offset, rather than sell, the credit, interest 
rate and/or other material risk elements of the initial position so as 
to benefit from a price movement occurring between acquisition of the 
underlying position and the subsequent offsetting transaction.
---------------------------------------------------------------------------

    \100\ See proposed rule Sec.  ----.3(b)(2)(i)(A)(2).
---------------------------------------------------------------------------

    Section ----.3(b)(2)(i)(A)(3) of the proposed rule's definition of 
trading account includes covered financial positions acquired or taken 
principally to lock in short-term arbitrage profits.\101\ Although 
similar to the positions described in Sec.  ----.3(b)(2)(i)(A)(2) of 
the proposed definition (i.e., those acquired for the purpose of 
benefitting from actual or expected short-term price movements), this 
part of the definition focuses on short-term arbitrage profits more 
generally, without regard to whether the transaction is predicated on 
expected or actual movements in price. Rather, a position acquired to 
lock in arbitrage profits would include positions acquired or taken 
with the intent to benefit from differences in multiple market prices, 
even in cases in which no movement in those prices is necessary to 
realize the intended profit. Such arbitrage-based transactions might 
involve profiting from the difference in the market price of multiple 
related positions or assets, or might instead involve the difference in 
market price for particular price or risk elements associated with 
positions or assets. This would include, for example, arbitrage profits 
resulting from the convergence or divergence in prices between 
different positions held by a banking entity engaged in relative value 
convergence arbitrage, which involves marrying a long and short 
position to benefit from a convergence or divergence in price between 
the two, or any similar strategy, because such convergence or 
divergence could happen at any time (i.e., in one day, in sixty-one 
days, or some other time period).
---------------------------------------------------------------------------

    \101\ See proposed rule Sec.  ----.3(b)(2)(i)(A)(3).
---------------------------------------------------------------------------

    Section ----.3(b)(2)(i)(A)(4) of the proposed rule's definition of 
trading account includes covered financial positions acquired or taken 
for the purpose of hedging another position that is itself held in a 
trading account.\102\ In particular, the CFTC assumes that, with 
respect to any position the purpose of which is to hedge another 
covered financial position in the trading account, the banking entity 
generally intends to hold the hedging position, whatever its nominal 
duration, for only so long as the underlying position is held. 
Accordingly, the proposed rule makes clear that such hedging positions 
fall within the definition of trading account.
---------------------------------------------------------------------------

    \102\ See proposed rule Sec.  ----.3(b)(2)(i)(A)(4).
---------------------------------------------------------------------------

iii. Overview of Current Market Risk Capital Rules Approach to Short-
Term Trading Positions
    The first prong of the proposed trading account definition, which 
references positions acquired principally for short-term trading 
purposes, is, like the statutory definition it implements, 
substantially similar to a key portion of the definition of a ``covered 
position'' under the Market Risk Capital Rules.\103\ For the reasons 
discussed below, the CFTC has taken this similarity into account and 
propose to construe the first prong of the definition of trading 
account under the proposed rule--and in particular its reference to 
``short-term''--in a manner that is consistent with the Market Risk 
Capital Rules' approach to identifying positions taken with short-term 
trading intent.
---------------------------------------------------------------------------

    \103\ The Federal banking agencies' current Market Risk Capital 
Rules are located at 12 CFR 3, Appendix B (OCC), 12 CFR 208, 
Appendix E and 12 CFR 225, Appendix E (Board), and 12 CFR 325, 
Appendix C (FDIC), and apply on a consolidated basis to banks and 
bank holding companies with trading activity (on a worldwide 
consolidated basis) that equals 10 percent or more of the 
institution's total assets, or $1 billion or more. On January 11, 
2011, the Federal banking agencies proposed revisions to the Market 
Risk Capital Rules that include, inter alia, changes to the 
definition of covered position. Proposed revisions to the Market 
Risk Capital Rules include (i) changes to portions of the covered 
position definition not relevant to the statutory definition of 
trading account in section 13 of the BHC Act and (ii) the addition 
of a requirement that any position in a trading account also be a 
``trading position'' in order to be considered a covered position. 
See 76 FR 1890 (Jan. 11, 2011). The revised definition of ``trading 
position'' that has been proposed for those purposes is generally 
identical to this proposed rule's definition of trading account 
(i.e., a position acquired or taken: (i) For the purpose of short-
term resale; (ii) with the intent of benefitting from actual or 
expected short-term price movements; (iii) to lock in short-term 
arbitrage profits; or (iv) to hedge another trading position). The 
CFTC also notes that the first prong of the proposed rule's trading 
account definition is also substantially similar to the Basel 
Committee's definition of ``trading book.'' See Basel Committee on 
Banking Supervision, Amendment to the Capital Accord to Incorporate 
Market Risks, available at http://bis.org/publ/bcbs119.pdf.
---------------------------------------------------------------------------

    The Market Risk Capital Rules define a covered position to include 
all positions in a bank's ``trading account,'' as that term is defined, 
in part, in the Report of Condition and Income that banks are required 
to file periodically with respect to their financial condition (``Call 
Report''). Under the Market Risk Capital Rules, a covered position is 
one that is subject to a risk-based capital charge that is based, at 
least in part, on the banking organization's internal risk management 
models for purposes of calculating the banking organization's risk-
based capital requirement.\104\ In

[[Page 8344]]

defining the term ``trading account,'' the Call Report notes that 
trading activities typically include, among other activities, 
``acquiring or taking positions in such items principally for the 
purpose of selling in the near-term or otherwise with the intent to 
resell in order to profit from short-term price movements.'' \105\ This 
language is substantially identical to the statutory definition of 
trading account in section 13 of the BHC Act in that it refers to 
acquiring or taking positions (i) principally for the purpose of 
selling in the near-term or (ii) otherwise with the intent to resell in 
order to profit from short-term price movements.
---------------------------------------------------------------------------

    \104\ The CFTC notes that the Market Risk Capital Rules, both in 
their current and proposed form, also (i) include within the 
definition of covered position other positions not captured by the 
reference to positions acquired for the purpose of short-term resale 
or with the intent of benefitting from actual or expected short-term 
price movements (e.g., all commodity and foreign exchange positions, 
regardless of the intended holding period) and (ii) exclude from 
that definition certain positions otherwise acquired with short-term 
trading intent for a variety of policy reasons. The CFTC has not 
proposed to incorporate such inclusions or exclusions for purposes 
of the proposed rule's definition of trading account; rather, the 
Market Risk Capital Rules and related concepts have been referred to 
only to the extent that they pertain to positions acquired for the 
purpose of short-term resale or with the intent of benefitting from 
actual or expected short-term price movements.
    \105\ Report of Condition and Income at A78a (also including, in 
the definition of ``trading account,'' ``regularly underwriting or 
dealing in securities; interest rate, foreign exchange rate, 
commodity, equity, and credit derivative contracts; other financial 
instruments; and other assets for resale * * * and * * * acquiring 
or taking positions in such items as an accommodation to customers 
or for other trading purposes.''). Accordingly, given its broader 
scope, the Call Report ``trading account'' includes trading 
positions that fall outside the statutory ``trading account'' for 
purposes of determining what is prohibited and permitted covered 
trading activity under section 13 of the BHC Act.
---------------------------------------------------------------------------

    In providing guidance regarding the application of ``trading 
account,'' the Call Report also states that trading account positions 
include any position that is classified as ``trading securities'' under 
relevant U.S. Generally Accepted Accounting Principles (``GAAP'') 
standards for accounting.\106\ Under the referenced accounting 
standards, trading securities are defined as those ``that are bought 
and held principally for the purpose of selling them in the near-term'' 
and ``generally used with the objective of generating profits on short-
term differences in price.'' \107\ The CFTC notes that the definition 
of a trading security under the relevant U.S. GAAP accounting standards 
is similar to both (i) the financial positions described in the second 
prong of the Call Report's definition of trading account and (ii) the 
financial positions described in the statutory definition of trading 
account under section 13 of the BHC Act.
---------------------------------------------------------------------------

    \106\ See Report of Condition and Income at A78a, referring to 
ASC Topic 320, Investments-Debt and Equity Securities (formerly FASB 
Statement of Financial Accounting Standards No. 115, ``Accounting 
for Certain Investments in Debt and Equity Securities'').
    \107\ See id. In formulating the proposed rule, the CFTC 
carefully considered whether to define trading account for purposes 
of the proposed rule in a manner that formally incorporated the 
accounting standards governing trading securities. The CFTC has not 
proposed this approach because: (i) The statutory proprietary 
trading prohibition under section 13 of the BHC Act applies to 
financial instruments, such as derivatives, to which the trading 
security accounting standards may not apply; (ii) these accounting 
standards permit companies to classify, at their discretion, assets 
as trading securities even where the assets would not otherwise meet 
the definition of trading security; and (iii) these accounting 
standards could change in the future without consideration of the 
potential impact on section 13 of the BHC Act.
---------------------------------------------------------------------------

    Although neither the Market Risk Capital Rules, the Call Report, 
nor relevant accounting standards provide a precise definition of what 
constitutes ``near-term'' or ``short-term'' for purposes of evaluating 
whether a position is of the type held in a trading account or is a 
trading security, guidance provided under relevant accounting standards 
notes that ``near-term'' for purposes of classifying trading activities 
is ``generally measured in hours and days rather than months or 
years.'' \108\ The CFTC expects that the precise period of time that 
may be considered near-term or short-term for purposes of evaluating 
any particular covered financial position would depend on a variety of 
factors, including the facts and circumstances of the covered financial 
position's acquisition, the banking entity's trading and business 
strategies, and the nature of the relevant markets. In considering the 
purpose for which a covered financial position is acquired or taken and 
evaluating whether such position is acquired or taken for short-term 
purposes, the CFTC intends to rely on a variety of information, 
including quantitative measurements of banking entities' covered 
trading activities (as described below in Part II.B.5 of this 
SUPPLEMENTARY INFORMATION), supervisory review of banking entities' 
compliance practices and internal controls, and supervisory review of 
individual transactions.
---------------------------------------------------------------------------

    \108\ See FASB ASC Master Glossary definition of ``trading.'' 
Although Sec.  ----.3(b)(2)(ii) of the proposed rule includes a 
rebuttable presumption that an account used to acquire or take 
certain covered financial positions that are held for 60 days or 
less is a trading account, the CFTC notes that U.S. GAAP does not 
include a presumption that securities sold within 60 days of 
acquisition were held for the purpose of selling them in the near 
term.
---------------------------------------------------------------------------

    In order to better reinforce the general consistency between the 
proposal's approach to defining a trading account and the ``trading 
account'' concept embedded in the Market Risk Capital Rules, the second 
prong of the proposed definition of trading account, contained in Sec.  
----.3(b)(2)(i)(B) of the proposed rule, provides that a trading 
account includes any account used to acquire or take one or more 
covered financial positions, other than positions that are foreign 
exchange derivatives, commodity derivatives, or contracts of sale of a 
commodity for future delivery (unless the position is otherwise held 
with short-term intent), that are also market risk capital rule covered 
positions, if the banking entity, or any affiliate of the banking 
entity that is a bank holding company, calculates risk-based capital 
ratios under the Market Risk Capital Rules.\109\ For these purposes, a 
``market risk capital rule covered position'' is defined as any covered 
position as that term is defined for purposes of (i) in the case of a 
banking entity that is a bank holding company or insured depository 
institution, the market risk capital rule that is applicable to the 
banking entity, and (ii) in the case of a banking entity that is 
affiliated with a bank holding company, other than a banking entity to 
which a market risk capital rule is applicable, the market risk capital 
rule that is applicable to the affiliated bank holding company.\110\ In 
particular, for banking entities already subject to the Market Risk 
Capital Rules, it appears that positions subject to trading account 
treatment under those rules because they involve short-term trading 
intent are generally the type of positions to which the proprietary 
trading restrictions of section 13 of the BHC Act were intended to 
apply. In addition, including all covered financial positions that 
receive trading account treatment under the Market Risk Capital Rules 
because they meet a nearly identical standard regarding short-term 
trading intent would also eliminate the potential for inconsistency or 
regulatory arbitrage in which a banking entity might characterize a 
position as

[[Page 8345]]

``trading'' for capital purposes but not for purposes of the proposed 
rule.
---------------------------------------------------------------------------

    \109\ The CFTC has excluded positions that are foreign exchange 
derivatives, commodity derivatives, or contracts of sale of a 
commodity for future delivery from this prong of the proposed 
trading account definition because all foreign exchange and 
commodity positions are considered ``covered positions'' under the 
Market Risk Capital Rules regardless of whether they involve the 
short-term trading intent required under the statutory definition of 
trading account in section 13(h)(6) of the BHC Act.
    \110\ See proposed rule Sec.  ----.3(c)(8). Accordingly, in the 
context of a subsidiary of a bank holding company (other than a 
subsidiary, such as a bank, to which a market risk capital rule is 
already directly applicable), if that bank holding company is 
subject to a market risk capital rule, any position of that 
subsidiary that meets the definition of a ``covered position'' under 
the market risk capital rule applicable to the bank holding company 
would be subject to Sec.  ----.3(b)(2)(i)(B) of the proposed rule.
---------------------------------------------------------------------------

    The CFTC emphasizes that this second prong of the trading account 
definition is being proposed in contemplation of the proposed revisions 
to the Market Risk Capital Rules and, in particular, the proposed 
definition of ``covered position'' under those proposed revisions. To 
the extent that those proposed revisions with respect to the definition 
of ``covered position'' are not adopted, or adopted in a form other 
than as proposed, the CFTC would expect to take that into account in 
determining whether or how to include the proposed second prong of the 
trading account definition for purposes of the final rule to implement 
section 13 of the BHC Act. \111\
---------------------------------------------------------------------------

    \111\ In particular, the CFTC notes that under the proposed 
revisions to the Market Risk Capital Rules, but not the existing 
Market Risk Capital Rule, the term ``covered position'' expressly 
includes, other than with respect to commodity and foreign exchange 
positions, only positions taken with short-term trading intent. See 
76 FR 1890 (Jan. 11, 2011). The CFTC does not intend to incorporate 
``covered positions'' under the Market Risk Capital Rules in a way 
that includes positions lacking short-term trading intent.
---------------------------------------------------------------------------

iv. Positions Acquired or Taken by Securities Dealers, Swap Dealers, 
and Security-Based Swap Dealers
    The third prong of the proposed definition of trading account is 
contained in Sec.  ----.3(b)(2)(i)(C) of the proposed rule and provides 
that a trading account includes any account used to acquire or take one 
or more covered financial positions by a banking entity that is: (i) A 
SEC-registered securities or municipal securities dealer; (ii) a 
government securities dealer that registered, or that has filed notice, 
with an appropriate regulatory agency; \112\ (iii) a CFTC-registered 
swap dealer; or (iv) a SEC-registered security-based swap dealer, in 
each case to the extent that the covered financial position is acquired 
or taken in connection with the activities that require the banking 
entity to be registered, or to file notice, as such.\113\ Similarly 
included is any covered financial position acquired or taken by a 
banking entity that is engaged in the business of a dealer, swap 
dealer, or security-based swap dealer outside of the United States, if 
such position is acquired or taken in connection with the activities of 
such business.\114\ As a result of this third prong, all covered 
financial positions acquired or taken by a registered dealer, swap 
dealer or security-based swap dealer, a government securities dealer 
that has filed notice with an appropriate regulatory agency, or a 
banking entity engaged in the same type of dealing activities outside 
the United States, are automatically included within the scope of 
positions described in the trading account definition, if they are 
acquired or taken in connection with the activities that require the 
banking entity to be registered, or file notice, as such (or, in the 
case of a banking entity engaged in the business of a dealer, swap 
dealer, or security-based swap dealer outside of the United States, in 
connection with the activities of such business). As discussed below, 
the proposed rule contains exemptions that permit a variety of covered 
trading activity in which these types of entities typically engage, 
notwithstanding the inclusion of all covered financial positions of 
such entities within the definition of trading account.
---------------------------------------------------------------------------

    \112\ See 15 U.S.C. 78c(a)(42)(E); 15 U.S.C. 78o-5(a)(1)(B); 17 
CFR 400.5(b); 17 CFR 449.1. Section 15C(a)(1)(A) of the Exchange Act 
requires any government securities dealer, other than a registered 
broker-dealer or a financial institution, to register with the SEC 
pursuant to section 15C(a)(2). Registered broker-dealers and 
financial institutions are required to file written notice with 
their appropriate regulatory agency, as defined in section 3(a)(34) 
of the Exchange Act, prior to acting as a government securities 
dealer. See 15 U.S.C. 78o-5(a)(1)(B). The proposed definition of 
trading account would cover positions of all three forms of 
government securities dealers: (i) those registered with the SEC; 
(ii) registered broker-dealers; and (iii) financial institutions 
that have filed notice with an appropriate regulatory agency.
    \113\ See proposed rule Sec.  ----.3(b)(2)(i)(C)(1)-(4). The 
CFTC emphasizes that this provision applies only to positions taken 
in connection with the activities that require the banking entity to 
be registered as one of the listed categories of dealer, not to all 
of the activities of that banking entity. For example, an insured 
depository institution may be registered as a swap dealer, but only 
the swap dealing activities that require it to be so registered 
would be covered by the second prong of the trading account 
definition. A position taken in connection with other activities of 
the insured depository institution that do not trigger registration 
as a swap dealer, such as lending, deposit-taking, the hedging of 
business risks, or other end-user activity, would only be included 
within the trading account if the position met one of the other 
prongs of the trading account definition (i.e., Sec. Sec.  --
--.3(b)(2)(i)(A) or (B) of the proposed rule).
    \114\ See proposed rule Sec.  ----.3(b)(2)(i)(C)(5).
---------------------------------------------------------------------------

    The CFTC has proposed this third prong of the trading account 
definition because all assets or other positions held by firms that 
register or file notice as securities or derivatives dealers as part of 
their dealing activity are generally held for sale to customers upon 
request or otherwise support the firm's trading activities (e.g., by 
hedging its dealing positions), and so would appear to involve the 
requisite short-term intent and be captured within the statutory 
definition of trading account. To the extent that a covered financial 
position is acquired or taken by such a banking entity outside the 
scope of the dealing activities that require the banking entity to be 
registered, or to file notice, as a dealer, swap dealer, or security-
based swap dealer, that position may still cause the relevant account 
to be a trading account under the proposed rule if the account holding 
such a position otherwise meets the terms of the first or second prong 
of the trading account definition (i.e., positions acquired or taken 
for short-term trading purposes or certain Market Risk Capital Rules 
positions).
v. Rebuttable Presumption for Certain Positions
    In order to provide greater clarity and guidance on the application 
of the trading account definition, and in particular for those banking 
entities with no experience in evaluating short-term trading intent or 
that are not subject to the Market Risk Capital Rules, the proposed 
rule also includes a rebuttable presumption regarding certain positions 
that, by reason of their holding period, are presumed to be trading 
account positions. In particular, Sec.  ----.3(b)(2)(ii) of the 
proposed rule provides that an account would be presumed to be a 
trading account if it is used to acquire or take a covered financial 
position, other than dealing positions or certain Market Risk Capital 
Rules covered positions that are automatically considered part of the 
trading account, that the banking entity holds for a period of sixty 
days or less. However, the presumption does not apply if the banking 
entity can demonstrate, based on all the facts and circumstances, that 
the covered financial position, either individually or as a category, 
was not acquired or taken principally for the purpose of short-term 
resale, benefitting from short-term price movements, realizing short-
term arbitrage profits, or hedging another trading account 
position.\115\ Because it appears likely that most positions held for 
sixty days or less would have been acquired with short-term trading 
intent, the proposal presumes such positions are trading account 
positions unless the banking entity can demonstrate otherwise. The 
purpose of the proposed rebuttable presumption is to simplify the 
process of evaluating whether individual positions are included in the 
definition of trading account. The proposal does not apply this 
rebuttable presumption to positions described in Sec.  --
--.3(b)(2)(i)(B) or (C) of the proposed rule (i.e., certain Market Risk 
Capital Rules positions and dealing positions), because these positions 
are automatically part of the trading account, and cannot be rebutted.
---------------------------------------------------------------------------

    \115\ See proposed rule Sec.  ----.3(b)(2)(ii).

---------------------------------------------------------------------------

[[Page 8346]]

    However, the CFTC recognizes that, for a variety of reasons, a 
banking entity may acquire a covered financial position for purposes 
other than short-term trading but nonetheless dispose of that position 
within the sixty-day period covered by the presumption. Accordingly, 
Sec.  ----.3(b)(2)(ii) is only a presumption, and may be rebutted by 
reference to all the facts and circumstances surrounding the 
acquisition of a particular position. For example, if a banking entity 
acquired a covered financial position with the demonstrable intent of 
holding it for investment or other non-trading purposes but, because of 
developments not expected or anticipated at the time of acquisition 
(e.g., increased customer demand, an unexpected increase in its 
volatility or a need to liquidate the position to meet unexpected 
liquidity demands), held it for less than sixty days, those facts and 
circumstances would generally suggest that the position was not 
acquired with short-term trading intent, notwithstanding the 
presumption.\116\ The proposed rule also makes clear that this rebuttal 
may be made not only with respect to a particular transaction, but also 
with respect to a particular category of transactions, recognizing that 
it may be possible to identify a category of similar transactions that 
clearly do not involve short-term trading, notwithstanding the typical 
holding period of the related positions.
---------------------------------------------------------------------------

    \116\ In such cases, the documented intention for acquiring or 
taking the position should be consistent with the intention 
articulated for financial reporting and other purposes.
---------------------------------------------------------------------------

    It is important to note that these presumptions are designed to 
help determine whether a transaction is within the definition of 
``proprietary trading,'' not whether a transaction is permissible under 
section 13 of the BHC Act. A transaction may fall within the definition 
of ``proprietary trading'' and yet be permissible if it meets one of 
the exemptions provided in the proposed rule, such as the exemption for 
market making-related activities.
vi. Request for Comment
    The CFTC requests comment on the proposed rule's approach to 
defining trading account. In particular, the CFTC requests comment on 
the following questions:
    Question 14. Is the proposed rule's definition of trading account 
effective? Is it over- or under-inclusive in this context? What 
alternative definition might be more effective in light of the language 
and purpose of the statute? How would such definition better identify 
the accounts that are intended to be covered by section 13 of the BHC 
Act?
    Question 14.1. Should the CFTC Rule's proposed definition of 
trading account include: (i) Sec.  ----.3(b)(2)(i)(B), relating to 
Federal Banking Agencies' Market Risk Capital Rules; or (ii) Sec. Sec.  
----.3(b)(2)(i)(C)(1),(2) and/or (4), relating to SEC registered 
dealers and dealers who have filed notice with the appropriate 
regulatory agency? Please explain the rationale for including or 
excluding the provisions in the proposed CFTC Rule.
    Question 15. Is the proposed rule's approach for determining when a 
position falls within the definition of ``trading account'' for 
purposes of the proposed rule from when it must be reported in the 
``trading account'' for purpose of filing the Call Report effective? 
What additional guidance could the CFTC provide on this distinction? 
Are there alternative approaches that would be more effective in light 
of the language and purpose of the statute? Is this approach workable 
for affiliates of bank holding companies that are not subject to the 
Federal banking agencies' Market Risk Capital Rules (e.g., affiliated 
investment advisers)? If not, why not? Are affiliates of bank holding 
companies familiar with the concepts from the Market Risk Capital Rules 
that are being incorporated into the proposed rule? If not, what steps 
would an affiliate of a bank holding company have to take to become 
familiar with these concepts and what would be the costs and/or 
benefits of such actions? Is application of the trading account concept 
from the Federal banking agencies' Market Risk Capital Rules to 
affiliates of bank holding companies necessary to promote consistency 
and prevent regulatory arbitrage? Please explain.
    Question 16. Is the manner in which the CFTC intends to take into 
account, and substantially adopt, the approach used in the Market Risk 
Capital Rules and related concepts for determining whether a position 
is acquired with short-term trading intent effective?
    Question 17. Should the proposed rule's definition of trading 
account, or its use of the term ``short-term,'' be clarified? Are there 
particular transactions or positions to which its application would be 
unclear? Should the proposed rule define ``short-term'' for these 
purposes? What alternative approaches to construing the term ``short-
term'' should the CFTC consider and/or adopt?
    Question 18. Are there particular transactions or positions to 
which the application of the proposed definition of trading account is 
unclear? Is additional regulatory language, guidance, or clarity 
necessary?
    Question 19. Is the exchange of variation margin as a potential 
indicator of short-term trading in derivative or commodity future 
transactions appropriate for the definition of trading account? How 
would this impact such transactions or the manner by which banking 
entities conduct such transactions? For instance, would banking 
entities seek to avoid the use of variation margin to avoid this rule? 
What are the costs and benefits of referring to the exchange of 
variation margin to determine if positions should be included in a 
banking entity's trading account? Please explain.
    Question 20. Are there particular transactions or positions that 
are included in the definition of trading account that should not be? 
If so, what transactions or positions and why?
    Question 21. Are there particular transactions or positions that 
are not included in the definition of trading account that should be? 
If so, what transactions or positions and why?
    Question 22. Is the proposed rule of construction for positions 
acquired or taken by dealers, swap dealers and security-based swap 
dealers appropriate and consistent with the purpose and language of 
section 13 of the BHC Act? Is its application to any particular type of 
entity, such as an insured depository institution engaged in 
derivatives dealing activities, sufficiently clear and effective? If 
not, what alternative would be clearer and/or more effective?
    Question 23. Is the rebuttable presumption included in the proposed 
rule appropriate and effective? Are there more effective ways in which 
to provide clarity regarding the determination of whether or not a 
position is included within the definition of trading account? If so, 
what are they?
    Question 24. Are records currently created and retained that could 
be used to demonstrate investment or other non-trading purposes in 
connection with rebutting the presumption in the proposed rule? If yes, 
please identify such records and explain when they are created and 
whether they would be useful in connection with a single transaction or 
a category of similar transactions. If no, we seek commenter input 
regarding the manner in which banking entities might demonstrate 
investment or other non-trading intent. Should the CFTC require banking 
entities to create and keep records to demonstrate investment or non-
trading intent with respect to their covered financial positions?

[[Page 8347]]

    Question 25. How should the proposed trading account definition 
address arbitrage positions? Should all arbitrage positions be included 
in the definition of trading account, unless the timing of such profits 
is long-term and established at the time the arbitrage position is 
acquired or taken? Please explain in detail, including a discussion of 
different arbitrage trading strategies and whether subjecting such 
strategies to the proposed rule would be consistent with the language 
and purpose of section 13 of the BHC Act.
    Question 26. Is the holding period referenced in the rebuttable 
presumption appropriate? If not, what holding period would be more 
appropriate, and why?
    Question 27. Should the proposed rule include a rebuttable 
presumption regarding positions that are presumed not to be within the 
definition of trading account? If so, why, and what would the 
presumption be?
    Question 28. Should any additional accounts be included in the 
proposed rule pursuant to the authority granted under section 13(h)(6) 
of the BHC Act? If so, what accounts and why? For example, should 
accounts used to acquire or take certain long-term positions be 
included in the definition? If so, how would subjecting such accounts 
to the proposed rule's prohibitions and restrictions be consistent with 
the language and purpose of section 13 of the BHC Act?
    Question 29. Do any of the activities currently engaged in by 
issuers of asset-backed securities that would be considered a banking 
entity constitute proprietary trading as defined by Sec.  ----.3(b) of 
this rule proposal? Would any activities relating to investment of 
funds in accounts held by issuers of asset-backed securities (e.g., 
reserve accounts, prefunding accounts, reinvestment accounts, etc.) or 
the purchase and sale of securities as part of the management of a 
collateralized debt obligation portfolio be considered proprietary 
trading under the proposed rule? What would be the potential impact of 
the prohibition on proprietary trading on the use of such accounts in 
(i) existing securitization transactions and (ii) future securitization 
transactions? Would any of the securities typically acquired and 
retained using these accounts be considered an ownership interest in a 
covered fund under the proposed rule? Does the exclusion of trading in 
certain government obligations in Sec.  ----.6(a) of the proposed rule 
mitigate the impact of the proposed rule on such issuers of asset-
backed securities and their activities? Why or why not?
c. Excluded Positions
i. Excluded Positions Under Certain Repurchase and Reverse Repurchase 
Arrangements
    Section ----.3(b)(2)(iii)(A) of the proposed rule's definition of 
trading account provides that an account will not be a trading account 
to the extent that such account is used to acquire or take one or more 
covered financial positions that arise under a repurchase or reverse 
repurchase agreement pursuant to which the banking entity has 
simultaneously agreed, in writing at the start of the transaction, to 
both purchase and sell a stated asset, at stated prices, and on stated 
dates or on demand with the same counterparty.\117\ This clarifying 
exclusion is proposed because positions held under a repurchase or 
reverse repurchase agreement operate in economic substance as a secured 
loan, and are not based on expected or anticipated movements in asset 
prices. Accordingly, these types of asset purchases and sales do not 
appear to be the type of transaction intended to be covered by the 
statutory definition of trading account.
---------------------------------------------------------------------------

    \117\ See proposed rule Sec.  ----.3(b)(2)(iii)(A).
---------------------------------------------------------------------------

ii. Excluded Positions Under Securities Lending Transactions
    Section ----.3(b)(2)(iii)(B) of the proposed rule's definition of 
trading account provides that an account will not be a trading account 
to the extent that such account is used to acquire or take one or more 
covered financial positions that arise under a transaction in which the 
banking entity lends or borrows a security temporarily to or from 
another party pursuant to a written securities lending agreement under 
which the lender retains the economic interests of an owner of such 
security, and has the right to terminate the transaction and to recall 
the loaned security on terms agreed to by the parties.\118\ This 
clarifying exclusion is proposed because a position held under a 
securities lending arrangement can be used, for example, to operate in 
economic substance and function, as a means to facilitate settlement of 
securities transactions, and is not based on expected or anticipated 
movements in asset prices. Accordingly, securities lending transactions 
do not appear to be the type of transaction intended to be covered by 
the statutory definition of trading account.
---------------------------------------------------------------------------

    \118\ See proposed rule Sec.  --.3(b)(2)(iii)(B). The language 
describing securities lending transactions in the proposed rule 
generally mirrors that contained in Rule 3a5-3 under the Exchange 
Act. See 17 CFR 240.3a5-3.
---------------------------------------------------------------------------

iii. Excluded Positions Acquired or Taken for Liquidity Management 
Purposes
    Section ----.3(b)(2)(iii)(C) of the proposed definition of trading 
account provides that an account will not be a trading account to the 
extent that such account is used to acquire or take a position for the 
purpose of bona fide liquidity management, so long as important 
criteria are met.\119\
---------------------------------------------------------------------------

    \119\ See proposed rule Sec.  ----.3(b)(2)(iii)(C).
---------------------------------------------------------------------------

    This proposed clarifying exclusion is intended to make clear that, 
where the purpose for which a banking entity acquires or takes a 
position is to ensure that it has sufficient liquid assets to meet its 
short-term cash demands, and the related position is held as part of 
the banking entity's liquidity management process, that transaction 
falls outside of the types of transactions described in the proposed 
rule's definition of trading account. Maintaining liquidity management 
positions is a critical aspect of the safe and sound operation of 
certain banking entities, and does not involve the requisite short-term 
trading intent that forms the basis of the statutory definition of 
``trading account.'' In the context of bona fide liquidity management 
activity that would qualify for the clarifying exclusion, a banking 
entity's purpose for acquiring or taking these types of positions is 
not to benefit from short-term profit or short-term price movements, 
but rather to ensure that it has sufficient, readily-marketable assets 
available to meet its expected short-term liquidity needs.
    However, the CFTC is concerned with the potential for abuse of this 
clarifying exclusion--specifically, that a banking entity might attempt 
to improperly mischaracterize positions acquired or taken for 
prohibited proprietary trading purposes as positions acquired or taken 
for liquidity management purposes. To address this, the proposed rule 
requires that the transaction be conducted in accordance with a 
documented liquidity management plan that meets five criteria. First, 
the plan would be required to specifically contemplate and authorize 
any particular instrument used for liquidity management purposes, its 
profile with respect to market, credit and other risks, and the 
liquidity circumstances in which the position may or must be used. 
Second, the plan would have to require that any transaction 
contemplated and authorized by the plan be principally for the purpose 
of managing the liquidity of

[[Page 8348]]

the banking entity, and not for the purpose of short-term resale, 
benefitting from actual or expected short-term price movements, 
realizing short-term arbitrage profits, or hedging a position acquired 
or taken for such short-term purposes. Third, the plan would have to 
require that any positions acquired or taken for liquidity management 
purposes be highly liquid and limited to financial instruments the 
market, credit and other risks of which are not expected to give rise 
to appreciable profits or losses as a result of short-term price 
movements.\120\ Fourth, the plan would be required to limit any 
position acquired or taken for liquidity management purposes, together 
with any other positions acquired or taken for such purposes, to an 
amount that is consistent with the banking entity's near-term funding 
needs, including deviations from normal operations, as estimated and 
documented pursuant to methods specified in the plan. Fifth, the plan 
would be required to be consistent with the CFTC's supervisory 
requirements, guidance and expectations regarding liquidity management. 
The CFTC would review these liquidity plans and transactions effected 
in accordance with these plans through supervisory and examination 
processes to ensure that the applicable criteria are met and that any 
position acquired or taken in reliance on the clarifying exclusion for 
liquidity management transactions is fully consistent with such plans.
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    \120\ Any instance in which positions characterized as taken for 
liquidity purposes do give rise to appreciable profits or losses as 
a result of short-term price movements will be subject to 
significant CFTC scrutiny and, absent compelling explanatory facts 
and circumstances, would be viewed as prohibited proprietary trading 
under the proposal.
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iv. Excluded Positions of Derivatives Clearing Organizations and 
Clearing Agencies
    Section ----.3(b)(2)(iii)(D) of the proposed rule's definition of 
trading account provides that an account will not be a trading account 
to the extent that such account is used to acquire or take one or more 
covered financial positions that are acquired or taken by a banking 
entity that is a derivatives clearing organization registered under 
section 5b of the Commodity Exchange Act (7 U.S.C. 7a-1) or a clearing 
agency registered with the SEC under section 17A of the Exchange Act 
(15 U.S.C. 78q-1) in connection with clearing derivatives or securities 
transactions.\121\ This clarifying exclusion is proposed because, in 
the case of a banking entity that acts as a registered, central 
counterparty in the securities or derivatives markets, these types of 
transactions do not appear to be the type of transaction intended to be 
covered by the statutory definition of trading account, as the purpose 
of such transactions is to provide a clearing service to third parties 
and not to profit from short-term resale or short-term price movements.
---------------------------------------------------------------------------

    \121\ See proposed rule Sec.  ----.3(b)(2)(iii)(D).
---------------------------------------------------------------------------

v. Request for Comment
    The CFTC requests comment regarding the proposed clarifying 
exclusions and whether any other types of activity or transactions 
should be excluded from the proposed definition of trading account for 
clarity. In particular, the CFTC requests comment on the following 
questions:
    Question 30. Are the proposed clarifying exclusions for positions 
under certain repurchase and reverse repurchase arrangements and 
securities lending transactions over- or under-inclusive and could they 
have unintended consequences? Is there an alternative approach to these 
clarifying exclusions that would be more effective? Are the proposed 
clarifying exclusions broad enough to include bona fide arrangements 
that operate in economic substance as secured loans and are not based 
on expected or anticipated movements in asset prices? Are there other 
types of arrangements, such as open dated repurchase arrangements, that 
should be excluded for clarity and, if so, how should the proposed rule 
be revised? Alternatively, are the proposed clarifying exclusions broad 
enough to not inadvertently exclude from coverage any similar 
arrangements or transactions that have these characteristics?
    Question 30.1. Should the proposed CFTC Rule include the clarifying 
exclusion for certain positions taken by clearing agencies that are 
registered with the SEC under section 17A of the Exchange Act? Please 
explain the rationale for including or excluding the provision in the 
proposed CFTC Rule.
    Question 30.2. The CFTC notes that only the actual repurchase or 
reverse repurchase arrangements would be exempt from the definition of 
trading account, and not the collateral or position that is being 
financed by the repurchase or reverse repurchase arrangement. The CFTC 
further notes that if a banking entity used a repurchase arrangement to 
finance a purchase of a covered financial position, that covered 
financial position would be considered in the trading account if it 
satisfied, at the time of its purchase, one of the three prongs set 
forth in the definition of trading account. Is this treatment of 
repurchase and reverse repurchase arrangements appropriate for the 
proposed CFTC Rule?
    Question 31. Are repurchase and reverse repurchase arrangements and 
securities lending transactions sufficiently similar such that they 
should be treated in the same way for purposes of the proposed rule? 
Are there aspects of repurchase and reverse repurchase arrangements or 
securities lending transactions that should be highlighted in 
considering the application of the proposed rule? Do repurchase and 
reverse repurchase arrangements or securities lending transactions 
raise any additional or heightened concerns regarding risk? Please 
identify and explain how these concerns should be reflected in the 
proposed rule.
    Question 32. Are the proposed exclusions for repurchase and reverse 
repurchase arrangements and securities lending transactions appropriate 
or are there conditions that commenters believe would be appropriate as 
a pre-requisite to relying on these exclusions? Please identify such 
conditions and explain. Alternatively, we seek commenter input 
regarding why repurchase and reverse repurchase arrangements and 
securities lending transactions do not present the potential for abuse, 
namely, that a banking entity might attempt to improperly 
mischaracterize prohibited proprietary trading as activity that 
qualifies for the proposed exclusions.
    Question 33. Is the proposed clarifying exclusion for liquidity 
management transactions effective and appropriate? If not, what 
alternative would be more effective and appropriate, and why? Is the 
proposed exclusion under- or over-inclusive? Does the proposed 
clarifying exclusion place sufficient limitations on liquidity 
management transactions to prevent abuse of the clarifying exclusion? 
If not, what additional limitations should be specified? Are any of the 
limitations contained in the proposed rule inappropriate or 
unnecessary? If so, how could such limitations be eliminated or altered 
in a way that does not permit abuse of the clarifying exclusion?
    Question 34. Is the proposed exclusion for liquidity management 
positions necessary? If not excluded, would such activity otherwise 
qualify for an exemption contained in the proposed rule (e.g., the 
exemptions contains in Sec. Sec.  ----.5 and ----.6(a) of the proposed 
rule)? What types of banking entities are likely to engage in the 
liquidity management activities described in the proposed exclusion?

[[Page 8349]]

    Question 35. What types of instruments do particular types of 
banking entities currently use in connection with liquidity management 
activities (e.g., Treasuries)? Why are such instruments chosen for 
liquidity management purposes? Would such instruments meet the proposed 
requirement that the position be highly liquid and limited to financial 
instruments the market, credit and other risk of which are not expected 
to give rise to appreciable profits or losses as a result of short-term 
price movements? Why or why not?
    Question 36. What methodologies do banking entities currently use 
for estimating deviations from normal operations in connection with 
liquidity management programs?
    Question 37. Which unit or units within a banking entity are 
typically responsible for liquidity management? What is the typical 
reporting line structure used to control and supervise that unit or 
units? Are the responsibilities of personnel in the unit limited to 
liquidity management or do they perform other functions in addition to 
liquidity management? How is compensation determined for personnel in 
the unit of the banking entity responsible for liquidity management?
    Question 38. Would current liquidity management programs meet the 
five proposed criteria for liquidity management programs? If not which 
criteria would not be met, and why? What effect would the proposed 
liquidity management exclusions have on current liquidity management 
programs and banking entities in general?
    Question 39. Are liquidity management programs used for purposes 
other than ensuring the banking entity has sufficient assets available 
to it that are readily marketable to meet expected short-term liquidity 
needs? If so, for what purposes, and why?
    Question 40. What costs or other burdens would arise if the 
proposal did not contain an exclusion for positions acquired or taken 
for liquidity management purpose? Please explain and quantify these 
costs or other burdens in detail.
    Question 41. Is the proposed liquidity management exclusion 
sufficiently clear? If not, why is the exclusion unclear and how should 
the CFTC clarify the terms of this exclusion?
    Question 42. Is the proposed clarifying exclusion for certain 
positions taken by derivatives clearing organizations and clearing 
agencies effective and appropriate? If not, what alternative would be 
more effective and appropriate, and why?
    Question 43. Are any additional clarifying exclusions warranted? If 
so, what clarifying exclusion, and why?
    Question 44. Should the proposed definition exclude any position 
the market risk of which cannot be hedged by the banking entity in a 
two-way market? \122\ If so, what would be the basis for concluding 
that such positions are clearly not within the statutory definition of 
trading account?
---------------------------------------------------------------------------

    \122\ The CFTC also notes that such an exclusion would be 
similar to the express exclusion of similar positions under the 
Federal banking agencies' most recent proposed revisions to the 
Market Risk Capital Rules. See 76 FR 1890, 1912 (Jan. 11, 2011) 
(excluding from the definition of a covered position any position 
the material risk elements of which the holder is unable to hedge in 
a two-way market).
---------------------------------------------------------------------------

    Question 45. Should the proposed definition include a clarifying 
exclusion for any position in illiquid assets? If so, what would be the 
basis for concluding that such positions are clearly not within the 
statutory definition of trading account? How should ``illiquid assets'' 
be defined for these purposes? Should the definition be consistent with 
the definition given that term in the Board's Conformance Rule under 
section 13 of the BHC Act (12 CFR 225.180 et seq.)? \123\
---------------------------------------------------------------------------

    \123\ See 76 FR 8265 (Feb. 14, 2011). The Board's conformance 
rule defines ``illiquid asset'' as ``any real property, security 
obligation, or other asset that (i) is not a liquid asset; (ii) 
because of statutory or regulatory restrictions applicable to the 
hedge fund, private equity fund or asset, cannot be offered, sold, 
or otherwise transferred by the hedge fund or private equity fund to 
a person that is unaffiliated with the relevant banking entity; or 
(iii) because of contractual restrictions applicable to the hedge 
fund, private equity fund or asset, cannot be offered, sold, or 
otherwise transferred by the hedge fund or private equity fund for a 
period of 3 years or more to a person that is unaffiliated with the 
relevant banking entity.'' 12 CFR 225.180(g). A ``liquid asset'' is 
defined in paragraph (h) of the conformance rule. See 12 CFR 
225.180(h).
---------------------------------------------------------------------------

d. Covered Financial Position
i. Definition of ``Covered Financial Position''
    Section ----.3(b)(3)(i) of the proposed rule defines a covered 
financial position as any long, short, synthetic or other position 
\124\ in: (i) A security, including an option on a security; (ii) a 
derivative, including an option on a derivative; or (iii) a contract of 
sale of a commodity for future delivery, or an option on such a 
contract. The types of financial instruments described in the proposed 
definition are consistent with those referenced in section 13(h)(4) of 
the BHC Act as part of the statutory definition of proprietary 
trading.\125\
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    \124\ The proposed definition's reference to any ``long, short, 
synthetic or other position'' is intended to make clear that a 
position in an identified category of financial instrument qualifies 
as a covered financial position regardless of whether the position 
is (i) an asset or liability or (ii) is acquired through acquisition 
or sale of the financial instrument or synthetically through a 
derivative or other transaction.
    \125\ Section 13(h)(4) of the BHC Act also permits the CFTC to 
extend the scope of the proprietary trading restrictions to other 
financial instruments. The CFTC has not proposed to do so at this 
time.
---------------------------------------------------------------------------

    To provide additional clarity, Sec.  ----.3(b)(3)(ii) of the 
proposed rule provides that, consistent with the statute, the term 
covered financial position does not include any position that is itself 
a loan, a commodity, or foreign exchange or currency.\126\ The 
exclusion of these types of positions is intended to eliminate 
potential confusion by making clear that the purchase and sale of 
loans, commodities and foreign exchange--none of which are referred to 
in section 13(h)(4) of the BHC Act--are outside the scope of 
transactions to which the proprietary trading restrictions apply. The 
reference in Sec.  ----.3(b)(3)(ii) to a position that is, rather than 
a position that is in, a loan, a commodity, or foreign exchange or 
currency is intended to capture only the purchase and sale of these 
instruments themselves. This reflects the fact that, consistent with 
section 13(h)(4) of the BHC Act and the proposed rule, although a 
position that is a foreign exchange derivative or commodity derivative 
is included in the definition of covered financial position and 
therefore subject to the prohibition on proprietary trading, a position 
that is a commodity or foreign currency is not.\127\ For example, the 
spot purchase of a commodity would meet the terms of the exclusion, but 
the acquisition of a futures position in the same commodity would not. 
The CFTC requests comment on the proposed rule's definition of covered 
financial position. In particular, the CFTC requests comment on the 
following questions:
---------------------------------------------------------------------------

    \126\ See proposed rule Sec.  ----.3(b)(ii).
    \127\ The types of commodity- and foreign exchange-related 
derivatives that are included within the definition of 
``derivative'' under the proposed rule are discussed in detail below 
in Part III.B.2.d.ii of this Supplementary Information.
---------------------------------------------------------------------------

    Question 46. Is the proposed rule's definition of covered financial 
position effective? Is the definition over- or under-inclusive? What 
alternative approaches might be more effective in light of the language 
and purpose of section 13 of the BHC Act, and why?
    Question 47. Are there definitions in other rules or regulations 
that might inform the proposed definition of covered financial 
position? If so, what rule or regulation? How should that approach be 
incorporated into the proposed definition? Why would that approach be 
more appropriate?

[[Page 8350]]

    Question 48. Are there particular transactions or positions to 
which the application of the proposed definition of covered financial 
position is unclear? Is additional regulatory language, guidance, or 
clarity necessary?
    Question 49. The proposal would apply to long, short, synthetic, or 
other positions in one of the listed categories of financial 
instruments. Does this language adequately describe the type of 
positions that are intended to fall within the proposed definition of 
covered financial position? If not, why not? Are there different or 
additional concepts that should be specified in this context? Please 
explain.
    Question 50. Should the CFTC expand the scope of covered financial 
positions to include other transactions, such as spot commodities or 
foreign exchange or currency, or certain subsets of transaction (e.g., 
spot commodities or foreign exchange or currency traded on a high-
frequency basis)? If so, which instruments and why?
    Question 51. What factors should the CFTC consider in deciding 
whether to extend the scope of the proprietary trading restriction to 
other financial instruments under the authority granted in section 
13(h)(4) of the BHC Act? Please explain.
    Question 52. Is the proposed exclusion of any position that is a 
loan, a commodity, or foreign exchange or currency effective? If not, 
what alternative approaches might be more effective in light of the 
language and purpose of section 13 of the BHC Act? Should additional 
positions be excluded? If so, why and under what authority?
ii. Other Terms Used in the Definition of Covered Financial Position
    The proposal also defines a number of terms used in the proposed 
definition of covered financial position. The term ``security'' is 
defined by reference to that same term under the Exchange Act.\128\ The 
terms ``commodity'' and ``contract of sale of a commodity for future 
delivery'' are defined by reference to those same terms under the 
Commodity Exchange Act.\129\ The CFTC has proposed to reference these 
existing definitions from the securities and commodities laws because 
these existing definitions are generally well-understood by market 
participants and have been subject to extensive interpretation in the 
context of securities and commodities trading activities.
---------------------------------------------------------------------------

    \128\ See proposed rule Sec.  ----.2(w).
    \129\ See proposed rule Sec. Sec.  ----.3(c)(1), (2).
---------------------------------------------------------------------------

    The proposed rule also defines the term ``derivative.'' \130\ In 
particular, the definition of ``derivative'' under the proposed rule 
includes any ``swap'' (as that term is defined in the Commodity 
Exchange Act) and any ``security-based swap'' (as that term is defined 
in the Exchange Act), in each case as further defined by the CFTC and 
SEC by joint regulation, interpretation, guidance, or other action, in 
consultation with the Board pursuant to section 712(d) of the Dodd-
Frank Act. The CFTC has proposed to incorporate these definitions of 
``swap'' and ``security-based swap'' under the Federal securities and 
commodities laws because those definitions: (i) Govern the primary 
Federal regulatory scheme applicable to exchange-traded and over-the-
counter derivatives; (ii) will be frequently evaluated and applied by 
banking entities in the course of their trading activities; and (iii) 
capture agreements and contracts that are, or function as, 
derivatives.\131\ The proposed rule also includes within the definition 
of derivative certain other transactions that, although not included 
within the definition of ``swap'' or ``security-based swap.'' 
Specifically, the proposed definition of derivative also includes: (i) 
any purchase or sale of a nonfinancial commodity for deferred shipment 
or delivery that is intended to be physically settled; (ii) any foreign 
exchange forward or foreign exchange swap (as those terms are defined 
in the Commodity Exchange Act); \132\ (iii) any agreement, contract, or 
transaction in foreign currency described in section 2(c)(2)(C)(i) of 
the Commodity Exchange Act (7 U.S.C. 2(c)(2)(C)(i)); \133\ (iv) any 
agreement, contract, or transactions in a commodity other than foreign 
currency described in section 2(c)(2)(D)(i) of the Commodity Exchange 
Act (7 U.S.C. 2(c)(2)(D)(i)); and (v) any transaction authorized under 
section 19 of the Commodity Exchange Act (7 U.S.C. 23(a) or (b)). The 
CFTC is requesting comment on whether including these five types of 
transactions within the proposed definition of derivative is 
appropriate.
---------------------------------------------------------------------------

    \130\ See proposed rule Sec.  ----.2(l).
    \131\ The CFTC notes that it has not included a variety of 
security-related derivatives within the proposed definition of 
derivative, as such transactions are ``securities'' for purposes of 
both the Exchange Act and the proposed rule and, as a result, 
already included in the broader definition of ``covered financial 
position'' to which the prohibition on proprietary trading applies.
    \132\ The CFTC notes that foreign exchange swaps and foreign 
exchange forwards are considered swaps for purposes of the Commodity 
Exchange Act definition of that term unless the Secretary of the 
Treasury determines, pursuant to section 1a(47)(E) of that Act (7 
U.S.C. 1a(47)(E)), that foreign exchange swaps and forwards should 
not be regulated as swaps under the Commodity Exchange Act and are 
not structured to evade certain provisions of the Dodd-Frank Act. On 
May 5, 2011, the Treasury Secretary proposed to exercise that 
authority to exclude foreign exchange forwards and foreign exchange 
swaps from the definition of ``swap.'' See Determination of Foreign 
Exchange Swaps and Foreign Exchange Forwards Under the Commodity 
Exchange Act, 76 FR 25774 (May 5, 2011). If the Secretary of the 
Treasury issues a final determination, as proposed, a ``foreign 
exchange swap'' and ``foreign exchange forward'' would be excluded 
from the definition of ``swap'' under the Commodity Exchange Act 
and, therefore, would fall outside of the proposed rule's definition 
of ``derivative.'' Accordingly, the CFTC has proposed to expressly 
include such transactions in the proposed definition of derivative, 
but have requested comment on a variety of questions related to 
whether foreign exchange swaps and forwards should be included or 
excluded from the definition of derivative. The CFTC notes that, 
aside from foreign exchange swaps and forwards, the Commodity 
Exchange Act's definition of ``swap'' (and therefore the proposed 
definition of ``derivative'') also includes other types of foreign 
exchange derivatives, including non-deliverable foreign exchange 
forwards (NDFs), foreign exchange options, and currency options, 
which fall outside of the Secretary of the Treasury's authority to 
issue a determination to exclude certain transactions from the 
``swap'' definition.
    \133\ Section 2(c)(2)(C)(i) was added to the Commodity Exchange 
Act in 2008 to address retail foreign exchange transactions that 
were documented as automatically renewing spot contracts (so-called 
rolling spot transactions) and therefore not futures contracts 
subject to the Commodity Exchange Act, but which were functionally 
and economically similar to futures. See Retail Foreign Exchange 
Transactions, 76 FR 41375, 47376-77 (July 15, 2011). However, 
section 2(c)(2)(C)(i) of the Commodity Exchange Act does not apply 
to transactions entered into by U.S. financial institutions, 
including insured depository institutions, brokers, dealers, and 
certain retail foreign exchange dealers. See 7 U.S.C. 
2(c)(2)(C)(i)(I)(aa). To apply this definitional prong to such 
banking entities, the definition of derivative includes a 
transaction ``described in'' section 2(c)(2)(C)(i) of the Commodity 
Exchange Act. In other words, the use of this phrase is intended to 
capture any transaction described in section 2(c)(2)(C)(i) without 
regard to the identity of the counterparty.
---------------------------------------------------------------------------

    To provide additional clarity, the proposed definition of 
derivative also clarifies two types of transactions that are outside 
the scope of the definition. First, the proposed definition of 
derivative would not include any consumer, commercial, or other 
agreement, contract, or transaction that the CFTC and SEC have further 
defined by joint regulation, interpretation, guidance, or other action 
as not within the definition of swap, as that term is defined in the 
Commodity Exchange Act, or security-based swap, as that term is defined 
in the Exchange Act. The SEC and CFTC have, in proposing rules further 
defining the terms ``swap'' and ``security-based swap,'' proposed to 
not include a variety of agreements, contracts, and transactions within 
those definitions by joint regulation or interpretation, and the CFTC 
has proposed to expressly reflect such

[[Page 8351]]

exclusions in the proposed rule's definition in order to avoid the 
potential application of its restrictions to transactions that are not 
commonly thought to be derivatives.\134\ Second, the proposed 
definition of derivative also does not include any identified banking 
product, as defined in section 402(b) of the Legal Certainty for Bank 
Products Act of 2000 (7 U.S.C. 27(b)), that is subject to section 
403(a) of that Act (7 U.S.C. 27a(a)). This provision is proposed to 
clearly exclude identified banking products that are expressly excluded 
(i) from the definition of ``security-based swap'' and (ii) from 
Commodity Exchange Act and CFTC jurisdiction pursuant to section 403(a) 
of the Legal Certainty for Bank Products Act of 2000.\135\
---------------------------------------------------------------------------

    \134\ See 76 FR 29818 (May 23, 2011). For example, the SEC and 
CFTC have proposed to not include (i) certain insurance products 
within the definitions of ``swap'' and ``security-based swap'' by 
regulation and (ii) certain consumer agreements (e.g., agreements to 
acquire or lease real property or purchase products at a capped 
price) and commercial agreements (e.g., employment contracts or the 
purchase of real property, intellectual property, equipment or 
inventory) by joint interpretation. See id. at 29832-34. The CFTC 
has proposed to define ``derivative'' in the proposed rule by 
reference to the definition of ''swap'' and ``security-based swap'' 
under the Federal securities and commodities laws in contemplation 
of the SEC and CFTC's proposed regulatory and interpretative 
exclusions; to the extent that such exclusions are not included in 
any final action taken by the SEC and CFTC, the CFTC will consider 
whether to state such exclusions expressly within the proposed 
rule's definition of derivative.
    \135\ Examples of excluded identified banking products are 
deposit accounts, savings accounts, certificates of deposit, or 
other deposit instruments issued by a bank.
---------------------------------------------------------------------------

    The proposed rule defines a ``loan'' as any loan, lease, extension 
of credit, or secured or unsecured receivable.\136\ The CFTC notes that 
the proposed definition of loan is expansive, and includes a broad 
array of loans and similar credit transactions, but does not include 
any asset-backed security that is issued in connection with a loan 
securitization or otherwise backed by loans.
---------------------------------------------------------------------------

    \136\ See proposed rule Sec.  ----.2(q).
---------------------------------------------------------------------------

    The CFTC requests comment on the proposed rule's definition of 
terms used in the definition of covered financial position. In 
particular, the CFTC requests comment on the following questions:
    Question 53. Are the proposed rule's definitions of commodity and 
contract of sale of a commodity for future delivery appropriate? If 
not, what alternative definitions would be more appropriate?
    Question 54. Is the proposed definition of derivative effective? If 
not, what alternative definition would be more effective? Should the 
proposed rule expressly incorporate the definition of ``swap'' and 
``security-based swap'' under the Federal commodities and securities 
laws? If not, what alternative approach should be taken? Are there 
transactions included in those incorporated definitions that should not 
be included in the proposed rule's definition? If so, what transactions 
and why? Are there transactions excluded from those incorporated 
definitions that should be included within the proposed rule's 
definition? If so, what transactions and why?
    Question 55. Is the proposed inclusion of foreign exchange forwards 
and swaps in the definition of derivative effective? If not, why not? 
On what basis would the CFTC conclude that such transactions are not 
derivatives? Are these transactions economically or functionally more 
similar to secured loans or repurchase arrangements than to commodity 
forwards and swaps? Would there be any unintended consequences to 
banking entities if such transactions are included in the proposal's 
definition of derivative? What effect is including foreign exchange 
swaps and forwards in the definition of derivative likely to have on 
banking entities, participants in the foreign exchange markets, and the 
liquidity and efficiency of foreign exchange markets generally? If 
included within the definition of derivative, should transactions in 
foreign exchange swaps and forwards be permitted under section 
13(d)(1)(J) of the BHC Act? If so, why and on what basis? Please 
quantify your responses, to the extent feasible.
    Question 56. Is the proposed inclusion of any purchase or sale of a 
nonfinancial commodity for deferred shipment or delivery that is 
intended to be physically settled in the definition of derivative 
effective? If not, why not? Would there be any unintended consequences 
to banking entities if such transactions are included in the proposal's 
definition of derivative?
    Question 57. Is the proposed inclusion of foreign currency 
transactions described in section 2(c)(2)(C)(i) of the Commodity 
Exchange Act in the definition of derivative effective? If not, why 
not? Would there be any unintended consequences to banking entities if 
such transactions are included in the proposal's definition of 
derivative?
    Question 58. Is the proposed inclusion of commodity transactions 
described in section 2(c)(2)(D)(i) of the Commodity Exchange Act in the 
definition of derivative effective? If not, why not? Would there be any 
unintended consequences to banking entities if such transactions are 
included in the proposal's definition of derivative?
    Question 59. Is the proposed inclusion of any transaction 
authorized under section 19 of the Commodity Exchange Act (7 U.S.C. 
23(a) or (b)) in the definition of derivative effective? If not, why 
not? Would there be any unintended consequences to banking entities if 
such transactions are included in the proposal's definition of 
derivative?
    Question 60. Is the manner in which the proposed definition of 
derivative excludes any transaction that the CFTC or SEC exclude by 
joint regulation, interpretation, guidance, or other action from the 
definition of ``swap'' or ``security-based swap'' effective? If not, 
what alternative approach would be more appropriate? Should such 
exclusions be restated in the proposed rule's definition? If so, why?
    Question 61. Is the proposed rule's definition of loan appropriate? 
If not, what alternative definition would be more appropriate? Should 
the definition of ``loan'' exclude a security? Should other types of 
traditional banking products be included in the definition of ``loan''? 
If so, why?
iii. Definition of Other Terms Related to Proprietary Trading
    Section ----.3(d) of the proposed rule defines a variety of other 
terms used throughout subpart B of the proposed rule. These definitions 
are discussed in further detail below in the relevant summary of the 
separate sections of the proposed rule in which they are used.
    The CFTC requests comment on the proposed rule's definition of 
other terms used in subpart B of the proposed rule. In particular, the 
CFTC requests comment on the following questions:
    Question 62. Are the proposed rule's definitions of other terms in 
Sec.  ----.3(d) appropriate? If not, what alternative definitions would 
be more appropriate?
    Question 63. Is the definition of additional terms for purposes of 
subpart B of the proposed rule necessary? If so, what terms should be 
defined? How should those terms be defined?
2. Section ----.4: Permitted Underwriting and Market Making-related 
Activities
    Section ----.4 of the proposed rule implements section 13(d)(1)(B) 
of the BHC Act, which permits banking entities to engage in certain 
underwriting and market making-related activities, notwithstanding the 
prohibition on proprietary trading.\137\

[[Page 8352]]

Section ----.4(a) addresses permitted underwriting activities, and 
Sec.  ----.4(b) addresses permitted market making-related activities.
---------------------------------------------------------------------------

    \137\ See 12 U.S.C. 1851(d)(1)(B).
---------------------------------------------------------------------------

a. Permitted Underwriting Activities
    Section ----.4(a) of the proposed rule permits a banking entity to 
purchase or sell a covered financial position in connection with the 
banking entity's underwriting activities to the extent that such 
activities are designed not to exceed the reasonably expected near-term 
demands of clients, customers, or counterparties (the ``underwriting 
exemption''). In order to rely on this exemption, a banking entity's 
underwriting activities must meet all seven of the criteria listed in 
Sec.  ----.4(a)(2). These seven criteria are intended to ensure that 
any banking entity relying on the underwriting exemption is engaged in 
bona fide underwriting activities, and conducts those activities in a 
way that is not susceptible to abuse through the taking of speculative, 
proprietary positions as a part of, or mischaracterized as, 
underwriting activity.
    First, the banking entity must have established the internal 
compliance program required by subpart D of the proposed rule, as 
further described below in Part III.D of this SUPPLEMENTARY 
INFORMATION. This requirement is intended to ensure that any banking 
entity relying on the underwriting exemption has reasonably designed 
written policies and procedures, internal controls, and independent 
testing in place to support its compliance with the terms of the 
exemption.
    Second, the covered financial position that is being purchased or 
sold must be a security. This requirement reflects the common usage and 
understanding of the term ``underwriting.'' \138\
---------------------------------------------------------------------------

    \138\ The CFTC notes, however, that a derivative or commodity 
future transaction may be otherwise permitted under another 
exemption (e.g., the exemptions for market making-related or risk-
mitigating hedging activities).
---------------------------------------------------------------------------

    Third, the transaction must be effected solely in connection with a 
distribution of securities for which the banking entity is acting as an 
underwriter. This prong is intended to give effect to the essential 
element of the underwriting exemption--i.e., that the transaction be in 
connection with underwriting activity. For these purposes, the proposed 
rule defines both (i) a distribution of securities and (ii) an 
underwriter. The definitions of these terms are generally identical to 
the definitions provided for the same terms in the SEC's Regulation 
M,\139\ which governs the activities of underwriters, issuers, selling 
security holders, and others in connection with offerings of securities 
under the Exchange Act.\140\ The CFTC has proposed to use similar 
definitions because the meanings of these terms under Regulation M are 
generally well-understood by market participants and define the scope 
of underwriting activities in which banking entities typically engage, 
including underwriting of SEC-registered offerings, underwriting of 
unregistered distributions, and acting as a placement agent in private 
placements.
---------------------------------------------------------------------------

    \139\ 17 CFR 242.100 et seq.
    \140\ See proposed rule Sec. Sec.  ----.4(a)(3), (4); 17 CFR 
242.100(b).
---------------------------------------------------------------------------

    With respect to the definition of distribution, the CFTC notes that 
Regulation M defines a distribution of securities as ``an offering of 
securities, whether or not subject to registration under the Securities 
Act that are distinguished from ordinary trading transactions by the 
magnitude of the offering and the presence of special selling 
efforts.'' \141\ The manner in which this Regulation M definition 
distinguishes a distribution of securities from other transactions 
appears to be relevant in the context of the underwriting exemption and 
useful to address potential evasion of the general prohibition on 
proprietary trading, while permitting bona fide underwriting 
activities. Accordingly, in order to qualify as a distribution for 
purposes of the proposal, as with Regulation M, the offering must meet 
the two elements--``magnitude'' and ``special selling efforts and 
selling methods.'' The CFTC has not defined the terms ``magnitude'' and 
``special selling efforts and selling methods'' in the proposed rule, 
but would expect to rely on the same factors considered under 
Regulation M in assessing these elements. For example, the number of 
shares to be sold, the percentage of the outstanding shares, public 
float, and trading volume that those shares represent are all relevant 
to an assessment of magnitude.\142\ In addition, delivering a sales 
document, such as a prospectus, and conducting road shows are generally 
indicative of special selling efforts and selling methods.\143\ Another 
indicator of special selling efforts and selling methods is 
compensation that is greater than that for secondary trades but 
consistent with underwriting compensation for an offering. Similar to 
the approach taken under Regulation M, the CFTC notes that 
``magnitude'' does not imply that a distribution must be large; 
instead, this factor is a means to distinguish a distribution from 
ordinary trading, and therefore does not preclude small offerings or 
private placements from qualifying for the underwriting exemption.
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    \141\ 17 CFR 242.100.
    \142\ See Review of Antimanipulation Regulation of Securities 
Offering, Exchange Act Release No. 33924 (Apr. 19, 1994), 59 FR 
21681, 21684 (Apr. 26, 1994) (``Regulation M Concept Release'').
    \143\ See Regulation M Concept Release, 59 FR at 21684-85.
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    The definition of ``underwriter'' in the proposed rule is generally 
similar to that under the SEC's Regulation M, except that the proposed 
rule's definition would also include, within that definition, a person 
who has an agreement with another underwriter to engage in a 
distribution of securities for or on behalf of an issuer or selling 
security holder.\144\ Consistent with current practices and the Council 
study, the CFTC proposes to take into consideration the extent to which 
the banking entity is engaged in the following activities when 
determining whether a banking entity is acting as an underwriter as 
part of a distribution of securities:
---------------------------------------------------------------------------

    \144\ See proposed rule Sec.  ----.4(a)(4)(ii).
---------------------------------------------------------------------------

    <bullet> Assisting an issuer in capital raising;
    <bullet> Performing due diligence;
    <bullet> Advising the issuer on market conditions and assisting in 
the preparation of a registration statement or other offering 
documents;
    <bullet> Purchasing securities from an issuer, a selling security 
holder, or an underwriter for resale to the public;
    <bullet> Participating in or organizing a syndicate of investment 
banks;
    <bullet> Marketing securities; and
    <bullet> Transacting to provide a post-issuance secondary market 
and to facilitate price discovery.
    The CFTC notes that the precise activities performed by an 
underwriter may vary depending on the liquidity of the securities being 
underwritten and the type of distribution being conducted. For example, 
each factor need not be present in a private placement.
    There may be circumstances in which an underwriter would hold 
securities that it could not sell in the distribution for investment 
purposes. If the acquisition of such unsold securities were in 
connection with the underwriting pursuant to the permitted underwriting 
activities exemption, the underwriter would also be able to dispose of 
such securities at a later time.\145\
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    \145\ The CFTC notes, however, that such sale would have to be 
made in compliance with other applicable provisions of the Federal 
securities laws and regulations.

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[[Page 8353]]

    Fourth, to the extent that the transaction involves a security for 
which a person must generally be a registered securities dealer, 
municipal securities dealer or government securities dealer in order to 
underwrite the security, the banking entity must have the appropriate 
dealer registration (or in the case of a financial institution that is 
a government securities dealer, has filed notice of that status as 
required by section 15C(a)(1)(B) of the Exchange Act) or otherwise be 
exempt from registration or excluded from regulation as a dealer.\146\ 
Similarly, if the banking entity is engaged in the business of a dealer 
outside the United States in a manner for which no U.S. registration is 
required, the banking entity must be subject to substantive regulation 
of its dealing business in the jurisdiction in which the business is 
located. This requirement is intended to ensure that (i) any 
underwriting activity conducted in reliance on the exemption is subject 
to appropriate regulation and (ii) banking entities are not 
simultaneously characterizing the transaction as underwriting for 
purposes of the exemption while characterizing it in a different manner 
for purposes of applicable securities laws.
---------------------------------------------------------------------------

    \146\ See proposed rule Sec.  ----.4(a)(2)(iv). For example, if 
a banking entity is a bank engaged in underwriting asset-backed 
securities for which it would be required to register as a 
securities dealer but for the exclusion contained in section 
3(a)(5)(C)(iii) of the Exchange Act, the proposed rule would not 
require that banking entity be a registered securities dealer in 
order to rely on the underwriting exemption for that transaction. 
The proposed rule does not apply the dealer registration/notice 
requirement to the underwriting of exempted securities, security-
based swaps, commercial paper, bankers acceptances or commercial 
bills because the underwriting of such instruments does not require 
registration as a securities dealer under the Exchange Act.
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    Fifth, the underwriting activities of the banking entity with 
respect to the covered financial position must be designed not to 
exceed the reasonably expected near-term demands of clients, customers 
and counterparties.\147\ This requirement restates the statutory 
limitation on the underwriting exemption.
---------------------------------------------------------------------------

    \147\ See proposed rule Sec.  ----.4(a)(2)(v).
---------------------------------------------------------------------------

    Sixth, the underwriting activities of the banking entity must be 
designed to generate revenues primarily from fees, commissions, 
underwriting spreads or other income, and not from appreciation in the 
value of covered financial positions it holds related to such 
activities or the hedging of such covered financial position.\148\ This 
requirement is intended to ensure that activities conducted in reliance 
on the underwriting exemption demonstrate patterns of revenue 
generation and profitability consistent with, and related to, the 
services an underwriter provides to its customers in bringing 
securities to market, rather than changes in the market value of the 
securities underwritten.
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    \148\ For these purposes, underwriting spreads would include any 
``gross spread'' (i.e., the difference between the price an 
underwriter sells securities to the public and the price it 
purchases them from the issuer) designed to compensate the 
underwriter for its services.
---------------------------------------------------------------------------

    Seventh, the compensation arrangements of persons performing 
underwriting activities at the banking entity must be designed not to 
encourage proprietary risk-taking. Activities for which a banking 
entity has established a compensation incentive structure that rewards 
speculation in, and appreciation of, the market value of securities 
underwritten, rather than success in bringing securities to market for 
a client, are inconsistent with permitted underwriting activities under 
the proposed rule. Although a banking entity relying on the 
underwriting exemption may appropriately take into account revenues 
resulting from movements in the price of securities that the banking 
entity underwrites to the extent that such revenues reflect the 
effectiveness with which personnel have managed underwriting risk, the 
banking entity should provide compensation incentives that primarily 
reward client revenues and effective client service, not proprietary 
risk-taking.
    The CFTC requests comment on the proposed rule's implementation of 
the underwriting exemption. In particular, the CFTC requests comment on 
the following questions:
    Question 64. Is the proposed rule's implementation of the 
underwriting exemption effective? If not, what alternative approach 
would be more effective? For example, should the exemption include 
other transactions that do not involve a distribution of securities for 
which the banking entity is acting as underwriter?
    Question 64.1. Should the proposed CFTC Rule include the 
underwriting exemption? Please explain the rationale for including or 
excluding the provision in the proposed CFTC Rule.
    Question 65. Are the seven requirements included in the 
underwriting exemption effective? Is the application of each 
requirement to potential transactions sufficiently clear? Should any of 
the requirements be changed or eliminated? Should other requirements be 
added in order to better provide an exemption that is not susceptible 
to abuse through the taking of speculative, proprietary positions in 
the context of, or mischaracterized as, underwriting? Alternatively, 
are any of the proposed requirements inappropriately restrictive in 
that they would be inconsistent with the statutory exemption for 
certain underwriting activities? If so, how?
    Question 66. Do underwriters currently have processes in place that 
would prevent or reduce the likelihood of taking speculative, 
proprietary positions in the context of, or mischaracterized as, 
underwriting? If so, what are those processes?
    Question 67. Would any of the proposed requirements cause 
unintended consequences? Would the proposed requirements alter current 
underwriting practices in any way? Would any of the proposed 
requirements trigger an unwillingness to engage in underwriting? What 
impact, if any, would the proposed exemption have on capital raising? 
Please explain.
    Question 68. What increased costs, if any, would underwriters incur 
to satisfy the seven proposed requirements of the underwriting 
exemption? Would underwriters pass the increased costs onto issuers, 
selling security holders, or their customers in connection with 
qualifying for the proposed exemption?
    Question 69. In addition to the specific activities highlighted 
above for purposes of evaluating whether a banking entity is acting as 
an underwriter as part of distribution of securities (e.g., assisting 
an issuer in capital raising, performing due diligence, etc.), are 
there other or alternative activities that should be considered? Please 
explain.
    Question 70. Should the requirement that a covered financial 
position be a security be expanded to include other financial 
instruments? If so, why? How are such other instruments underwritten 
within the meaning of section 13(d)(1)(B) of the BHC Act?
    Question 71. Is the proposed definition of a ``distribution'' of 
securities appropriate, or over- or under-inclusive in this context? Is 
there any category of underwriting activity that would not be captured 
by the proposed definition? If so, what are the mechanics of that 
underwriting activity? Should it be permitted under the proposed rule, 
and, if so, why? Would an alternative definition better identify 
offerings intended to be covered by the proposed definition? If so, 
what alternative definition, and why?
    Question 72. Is the proposed definition of ``underwriter'' 
appropriate, or over- or under-inclusive in this context? Would an 
alternative definition, such as the statutory

[[Page 8354]]

definition of ``underwriter'' under the Securities Act, better identify 
persons intended to be covered by the proposed definition? If so, why?
    Question 73. How accurately can a banking entity engaging in 
underwriting predict the near-term demands of clients, customers, and 
counterparties with respect to an offering? How can principal risk that 
is retained in connection with underwriting activities to support near-
term client demand be distinguished from positions taken for 
speculative purposes?
    Question 74. Is the requirement that the underwriting activities of 
a banking entity relying on the underwriting exemption be designed to 
generate revenues primarily from fees, commissions, underwriting 
spreads or similar income effective? If not, how should the requirement 
be changed? Does the requirement appropriately capture the type and 
nature of revenues typically generated by underwriting activities? Is 
any further clarification or additional guidance necessary?
    Question 75. Is the requirement that the compensation arrangements 
of persons performing underwriting activities at a banking entity be 
designed not to reward proprietary risk-taking effective? If not, how 
should the requirement be changed? Are there other types of 
compensation incentives that should be clearly referenced as 
consistent, or inconsistent, with permitted underwriting activity? Are 
there specific and identifiable characteristics of compensation 
arrangements that clearly incentivize prohibited proprietary trading?
    Question 76. Are there other types of underwriting activities that 
should also be included within the scope of the underwriting exemption? 
If so, what additional activities and why? How would an exemption for 
such additional activities be consistent with the language and purpose 
of section 13 of the BHC Act? What criteria, requirements, or 
restrictions would be appropriate to include with respect to such 
additional activities to prevent misuse or evasion of the prohibition 
on proprietary trading?
    Question 77. Does the proposed underwriting exemption appropriately 
accommodate private placements? If not, what changes are necessary to 
do so?
    Question 78. The creation, offer and sale of certain structured 
securities such as trust preferred securities or tender option bonds, 
among others, may involve the purchase of another security and 
repackaging of that security through an intermediate entity. Should the 
sale of the security by a banking entity to an intermediate entity as 
part of the creation of the structured security be permitted under one 
of the exemptions to the prohibition on proprietary trading currently 
included in the proposed rule (e.g., underwriting or market making)? 
Why or why not? For purposes of determining whether an exemption is 
available under these circumstances, should gain on sale resulting from 
the sale of the purchased security to the intermediate entity as part 
of the creation of the structured security be considered a relevant 
factor? Why or why not? What other factors should be considered in 
connection with the creation of the structured securities and why? 
Would the analysis be different if the banking entity acquired and 
retained the security to be sold to the intermediate entity as part of 
the creation of the structured securities as part of its underwriting 
of the underlying security? Why or why not?
    Question 79. We seek comment on the application of the proposed 
exemption to a banking entity retaining a portion of an underwriting. 
Please discuss whether or not firms frequently retain securities in 
connection with a distribution in which the firm is acting as 
underwriter. Please identify the types of offerings in which this may 
be done (e.g., fixed income offerings, securitized products, etc.). 
Please identify and discuss any circumstances which can contribute to 
the decision regarding whether or not to retain a portion of an 
offering. Please describe the treatment of retained securities (e.g., 
the time period of retention, the type of account in which securities 
are retained, the potential disposition of the securities). Please 
discuss whether or not the retention is documented and, if so, how. 
Should the CFTC require disclosure of securities retained in connection 
with underwritings? Should the CFTC require specific documentation to 
demonstrate that the retained portion is connected to an underwriting 
pursuant to the proposed rule? If so, what kind of documentation should 
be required? Please discuss how you believe retention should be 
addressed under the proposal.
b. Permitted Market Making-related Activities
    Section ----.4(b) of the proposed rule permits a banking entity to 
purchase or sell a covered financial position in connection with the 
banking entity's market making-related activities (the ``market-making 
exemption'').
i. Approach to Implementing the Exemption for Market Making-Related 
Activities
    As the Council study noted, implementing the statutory exception 
for permitted market making-related activities requires a regulatory 
regime that differentiates permitted market making-related activity, 
and in particular the taking of principal positions in the course of 
making a market in particular financial instruments, from prohibited 
proprietary trading. Although the purpose and function of these two 
activities are markedly different--market making-related activities 
provide intermediation and liquidity services to customers, while 
proprietary trading involves the generation of profit through 
speculative risk-taking--clearly distinguishing these activities may be 
difficult in practice. Market making-related activities, like 
prohibited proprietary trading, sometimes require the taking of 
positions as principal, and the amount of principal risk that must be 
assumed by a market maker varies considerably by asset class and 
differing market conditions.\149\ It may be difficult to distinguish 
principal positions that appropriately support market making-related 
activities from positions taken for short-term, speculative purposes. 
In particular, it may be difficult to determine whether principal risk 
has been retained because (i) the retention of such risk is necessary 
to provide intermediation and liquidity services for a relevant 
financial instrument or (ii) the position is part of a speculative 
trading strategy designed to realize profits from price movements in 
retained principal risk.\150\
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    \149\ With respect to certain kinds of market making-related 
activities, such as market making in securities, these principal 
positions are often referred to as ``inventory'' or ``inventory 
positions.'' However, since certain types of market making-related 
activities, such as market making in derivatives, involve the 
retention of principal positions arising out of multiple derivatives 
transactions in particular risks (e.g., retained principal interest 
rate risk), rather than retention of actual financial instruments, 
the broader term ``principal positions'' is used in this discussion.
    \150\ The Council study contains a detailed discussion of the 
challenges involved in delineating prohibited proprietary trading 
from permitted market making-related activities. See Council study 
at 15-18.
---------------------------------------------------------------------------

    In order to address these complexities, the CFTC has proposed a 
multi-faceted approach that draws on several key elements. First, 
similar to the underwriting exemption, the proposed rule includes a 
number of criteria that a banking entity's activities must meet in 
order to rely on the exemption for market making-related

[[Page 8355]]

activities. These criteria are intended to ensure that the banking 
entity is engaged in bona fide market making. As described in greater 
detail in Part III.D of the Supplementary Information, among these 
criteria is the requirement that the banking entity have in place a 
programmatic compliance regime to guide its compliance with section 13 
of the BHC Act and the proposed rule. This compliance regime includes 
requirements that a banking entity have effective policies, procedures, 
and internal controls that are designed to ensure that prohibited 
proprietary trading positions are not taken under the guise of 
permitted market making-related activity. Second, as described in 
greater detail in Part III.B.5 of this SUPPLEMENTARY INFORMATION: 
Appendix B of the proposed rule contains a detailed commentary 
regarding how the CFTC proposes to identify permitted market making-
related activities. This commentary includes six principles the CFTC 
proposes to use as a guide to help distinguish market-making related 
activities from prohibited proprietary trading. Third, also as 
described in greater detail in Part III.B.5 of this Supplementary 
Information, Sec.  ----.7 and Appendix A of the proposed rule require a 
banking entity with significant covered trading activities to report 
certain quantitative measurements for each of its trading units.\151\ 
These quantitative measurements are intended to assist both banking 
entities and the CFTC in assessing whether the quantitative profile of 
a trading unit (e.g., the types of revenues it generates and the risks 
it retains) is consistent with permitted market making-related 
activities under the proposed rule.
---------------------------------------------------------------------------

    \151\ The definition of ``trading unit'' for this purpose is 
discussed in detail in Part III.B.5 of this SUPPLEMENTARY 
INFORMATION.
---------------------------------------------------------------------------

    The proposal's multi-faceted approach is intended, through the 
incorporation of multiple regulatory and supervisory tools, to strike 
an appropriate balance in implementing the market-making exemption in a 
way that articulates the scope of permitted activities and meaningfully 
addresses the potential for misuse of the exemption, while not unduly 
constraining the important liquidity and intermediation services that 
market makers provide to their customers and to the capital markets at 
large.
    The CFTC requests comment on the proposed rule's approach to 
implementing the exemption for permitted market making-related 
activities. In particular, the CFTC requests comment on the following 
questions:
    Question 80. Is the proposed rule's approach to implementing the 
exemption for permitted market making-related activities (i) 
appropriate and (ii) likely to be effective? If not, what alternative 
approach would be more appropriate or effective?
    Question 81. Does the proposed multi-faceted approach appropriately 
take into account and address the challenges associated with 
differentiating prohibited proprietary trading from permitted market 
making-related activities? Should the approach include other elements? 
If so, what elements and why? Should any of the proposed elements be 
revised or eliminated? If so, why and how?
    Question 82. Does the proposed multi-faceted approach provide 
banking entities and market participants with sufficient clarity 
regarding what constitutes permitted market making-related activities? 
If not, how could greater clarity be provided?
    Question 83. What impact will the proposed multi-faceted approach 
have on the market making-related services that a banking entity 
provides to its customers? How will the proposed approach impact market 
participants who use the services of market makers? How will the 
approach impact the capital markets at large, and in particular the 
liquidity, efficiency and price transparency of capital markets? If any 
of these impacts are positive, how can they be amplified? If any of 
these impacts are negative, how can they be mitigated? Would the 
proposed rule's prohibition on proprietary trading and exemption for 
market making-related activity reduce incentives or opportunities for 
banking entities to trade against customers, as opposed to trading on 
behalf of customers? If so, please discuss the benefits arising from 
such reduced incentives or opportunities.
    Question 84. What burden will the proposed multi-faceted approach 
have on banking entities, their customers, and other market 
participants? How can any burden be minimized or eliminated in a manner 
consistent with the language and purpose of the statute?
    Question 85. Are there particular asset classes that raise special 
concerns in the context of market making-related activity that should 
be considered in connection with the proposed market-making exemption? 
If so, what asset class(es) and concern(s), and how should the concerns 
be addressed in the proposed exemption?
    Question 86. Are there other market making-related activities that 
the rule text should more clearly permit? Why or why not?
ii. Required Criteria for Permitted Market Making-Related Activities
    As part of the proposal's multi-faceted approach to implementing 
the exemption for permitted market making-related activities, Sec.  --
--.4(b)(2) of the proposed rule specifies seven criteria that a banking 
entity's market making-related activities must meet in order to rely on 
the exemption, each of which are described in detail below. These 
criteria are designed to ensure that any banking entity relying on the 
exemption is engaged in bona fide market making-related activities and 
conducts those activities in a way that is not susceptible to abuse 
through the taking of speculative, proprietary positions as a part of, 
or mischaracterized as, market making-related activity.
First Criterion--Establishment of Internal Compliance Program
    Section ----.4(b)(2)(i) of the proposed rule requires a banking 
entity to establish a comprehensive compliance program to monitor and 
control its market making-related activities. Subpart D of the proposed 
rule further describes the appropriate elements of an effective 
compliance program. This criterion is intended to ensure that any 
banking entity relying on the market-making exemption has reasonably 
designed written policies and procedures, internal controls, and 
independent testing in place to support its compliance with the terms 
of the exemption.
Second Criterion--Bona Fide Market Making
    Section ----.4(b)(2)(ii) of the proposed rule articulates the core 
element of the statutory exemption, which is that the activity must be 
market making-related. In order to give effect to this requirement, 
Sec.  ----.4(b)(2)(ii) of the proposed rule requires the trading desk 
or other organizational unit that purchases or sells a particular 
covered financial position to hold itself out as being willing to buy 
and sell, or otherwise enter into long and short positions in, the 
covered financial position for its own account on a regular or 
continuous basis. Notably, this criterion requires that a banking 
entity relying on the exemption with respect to a particular 
transaction must actually make a market in the covered financial 
position involved; simply because a banking entity makes a market in 
one type of covered financial position does not permit it to rely on 
the market-making exemption for another type of covered

[[Page 8356]]

financial position.\152\ Similarly, the particular trading desk or 
other organizational unit of the banking entity that is relying on the 
exemption for a particular type of covered financial position must also 
be the trading desk or other organizational unit that is actually 
making the market in that covered financial position; market making in 
a particular covered financial position by one trading desk of a 
banking entity does not permit another trading desk of the banking 
entity to rely on the market-making exemption for that type of covered 
financial position.
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    \152\ The CFTC notes that a market maker may often make a market 
in one type of covered financial positions and hedge its activities 
using different covered financial positions in which it does not 
make a market. Such hedging transactions would meet the terms of the 
market-making exemption if the hedging transaction met the 
requirements of Sec.  ----.4(b)(3) of the proposed rule.
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    As previously noted, the CFTC is adopting the entire text of the 
Joint Rule as part of its proposed rule. Similarly, the CFTC is 
proposing the same criteria and considerations to determine bona-fide 
market making activities as was previously proposed in the Joint 
Release. Both prior to and since the issuance of the Joint Release, the 
CFTC and the SEC have been working toward the issuance of a joint final 
rule to further define the terms ``swap dealer'' and ``security-based 
swap dealer'' (the ``Entities Definition Rulemaking''). The Commodity 
Exchange Act defines the term ``swap dealer'' to include any person who 
``(i) holds itself out as a dealer in swaps; (ii) makes a market in 
swaps; (iii) regularly enters into swaps with counterparties as an 
ordinary course of business for its own account; or (iv) engages in any 
activity causing the person to be commonly known in the trade as a 
dealer or market maker in swaps.'' \153\ The CFTC has received a number 
of comments in the Entities Definition Rulemaking regarding the 
criteria for determining whether a person is engaging in market making 
activity for the purposes of determining whether a person is a swap 
dealer. Accordingly, the CFTC anticipates that the final rule further 
defining the term ``swap dealer'' will provide guidance on these 
criteria as to market making. Therefore, following the issuance of the 
Entities Definition Rulemaking, the CFTC also may consider the extent 
to which ``market making'' for purposes of determining whether a person 
is a swap dealer should be considered ``bona fide market making'' for 
purposes of this Rule.
---------------------------------------------------------------------------

    \153\ 7 U.S.C. 1a(49). The Exchange Act includes a similar test 
for a security-based swap dealer. 15 U.S.C. 78c(a)(71).
---------------------------------------------------------------------------

    The language used in Sec.  ----.4(b)(2)(ii) of the proposed rule to 
describe bona fide market making-related activity is similar to the 
definition of ``market maker'' under section 3(a)(38) of the Exchange 
Act.\154\ The CFTC has proposed to use similar language because the 
Exchange Act definition is generally well-understood by market 
participants and is consistent with the scope of bona fide market 
making-related activities in which banking entities typically engage.
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    \154\ Section 3(a)(38) of the Exchange Act defines ``market 
maker'' as ``any specialist permitted to act as a dealer, any dealer 
acting in the capacity of block positioner, and any dealer who, with 
respect to a security, holds himself out (by entering quotations in 
an inter-dealer quotation communications system or otherwise) as 
being willing to buy and sell such security for his own account on a 
regular or continuous basis.'' 15 U.S.C. 78c(a)(38).
---------------------------------------------------------------------------

    In assessing whether a particular trading desk or other 
organizational unit holds itself out as being willing to buy and sell, 
or otherwise enter into long and short positions in, a covered 
financial position for its own account on a regular or continuous basis 
in liquid markets, the CFTC expects to take an approach similar to that 
used by the SEC in the context of assessing whether a person is 
engaging in bona fide market making. The precise nature of a market 
maker's activities often varies depending on the liquidity, trade size, 
market infrastructure, trading volumes and frequency, and geographic 
location of the market for any particular covered financial position. 
In the context of relatively liquid positions, such as equity 
securities or other exchange-traded instruments, a trading desk or 
other organizational unit's market making-related activity should 
generally include:
    <bullet> Making continuous, two sided quotes and holding oneself 
out as willing to buy and sell on a continuous basis;
    <bullet> A pattern of trading that includes both purchases and 
sales in roughly comparable amounts to provide liquidity;
    <bullet> Making continuous quotations that are at or near the 
market on both sides; and
    <bullet> Providing widely accessible and broadly disseminated 
quotes.\155\
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    \155\ The CFTC notes that these indicia are generally consistent 
with the indicia of bona fide market making in equity markets 
articulated by the SEC for purposes of describing the exception to 
the locate requirement of the SEC's Regulation SHO for market makers 
engaged in bona fide market-making activities. See Exchange Act 
Release No. 58775 (October 14, 2008), 73 FR 61690, 61698-61699 (Oct. 
17, 2008); see also 17 CFR 242.203(b)(2)(iii).

In less liquid markets, such as over-the-counter markets for debt and 
equity securities or derivatives, the appropriate indicia of market 
---------------------------------------------------------------------------
making-related activities will vary, but should generally include:

    <bullet> Holding oneself out as willing and available to provide 
liquidity by providing quotes on a regular (but not necessarily 
continuous) basis; \156\
---------------------------------------------------------------------------

    \156\ The frequency of such regular quotations will itself vary; 
less illiquid markets may involve quotations on a daily or more 
frequent basis, while highly illiquid markets may trade only by 
appointment.
---------------------------------------------------------------------------

    <bullet> With respect to securities, regularly purchasing covered 
financial positions from, or selling the positions to, clients, 
customers, or counterparties in the secondary market; and
    <bullet> Transaction volumes and risk proportionate to historical 
customer liquidity and investments needs.

The CFTC would apply these indicia when evaluating when a banking 
entity is eligible for the market making-related activities exemption, 
but also recognize that these indicia cannot be applied at all times 
and under all circumstances because some may be inapplicable to the 
specific asset class or market in which the market making activity is 
conducted.

    The bona fide market making-related activity described in Sec.  --
--.4(b)(2)(ii) of the proposed rule would include block positioning if 
undertaken by a trading desk or other organizational unit of a banking 
entity for the purpose of intermediating customer trading.\157\ In 
addition, bona fide market making-related activity may include taking 
positions in securities in anticipation of customer demand, so long as 
any

[[Page 8357]]

anticipatory buying or selling activity is reasonable and related to 
clear, demonstrable trading interest of clients, customers, or 
counterparties.
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    \157\ The definition of ``market maker'' in the Exchange Act 
includes a dealer acting in the capacity of a block positioner. 
Although the term ``block positioner'' is not defined in the 
proposed rule, the Agencies note that the SEC has adopted a 
definition of ``qualified block positioner'' in the SEC's Rule 3b-
8(c) (17 CFR 240.3b-8(c)), which may serve as guidance in 
determining whether a block positioner engaged in block positioning 
is engaged in bona fide market making-related activities for 
purposes of Sec.  ----.4(b)(2)(ii) of the proposed rule. Under the 
SEC's Rule 3b-8(c), among other things, a qualified block positioner 
must meet all of the following conditions: (i) Engages in the 
activity of purchasing long or selling short, from time to time, 
from or to a customer (other than a partner or a joint venture or 
other entity in which a partner, the dealer, or a person associated 
with such dealer participates) a block of stock with a current 
market value of $200,000 or more in a single transaction, or in 
several transactions at approximately the same time, from a single 
source to facilitate a sale or purchase by such customer; (ii) has 
determined in the exercise of reasonable diligence that the block 
could not be sold to or purchased from others on equivalent or 
better terms; and (iii) sells the shares comprising the block as 
rapidly as possible commensurate with the circumstances. The CFTC 
notes that the rule establishes a minimum dollar value threshold for 
a block. The size of a block will vary among different asset 
classes.
---------------------------------------------------------------------------

Third Criterion--Reasonably Expected Near-Term Demands of Clients, 
Customers, and Counterparties
    Under Sec.  ----.4(b)(2)(iii) of the proposed rule, the market 
making-related activities of the trading desk or other organization 
unit that conducts a transaction in reliance on the market-making 
exemption must be designed not to exceed the reasonably expected near-
term demands of clients, customers, and counterparties. This criterion 
implements the language in section 13(d)(1)(B) of the BHC Act and is 
intended to prevent a trading desk relying on the market-making 
exemption from taking a speculative proprietary position unrelated to 
customer needs as part of its purported market making-related 
activities. As described in further detail in Parts III.B.5 and III.D 
of the SUPPLEMENTARY INFORMATION, the proposed rule also includes a 
programmatic compliance requirement and requires reporting of 
quantitative measurements for certain banking entities, both of which 
are designed, in part, to meaningfully circumscribe the principal 
positions taken as part of market making-related activities to those 
which are necessary to meet the reasonably expected near-term demands 
of clients, customers and counterparties. The CFTC expects that the 
programmatic compliance requirement and required reporting of 
quantitative measurements will play an important role in assessing a 
banking entity's compliance with Sec.  ----.4(b)(2)(iii)'s requirement. 
In addition, as described in Part II.B.5 of the Supplementary 
Information, Appendix B of the proposed rule provides additional, 
detailed commentary regarding how the CFTC expects a firm relying on 
the market-making exemption to manage principal positions and how the 
CFTC proposes to assess whether such positions are consistent with 
market making-related activities under the proposed rule.
    In order for a banking entity's expectations regarding near-term 
customer demand to be considered reasonable, such expectations should 
be based on more than a simple expectation of future price appreciation 
and the generic increase in marketplace demand that such price 
appreciation reflects. Rather, a banking entity's expectation should 
generally be based on the unique customer base of the banking entity's 
specific market-making business lines and the near-term demands of 
those customers based on particular factors beyond a general 
expectation of price appreciation. To the extent that a trading desk or 
other organizational unit of a banking entity is engaged wholly or 
principally in trading that is not in response to, or driven by, 
customer demands, the CFTC would not expect those activities to qualify 
under Sec.  ----.4(b) of the proposed rule, regardless of whether those 
activities promote price transparency or liquidity. For example, a 
trading desk or other organizational unit of a banking entity that is 
engaged wholly or principally in arbitrage trading with non-customers 
would not meet the terms of the proposed rule's market making 
exemption. In the case of a market maker engaging in market making in a 
security that is executed on an organized trading facility or exchange, 
that market maker's activities are generally consistent with reasonably 
expected near-term customer demand when such activities involve 
passively providing liquidity by submitting resting orders that 
interact with the orders of others in a non-directional or market-
neutral trading strategy and the market maker is registered, if the 
exchange or organized trading facility registers market makers.\158\ 
However, activities by such a person that primarily takes liquidity on 
an organized trading facility or exchange, rather than provides 
liquidity, would not qualify for the market-making exemption under the 
proposed rule, even if those activities were conducted by a registered 
market maker.
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    \158\ The CFTC emphasizes that the status of being a registered 
market maker is not, on its own, a sufficient basis for relying on 
the exemption for market making-related activity contained in Sec.  
----.4(b); however, being a registered market maker is required 
under these circumstances if the applicable exchange or organized 
trading facility registers market makers. Registration as a market 
maker generally involves filing a prescribed form with an exchange 
or organized trading facility, in accordance with its rules and 
procedures, and complying with the applicable requirements for 
market makers set forth in the rules of that exchange or organized 
trading facility. See, e.g., Nasdaq Rule 4612, New York Stock 
Exchange Rule 104, CBOE Futures Exchange Rule 515, BATS Exchange 
Rule 11.5.
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Fourth Criterion--Registration Under Securities or Commodities Laws
    Under Sec.  ----.4(b)(2)(iv) of the proposed rule, a banking entity 
relying on the market-making exemption with respect to trading in 
securities or certain derivatives must be appropriately registered as a 
dealer, or exempt from registration or excluded from regulation as a 
dealer, under applicable securities or commodities laws. With respect 
to a market-making transaction in one or more covered financial 
positions that are securities, other than exempted securities, 
security-based swaps, commercial paper, bankers acceptances or 
commercial bills, for which a person must be a registered securities 
dealer, municipal securities dealer or government securities dealer in 
order to deal in the security, the banking entity must have the 
appropriate dealer registration (or in the case of a financial 
institution that is a government securities dealer, has filed notice of 
that status as required by section 15C(a)(1)(B) of the Exchange Act) or 
otherwise be exempt from registration or excluded from regulation as a 
dealer.\159\ Similarly, with respect to a market-making transaction 
involving a swap or security-based swap for which a person must 
generally be a registered swap dealer or security-based swap dealer, 
respectively, the banking entity must be appropriately registered or 
otherwise be exempt from registration or excluded from regulation as a 
swap dealer or security-based swap dealer.\160\ If the banking entity 
is engaged in the business of a securities dealer, swap dealer or 
security-based swap dealer outside the United States in a manner for 
which no U.S. registration is required, the banking entity must be 
subject to substantive regulation of its dealing business in the 
jurisdiction in which the business is located. This requirement is 
intended to ensure that

[[Page 8358]]

(i) any market making-related activity conducted in reliance on the 
exemption is subject to appropriate regulation and (ii) a banking 
entity does not simultaneously characterize the transaction as market 
making-related for purposes of the exemption while characterizing it in 
a different manner for purposes of applicable securities or commodities 
laws.
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    \159\ See proposed rule Sec. Sec.  ----.4(b)(2)(iv)(A), (D), 
(E). For example, if a banking entity is a bank engaged in market-
making in qualified Canadian government obligations for which it 
would be required to register as a securities dealer but for the 
exclusion contained in section 3(a)(5)(C)(i)(I) of the Exchange Act, 
the proposed rule would not require that banking entity to be a 
registered securities dealer in order to rely on the market-making 
exemption for that market-making transaction. Such a bank would, 
however, be required to file notice that it is a government 
securities dealer and comply with rules applicable to financial 
institutions that are government securities dealers. See 15 U.S.C. 
78c(a)(42)(E); 15 U.S.C. 78o-5(a)(1)(B); 17 CFR 400.5(b); 17 CFR 
449.1. Similar to the underwriting exemption, the proposed rule does 
not apply the dealer registration requirement to market making in 
securities that are exempted securities, commercial paper, bankers 
acceptances or commercial bills because dealing in such securities 
does not require registration as securities dealer under the 
Exchange Act; however, registering as a municipal securities dealer 
or government securities dealer is required, if applicable.
    \160\ See proposed rule Sec. Sec.  ----.4(b)(2)(iv)(B), (C). A 
banking entity may be required to be a registered securities dealer 
if it engages in market-making transactions involving security-based 
swaps with persons that are not eligible contract participants. See 
15 U.S.C. 78c(a)(5) (the definition of ``dealer'' in section 3(a)(5) 
of the Exchange Act, 15 U.S.C. 78c(a)(5), generally includes ``any 
person engaged in the business of buying and selling securities (not 
including security-based swaps, other than security-based swaps with 
or for persons that are not eligible contract participants), for 
such person's own account.'').
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Fifth Criterion--Revenues From Fees, Commissions, Bid/Ask Spreads or 
Other Similar Income
    Under Sec.  ----.4(b)(2)(v) of the proposed rule, the market 
making-related activities of the banking entity must be designed to 
generate revenues primarily from fees, commissions, bid/ask spreads or 
other income not attributable to appreciation in the value of covered 
financial positions it holds in trading accounts or the hedging of such 
positions. This criterion is intended to ensure that activities 
conducted in reliance on the market-making exemption demonstrate 
patterns of revenue generation and profitability consistent with, and 
related to, the intermediation and liquidity services a market maker 
provides to its customers, rather than changes in the market value of 
the positions or risks held in inventory. Similar to the requirement 
that a firm relying on the market-making exemption design its 
activities not to exceed reasonably expected near-term client, 
customer, or counterparty demands, the Agencies expect that the 
programmatic compliance requirement and required reporting of 
quantitative measurements will play an important role in assessing a 
banking entity's compliance with Sec.  ----.4(b)(2)(v)'s requirement. 
In addition, as described in Part III.B.5 of this SUPPLEMENTARY 
INFORMATION, Appendix B of the proposed rule provides additional, 
detailed commentary regarding how the CFTC proposes to assess whether 
the types of revenues generated by a banking entity relying on the 
market-making exemption are consistent with market making-related 
activities.
Sixth Criterion--Compensation Incentives
    Under Sec.  ----.4(b)(2)(vii) of the proposed rule, the 
compensation arrangements of persons performing market making-related 
activities at the banking entity must be designed not to encourage or 
reward proprietary risk-taking. Activities for which a banking entity 
has established a compensation incentive structure that rewards 
speculation in, and appreciation of, the market value of a covered 
financial position held in inventory, rather than success in providing 
effective and timely intermediation and liquidity services to 
customers, are inconsistent with permitted market making-related 
activities. Although a banking entity relying on the market-making 
exemption may appropriately take into account revenues resulting from 
movements in the price of principal positions to the extent that such 
revenues reflect the effectiveness with which personnel have managed 
principal risk retained, a banking entity relying on the market-making 
exemption should provide compensation incentives that primarily reward 
customer revenues and effective customer service, not proprietary risk-
taking. In addition, as described in Part III.B.5 of this Supplementary 
Information, Appendix B of the proposed rule provides further 
commentary regarding how the CFTC proposes to assess whether the 
compensation incentives provided to trading personnel performing 
trading activities in reliance on the market-making exemption are 
consistent with market making-related activities.
Seventh Criterion--Consistency With Appendix B Commentary
    Under Sec.  ----.4(b)(2)(vi) of the proposed rule, the market 
making-related activities of the trading desk or other organizational 
unit that conducts the purchase or sale are required to be consistent 
with the commentary provided in Appendix B, which provides guidance 
that the CFTC proposes to apply to help distinguish permitted market 
making-related activities from prohibited proprietary trading. Appendix 
B's proposed commentary, which is described in detail below in Part 
III.B.5 of this Supplementary Information, discusses various factors by 
which the CFTC proposes to distinguish prohibited proprietary trading 
from permitted market making-related activities (e.g., how and to what 
extent a market maker hedges the risk of its market-making 
transactions, including (i) further detail related directly to other 
criteria in Sec.  ----.4(b)(2) (e.g., the types of revenues generated 
by market makers), and (ii) expectations regarding other factors not 
expressly included in Sec.  ----.4(b)(2)).
ii. Market Making-Related Hedging
    Section ----.4(b)(3) of the proposed rule provides that certain 
hedging transactions related to market-making positions and holdings 
will also be deemed to be made in connection with a banking entity's 
market making-related activities for purposes of the market-making 
exemption. In particular, Sec.  ----.4(b)(3) provides that the purchase 
or sale of a covered financial position for hedging purposes will 
qualify for the market-making exemption if it meets two requirements. 
First, the purchase or sale must be conducted in order to reduce the 
specific risks to the banking entity in connection with and related to 
individual or aggregated positions, contracts, or other holdings 
acquired pursuant to the market-making exemption. Where the purpose of 
a transaction is to hedge a market making-related position, it would 
appear to be market making-related activity of the type described in 
section 13(d)(1)(B) of the BHC Act. Second, the hedging transaction 
must also meet the criteria specified in the general exemption for 
risk-mitigating hedging activity for purposes of the proprietary 
trading prohibition, which is contained in Sec. Sec.  ----.5(b) and (c) 
of the proposed rule and described in detail in Part III.B.3 of this 
Supplementary Information. Those criteria are intended to clearly 
define the scope of appropriate risk-mitigating hedging activities, to 
foreclose reliance on the exemption for prohibited proprietary trading 
that is conducted in the context of, or mischaracterized as, hedging 
activity, and to require documentation regarding the hedging purpose of 
certain transactions that are established at a level of organization 
that is different than the level of organization establishing or 
responsible for the underlying risk or risks that are being hedged, 
which in the context of the market making-related activity would 
generally be the trading desk.
iii. Request for Comment
    The CFTC requests comment on the proposed criteria that must be met 
in order to rely on the market-making exemption. In particular, the 
CFTC requests comment on the following questions (as well as related 
questions in Part III.B.5 of this Supplementary Information):
    Question 87. Are the seven criteria included in the market-making 
exemption effective? Is the application of each criterion to potential 
transactions sufficiently clear? Should any of the criteria be changed 
or eliminated? Should other criteria be added?
    Question 87.1. Should the proposed CFTC Rule's market making 
exemption include the requirements set forth in Sec. Sec.  --
--.4(b)(2)(iv)(A),(C), (D) and (E), relating to SEC registered dealers 
and dealers who have filed notice with the appropriate regulatory 
agency? Please explain the rationale for including or excluding the 
provision in the proposed CFTC Rule.

[[Page 8359]]

    Question 88. Is incorporation of concepts from the definition of 
``market maker'' under the Exchange Act useful for purposes of section 
13 of the BHC Act and consistent with its purposes? If not, what 
alternative definition would be more useful or more consistent?
    Question 88.1. Alternatively, to what extent should the CFTC 
incorporate concepts regarding market making from the Entities 
Definitions Rulemaking for purposes of section 13 of the BHC Act?
    Question 89. Is the proposed exemption overly broad or narrow? For 
example, would it encompass activity that should be considered 
prohibited proprietary trading under the proposed rule? Alternatively, 
would it prohibit forms of market making or market making-related 
activities that are permitted under other rules or regulations?
    Question 90. We seek commenter input on the types of banking 
entities and forms of activities that would not qualify for the 
proposed market-making exemption but that commenters consider to 
otherwise be market making. Please discuss the impact of not permitting 
such activities under the proposed exemption (e.g., the impact on 
liquidity).
    Question 91. Is the requirement that a trading desk or other 
organizational unit relying on the market-making exemption hold itself 
out as being willing to buy and sell, or otherwise enter into long and 
short positions in, the relevant covered financial position for its own 
account on a regular or continuous basis effective? If not, what 
alternative would be more effective? Does the proposed requirement 
appropriately differentiate between market making-related activities in 
different markets and asset classes? If not, how could such differences 
be better reflected? Should the requirement be modified to include 
certain arbitrage trading activities engaged in by market makers that 
promote liquidity or price transparency, but do not serve customer, 
client or counterparty demands, within the scope of market making-
related activity? If so why? How could such liquidity- or price 
transparency-promoting activities be meaningfully identified and 
distinguished from prohibited proprietary trading practices that also 
may incidentally promote liquidity or price transparency? Do particular 
markets or instruments, such as the market for exchange-traded funds, 
raise particular issues that are not adequately or appropriately 
addressed in the proposal? If so, how could the proposal better address 
those instruments, markets or market features?
    Question 92. Do the proposed indicia of market making in liquid 
markets accurately reflect the factors that should generally be used to 
analyze whether a banking entity is engaged in market making-related 
activities for purposes of section 13 of the BHC Act and the proposed 
rule? If not, why not? Should any of the proposed factors be eliminated 
or modified? Should any additional factors be included? Is reliance on 
the SEC's indicia of bona fide market making for purposes of Regulation 
SHO under the Exchange Act and the equity securities market appropriate 
in the context of section 13 of the BHC Act and the proposed rule with 
respect to liquid markets? If not, why not?
    Question 93. Do the proposed indicia of market making in illiquid 
markets accurately reflect the factors that should generally be used to 
analyze whether a banking entity is engaged in market making-related 
activities for purposes of section 13 of the BHC Act and the proposed 
rule? If not, why not? Should any of the proposed factors be eliminated 
or modified? Should any additional factors be included?
    Question 94. How accurately can a banking entity predict the near-
term demands of clients, customers, and counterparties? Are there 
measures that can distinguish the amount of principal risk that should 
be retained to support such near-term client, customer, or counterparty 
demand from positions taken for speculative purposes? How is client, 
customer, or counterparty demand anticipated in connection with market 
making-related activities, and how does such approach vary by asset 
class?
    Question 95. Is the requirement that a banking entity relying on 
the market-making exemption be registered as a dealer (or in the case 
of a financial institution that is a government securities dealer, has 
filed notice of that status as required by section 15C(a)(1)(B) of the 
Exchange Act), or exempt from registration or excluded from regulation 
as a dealer under relevant securities or commodities laws effective? If 
not, how should the requirement be changed? Does the requirement 
appropriately take into account the particular registration 
requirements applicable to dealing in different types of financial 
instruments? If not, how could it better do so? Does the requirement 
appropriately take into account the various registration exemptions and 
exclusions available to certain entities, such as banks, under the 
securities and commodities laws? If not, how could it better do so?
    Question 96. Is the requirement that a trading desk or other 
organizational unit of a banking entity relying on the market-making 
exemption be designed to generate revenues primarily from fees, 
commissions, bid/ask spreads or similar income effective? If not, how 
should the requirement be changed? Does the requirement appropriately 
capture the type and nature of revenues typically generated by market 
making-related activities? Is any further clarification or additional 
guidance necessary? Can revenues primarily from fees, commissions, bid/
ask spreads or similar income be meaningfully separated from other 
types of revenues?
    Question 97. Is the requirement that the compensation arrangements 
of persons performing market making-related activities at a banking 
entity not be designed to encourage proprietary risk-taking effective? 
If not, how should the requirement be changed? Are there other types of 
compensation incentives that should be clearly referenced as 
consistent, or inconsistent, with permitted market making-related 
activity? Are their specific and identifiable characteristics of 
compensation arrangements that clearly incentivize prohibited 
proprietary trading?
    Question 98. Is the inclusion of market making-related hedging 
transactions within the market-making exemption effective and 
appropriate? Are the proposed requirements that certain hedging 
transactions must meet in order to be considered to have been made in 
connection with market making-related activity effective and 
sufficiently clear? If not, what alternative requirements would be more 
effective and/or clearer? Should any of the proposed requirements be 
eliminated? If so, which ones, and why?
    Question 99. Should the terms ``client,'' ``customer,'' or 
``counterparty'' be defined for purposes of the 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?
    Question 100. Are there other types of market making-related 
activities that should also be included within the

[[Page 8360]]

scope of the market-making exemption? If so, what additional activities 
and why? How would an exemption for such additional activities be 
consistent with the language and intent of section 13 of the BHC Act? 
What criteria, requirements, or restrictions would be appropriate to 
include with respect to such additional activities? How would such 
criteria, requirements, or restrictions prevent circumvention or 
evasion of the prohibition on proprietary trading?
    Question 101. Do banking entities currently have processes in place 
that would prevent or reduce the likelihood of taking speculative, 
proprietary positions in the context of, or mischaracterized as, market 
making-related activities? If so, what processes?
3. Section ---- .5: Permitted Risk-Mitigating Hedging Activities
    Section ---- .5 of the proposed rule permits a banking entity to 
purchase or sell a covered financial position if the transaction is 
made in connection with, and related to, individual or aggregated 
positions, contracts, or other holdings of a banking entity and is 
designed to reduce the specific risks to the banking entity in 
connection with and related to such positions, contracts, or other 
holdings (the ``hedging exemption''). This section of the proposed rule 
implements, in relevant part, section 13(d)(1)(C) of the BHC Act, which 
provides an exemption from the prohibition on proprietary trading for 
certain risk-mitigating hedging activities.
a. Approach To Implementing the Hedging Exemption
    Like market making-related activities, risk-mitigating hedging 
activities present certain implementation challenges because of the 
potential that prohibited proprietary trading could be conducted in the 
context of, or mischaracterized as, a hedging transaction. This is 
because it may often be difficult to identify in retrospect whether a 
banking entity engaged in a particular transaction to manage or 
eliminate risks arising from related positions, on the one hand, or to 
profit from price movements related to the hedge position itself, on 
the other. The intent with which a purported hedge position is acquired 
may often be difficult to discern in practice.
    In light of these complexities, the CFTC has again proposed a 
multi-faceted approach to implementation. As with the underwriting and 
market-making exemptions, the CFTC has proposed a set of criteria that 
must be met in order for a banking entity to rely on the hedging 
exemption. The proposed criteria are intended to define the scope of 
permitted risk-mitigating hedging activities and to foreclose reliance 
on the exemption for prohibited proprietary trading that is conducted 
in the context of, or mischaracterized as, permitted hedging activity. 
This includes implementation of the programmatic compliance regime 
required under subpart D of the proposed rule and, in particular, 
requires that a banking entity with significant trading activities 
implement robust, detailed hedging policies and procedures and related 
internal controls that are designed to prevent prohibited proprietary 
trading in the context of permitted hedging activity.\161\ In 
particular, a banking entity's compliance regime must include written 
hedging policies at the trading unit level and clearly articulated 
trader mandates for each trader to ensure that the decision of when and 
how to put on a hedge is consistent with such policies and mandates, 
and not fully left to a trader's discretion.\162\ In addition, to 
address potential supervisory concerns raised by certain types of 
hedging transactions, Sec.  ---- .5 of the proposed rule also requires 
a banking entity to document certain hedging transactions at the time 
the hedge is established. This multi-faceted approach is intended to 
articulate the CFTC's expectations regarding the scope of permitted 
risk-mitigating hedging activities in a manner that limits potential 
abuse of the hedging exemption while not unduly constraining the 
important risk management function that is served by a banking entity's 
hedging activities.
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    \161\ These aspects of the compliance program requirement are 
described in further detail in Part III.D of this Supplementary 
Information.
    \162\ See, e.g., proposed rule Appendix C.II.a.
---------------------------------------------------------------------------

b. Required Criteria for Permitted Risk-Mitigating Hedging Activities
    Section ---- .5(b) of the proposed rule describes the seven 
criteria that a banking entity must meet in order to rely on the 
hedging exemption. First, Sec.  ---- .5(b)(1) of the proposed rule 
requires the banking entity to have established an internal compliance 
program, consistent with the requirements of subpart D, that is 
designed to ensure the banking entity's compliance with the 
requirements of this paragraph, including reasonably-designed written 
policies and procedures, internal controls, and independent testing. 
This criterion is intended to ensure that any banking entity relying on 
the exemption has appropriate internal control processes in place to 
support its compliance with the terms of the exemption.
    Second, Sec.  ---- .5(b)(2)(i) of the proposed rule requires that a 
transaction for which a banking entity is relying on the hedging 
exemption have been made in accordance with written policies, 
procedures and internal controls established by the banking entity 
pursuant to subpart D. This criterion would preclude reliance on the 
hedging exemption if the transaction was inconsistent with a banking 
entity's own hedging policies and procedures, as such inconsistency 
would appear to be indicative of prohibited proprietary trading.
    Third, Sec.  ---- .5(b)(2)(ii) of the proposed rule requires that 
the transaction hedge or otherwise mitigate one or more specific risks, 
including market risk, counterparty or other credit risk, currency or 
foreign exchange risk, interest rate risk, basis risk, or similar 
risks, arising in connection with and related to individual or 
aggregated positions, contracts, or other holdings of a banking entity. 
This criterion implements the essential element of the hedging 
exemption--i.e., that the transaction be risk-mitigating. Notably, and 
consistent with the statutory reference to mitigating risks of 
individual or aggregated positions, this criterion would include the 
hedging of risks on a portfolio basis. For example, it would include 
the hedging of one or more specific risks arising from a portfolio of 
diverse holdings, such as the hedging of the aggregate risk of one or 
more trading desks. However, in each case, the CFTC would expect that 
the transaction or series of transactions being used to hedge is, in 
the aggregate, demonstrably risk-reducing with respect to the 
positions, contracts, or other holdings that are being hedged. A 
banking entity relying on the exemption should be prepared to identify 
the specific position or portfolio of positions that is being hedged 
and demonstrate that the hedging transaction is risk-reducing in the 
aggregate, as measured by appropriate risk management tools.
    In addition, this criterion would include a series of hedging 
transactions designed to hedge movements in the price of a portfolio of 
positions. For example, a banking entity may need to engage in dynamic 
hedging, which involves rebalancing its current hedge position(s) based 
on a change in the portfolio resulting from permissible activities or 
from a change in the price, or other characteristic, of the individual 
or aggregated positions, contracts, or other holdings. The CFTC 
recognizes that, in such dynamic hedging, material

[[Page 8361]]

changes in risk may require a corresponding modification to the banking 
entity's current hedge positions.\163\
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    \163\ 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 
proposed rule Sec.  ----.5(b)(2)(iii).
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    The CFTC also expects that a banking entity relying on the 
exemption would be able to demonstrate that the banking entity is 
already exposed to the specific risks being hedged; generally, the 
purported hedging of risks to which the banking entity is not actually 
exposed would not meet the terms of the exemption. However, the hedging 
exemption would be available in certain cases where the hedge is 
established slightly before the banking entity becomes exposed to the 
underlying risk if such anticipatory hedging activity: (i) Is 
consistent with appropriate risk management practices; (ii) otherwise 
meets the terms of the hedging exemption; and (iii) does not involve 
the potential for speculative profit. For example, if a banking entity 
was contractually obligated, or otherwise highly likely, to become 
exposed to a particular risk and there was a sound risk management 
rationale for hedging that risk slightly in advance of actual exposure, 
the hedging transaction would generally be consistent with the 
requirement described in Sec.  ----.5(b)(2)(ii) of the proposed rule.
    Fourth, Sec.  ----.5(b)(2)(iii) of the proposed rule requires that 
the transaction be reasonably correlated, based upon the facts and 
circumstances of the underlying and hedging positions and the risks and 
liquidity of those positions, to the risk or risks the transaction is 
intended to hedge or otherwise mitigate. A transaction that is only 
tangentially related to the risks that it purportedly mitigates would 
appear to be indicative of prohibited proprietary trading. Importantly, 
the CFTC has not proposed that a transaction relying on the hedging 
exemption be fully correlated; instead, only reasonable correlation is 
required.\164\ The degree of correlation that may be reasonable will 
vary depending on the underlying risks and the availability of 
alternative hedging options--risks that can be easily and cost-
effectively hedged with extremely high or near-perfect correlation 
would typically be expected to be so hedged, whereas other risks may be 
difficult or impossible to hedge with anything greater than partial 
correlation. Moreover, it is important to consider the fact that 
trading positions are often subject to a number of different risks, and 
some risks may be hedged easily and at low cost but may only account 
for a small proportion of the total risk in the position.\165\ More 
generally, potential correlation levels between asset classes can 
differ significantly, and analysis of the reasonableness of correlation 
would depend on the facts and circumstances of the initial position(s), 
risk(s) created, liquidity of the instrument, and the legitimacy of the 
hedge. Regardless of the precise degree of correlation, if the 
predicted performance of a hedge position during the period that the 
hedge position and the related position are held would result in a 
banking entity earning appreciably more profits on the hedge position 
than it stood to lose on the related position, the hedge would appear 
likely to be a proprietary trade designed to result in profit rather 
than an exempt hedge position.
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    \164\ Although certain accounting standards, such as FASB ASC 
Topic 815 hedge accounting, address circumstances in which a 
transaction may be considered a hedge of another transaction, the 
proposed rule does not refer to or rely on these accounting 
standards, because such standards (i) are designed for financial 
statement purposes, not to identify proprietary trading and (ii) 
change often and are likely to change in the future without 
consideration of the potential impact on section 13 of the BHC Act.
    \165\ Interest rate risk in an equity derivative transaction is 
one example--the hedging of interest rate risk in an equity 
derivative position may only result in a small reduction in overall 
risk and interest rates may only exhibit a small correlation with 
the value of the equity derivative, but the lack of perfect or 
significant correlation would not impair reliance on the hedging 
exemption.
---------------------------------------------------------------------------

    Fifth, Sec.  ----.5(b)(2)(iv) of the proposed rule requires that 
the hedging transaction not give rise, at the inception of the hedge, 
to significant exposures that are not themselves hedged in a 
contemporaneous transaction. A transaction that creates significant new 
risk exposure that is not itself hedged at the same time would appear 
to be indicative of prohibited proprietary trading. For example, over-
hedging, correlation trading, or pairs trading strategies that generate 
profits through speculative, proprietary risk-taking would fail to meet 
this criterion. Similarly, a transaction involving a pair of positions 
that hedge each other with respect to one type of risk exposure, but 
create or contain a residual risk exposure would, taken together, 
constitute prohibited proprietary trading and not risk-mitigating 
hedging if those positions were taken collectively for the purpose of 
profiting from short-term movements in the effective price of the 
residual risk exposure. However, the proposal also recognizes that any 
hedging transaction will inevitably give rise to certain types of new 
risk, such as counterparty credit risk or basis risk reflecting the 
differences between the hedge position and the related position; the 
proposed criterion only prohibits the introduction of additional 
significant exposures through the hedging transaction. In addition, 
proposed Sec.  ----.5(b)(2)(iv) only requires that no new and 
significant exposures be introduced at the inception of the hedge, and 
not during the entire period that the hedge is maintained, reflecting 
the fact that new, unanticipated risks can and sometimes do arise out 
of hedging positions after the hedge is established. The CFTC has 
proposed to address the appropriate management of risks that arise out 
of a hedge position after inception through Sec.  ----.5(b)(2)(v) of 
the proposed rule.
    Sixth, Sec.  ----.5(b)(2)(v) of the proposed rule requires that any 
transaction conducted in reliance on the hedging exemption be subject 
to continuing review, monitoring and management after the hedge 
position is established. Such review, monitoring, and management must: 
(i) be consistent with the banking entity's written hedging policies 
and procedures; (ii) maintain a reasonable level of correlation, based 
upon the facts and circumstances of the underlying and hedging 
positions and the risks and liquidity of those positions, to the risk 
or risks the purchase or sale is intended to hedge or otherwise 
mitigate; and (iii) mitigate any significant exposure arising out of 
the hedge after inception. In accordance with a banking entity's 
written internal hedging policies, procedures, and internal controls, a 
banking entity should actively review and manage its hedging positions 
and the risks that may arise out of those positions over time. A 
banking entity's internal hedging policies should be designed to ensure 
that hedges remain effective as correlations or other factors change. 
In particular, a risk-mitigating hedge position typically should be 
unwound as exposure to the underlying risk is reduced or increased as 
underlying risk increases, as selective hedging activity would appear 
to be indicative of prohibited proprietary trading.\166\ A banking 
entity's written internal hedging policies, procedures, and internal 
controls for monitoring and managing its hedges also should be 
reasonably designed to prevent the occurrence of such prohibited

[[Page 8362]]

proprietary trading activity and be reasonably specific about the level 
of hedging that is expected to be maintained regardless of 
opportunities for profit associated with over- or under-hedging.
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    \166\ The CFTC notes that in some cases, it may be appropriate 
for a banking entity to unwind a hedge, even if the underlying risk 
remains, if the cost of that hedge become uneconomic, better hedging 
options become available, or the overall risk profile of the banking 
entity has changed such that no longer hedging the risk is 
consistent with appropriate risk management practices.
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    Seventh, Sec.  ----.5(b)(2)(vi) of the proposed rule requires that 
the compensation arrangements of persons performing the risk-mitigating 
hedging activities are designed not to reward proprietary risk-taking. 
Hedging activities for which a banking entity has established a 
compensation incentive structure that rewards speculation in, and 
appreciation of, the market value of a covered financial position, 
rather than success in reducing risk, are inconsistent with permitted 
risk-mitigating hedging activities.
c. Documentation Requirement
    Section ----.5(c) of the proposed rule imposes a documentation 
requirement on certain types of hedging transactions. Specifically, for 
any transaction that a banking entity conducts in reliance on the 
hedging exemption that involves a hedge established at a level of 
organization that is different than the level of organization 
establishing the positions, contracts, or other holdings the risks of 
which the hedging transaction is designed to reduce, the banking entity 
must, at a minimum, document the risk-mitigating purpose of the 
transaction and identify the risks of the individual or aggregated 
positions, contracts, or other holdings of a banking entity that the 
transaction is designed to reduce.\167\ Such documentation must be 
established at the time the hedging transaction is effected, not after 
the fact. The CFTC is concerned that hedging transactions established 
at a different level of organization than the positions being hedged 
may present or reflect heightened potential for prohibited proprietary 
trading, as a banking entity may be able, after the fact, to point to a 
particular, offsetting exposure within its organization after a 
position is established and characterize that position as a hedge even 
when, at the time the position was established, it was intended to 
generate speculative proprietary gains, not mitigate risk. To address 
this concern, the CFTC has proposed to require a banking entity, when 
establishing a hedge at a different level of organization than that 
establishing or responsible for the underlying positions or risks being 
hedged, to document the hedging purpose of the transaction and risks 
being hedged so as to establish a contemporaneous, documentary record 
that will assist the CFTC in assessing the actual reasons for which the 
position was established.
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    \167\ For example, a hedge would be established at a different 
level of organization of the banking entity if multiple market 
making desks were exposed to similar risks and, to hedge such risks, 
a portfolio hedge was established at the direction of a supervisor 
or risk manager responsible for more than one desk rather than at 
each of the market making desks that established the initial 
positions, contracts, or other holdings.
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d. Request for Comment
    The CFTC requests comment on the proposed implementation of the 
risk-mitigating hedging exemption with respect to proprietary trading. 
In particular, the CFTC requests comment on the following questions:
    Question 102. Is the proposed rule's approach to implementing the 
hedging exemption effective? If not, what alternative approach would be 
more effective?
    Question 103. Does the proposed multi-faceted approach 
appropriately take into account and address the challenges associated 
with differentiating prohibited proprietary trading from permitted 
hedging activities? Should the approach include other elements? If so, 
what elements and why? Should any of the proposed elements be revised 
or eliminated? If so, why and how?
    Question 104. Does the proposed approach to implementing the 
hedging exemption provide banking entities and market participants with 
sufficient clarity regarding what constitutes permitted hedging 
activities? If not, how could greater clarity be provided?
    Question 105. What impact will the proposed approach to 
implementing the hedging exemption have on the hedging and risk 
management activities of a banking entity and the services it provides 
to its clients? If any of these impacts are positive, how can they be 
amplified? If any of these impacts are negative, how can they be 
mitigated?
    Question 106. What burden will the proposed approach to 
implementing the hedging exemption have on banking entities? How can 
any burden be minimized or eliminated in a manner consistent with the 
language and purpose of the statute?
    Question 107. Are the criteria included in the hedging exemption 
effective? Is the application of each criterion to potential 
transactions sufficiently clear? Should any of the criteria be changed 
or eliminated? Should other requirements be added?
    Question 108. Is the requirement that a transaction hedge or 
otherwise mitigate one or more specific risks, including market risk, 
counterparty or other credit risk, currency or foreign exchange risk, 
interest rate risk, basis risk, or similar risks, arising in connection 
with and related to individual or aggregated positions, contracts, or 
other holdings of a banking entity effective? If not, what requirement 
would be more effective? Does the proposed approach sufficiently 
articulate the types of risks that a banking entity typically hedges? 
Does the proposal sufficiently address application of the hedging 
exemption to portfolio hedging strategies? If not, how should the 
proposal be changed?
    Question 109. Does the manner in which section ----.5 of the 
proposal implements the risk-mitigating hedging exemption effectively 
address transactions that hedge or otherwise mitigate specific risks 
arising in connection with and related to aggregated positions, 
contracts, or other holdings of a banking entity? Do certain hedging 
strategies or techniques that involve hedging the risks of aggregated 
positions (e.g., portfolio hedging) (i) create the potential for abuse 
of the hedging exemption or (ii) give rise to challenges in determining 
whether a banking entity is engaged in exempt, risk-mitigating hedging 
activity or prohibited proprietary trading? If so, what hedging 
strategies and techniques, and how? Should additional restrictions, 
conditions, or requirements be placed on the use of the hedging 
exemption with respect to aggregated positions so as to limit potential 
abuse of the exemption, assist banking entities and the CFTC in 
determining compliance with the exemption, or otherwise improve the 
effectiveness of the rule? If so, what additional restrictions, 
conditions, or requirements, and why?
    Question 110. Is the requirement that the transaction be reasonably 
correlated to the risk or risks the transaction is intended to hedge or 
otherwise mitigate effective? If not, how should the requirement be 
changed? Should some specific level of correlation and/or hedge 
effectiveness be required? Should the proposal specify in greater 
detail how correlation should be measured? Should the proposal require 
hedges to be effective in periods of financial stress? Does the 
proposal sufficiently reflect differences in levels of correlation 
among asset classes? If not, how could it better do so?
    Question 111. Is the requirement that the transaction not give 
rise, at the inception of the hedge, to significant exposures that are 
not themselves hedged in a contemporaneous transaction effective? Does 
the requirement establish an appropriate range for legitimate hedging 
while

[[Page 8363]]

constraining impermissible proprietary trading? Is this requirement 
sufficiently clear? If not, what alternative would be more effective 
and/or clearer? Are there types of risk-mitigating hedging activities 
that may give rise to new and significant exposures that should be 
permitted under the hedging exemption? If so, what activities? Should 
the requirement that no significant exposure be introduced be extended 
for the duration of the hedging position? If so, why?
    Question 112. Is the requirement that any transaction conducted in 
reliance on the hedging exemption be subject to continuing review, 
monitoring and management after the transaction is established 
effective? If not, what alternative would be more effective?
    Question 113. Is the requirement that the compensation arrangements 
of persons performing risk-mitigating hedging activities at a banking 
entity be designed not to reward proprietary risk-taking effective? If 
not, how should the requirement be changed? Are there other types of 
compensation incentives that should be clearly referenced as 
consistent, or inconsistent, with permitted risk-mitigating hedging 
activity? Are there specific and identifiable characteristics of 
compensation arrangements that clearly incentivize prohibited 
proprietary trading?
    Question 114. Is the proposed documentation requirement effective? 
If not, what alternative would be more effective? Are there certain 
additional types of hedging transactions that should be subject to the 
documentation requirement? If so, what transactions and why? Should all 
types of hedging transactions be subject to the documentation 
requirement? If so, why? Should banking entities be required to 
document more aspects of a particular transaction (e.g., all of the 
criteria applicable to Sec.  ----.5(b) of the proposed rule)? If so, 
what aspects and why? What burden would the proposed documentation 
requirement place on banking entities? How might such burden be reduced 
or eliminated in a manner consistent with the language and purpose of 
the statute?
    Question 115. Aside from the required documentation, do the 
substantive requirements of the proposed risk-mitigating hedging 
exemption suggest that additional documentation would be required to 
achieve compliance with the proposed rule? If so, what burden would 
this additional documentation requirement place on banking entities? 
How might such burden be reduced or eliminated in a manner consistent 
with the language and purpose of the statute?
4. Section --.6: Other Permitted Trading Activities
    Section ----.6 of the proposed rule permits a banking entity to 
engage in certain other trading activities described in section 
13(d)(1) of the BHC Act. These permitted activities include trading in 
certain government obligations, trading on behalf of customers, trading 
by insurance companies, and trading outside of the United States by 
certain foreign banking entities. Section ----.6 of the proposed rule 
does not contain all of the statutory exemptions contained in section 
13(d)(1) of the BHC Act. Several of these exemptions appear, either by 
plain language or by implication, to be intended to apply only to 
covered fund activities and investments, and so the CFTC has not 
proposed to include them in the proposed rule's proprietary trading 
provisions.\168\ Those exemptions are referenced in other portions of 
the proposed rule pertaining to covered funds.
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    \168\ In particular, the proposed rule does not apply (i) the 
exemption in section 13(d)(1)(E) of the BHC Act for SBICs and 
certain public welfare or qualified rehabilitation investments, or 
(ii) the exemptions in sections 13(d)(1)(G) and 13(d)(1)(I) of the 
BHC Act for certain covered funds activities and investments, to the 
proprietary trading provisions of subpart B.
---------------------------------------------------------------------------

    The CFTC requests comment on the proposed rule's approach to 
implementing the exemptions contained in section 13(d)(1) of the BHC 
Act to the proposed rule's proprietary trading provisions. In 
particular, the CFTC requests comment on the following questions:
    Question 116. Is the proposed rule's approach of identifying which 
of the statutory exemptions contained in section 13(d)(1) of the BHC 
Act apply to the proposed rule's proprietary trading provisions 
effective and/or consistent with the language and purpose of the 
statute? If not, what alternative would be more effective and/or 
consistent with the language and purpose of the statute?
    Question 117. Are there statutory exemptions that should apply to 
the proposed rule's proprietary trading provisions that were not 
included? If so, what exemptions and why?
    Question 118. Are there statutory exemptions that were included in 
the proposed rule's proprietary trading provisions that should not have 
been included? If so, what exemptions and why?
a. Permitted Trading in Government Obligations
    Section ----.6(a) of the proposed rule, which implements section 
13(d)(1)(A) of the BHC Act,\169\ permits the purchase or sale of a 
covered financial position that is: (i) an obligation of the United 
States or any agency thereof;\170\ (ii) an obligation, participation, 
or other instrument of or issued by the Government National Mortgage 
Association, the Federal National Mortgage Association, the Federal 
Home Loan Mortgage Corporation, a Federal Home Loan Bank, the Federal 
Agricultural Mortgage Corporation or a Farm Credit System institution 
chartered under and subject to the provisions of the Farm Credit Act of 
1971 (12 U.S.C. 2001 et seq.); or (iii) an obligation issued by any 
State or any political subdivision thereof.\171\ The proposed rule also 
clarifies that these obligations include limited as well as general 
obligations of the relevant government entity. The CFTC notes that, 
consistent with the statutory language, the types of instruments 
described with respect to the enumerated government-sponsored entities 
include not only obligations of such entities, but also participations 
and other instruments of or issued by such entity. This would include, 
for example, pass-through or participation certificates that are issued 
and guaranteed by one of these government-sponsored entities (e.g., the 
Federal National Mortgage Association and the Federal Home Loan 
Mortgage Corporation) in connection with their securitization 
activities.
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    \169\ Section 13(d)(1)(A) of the BHC Act permits a banking 
entity to purchase, sell, acquire or dispose securities and other 
instruments described in section 13(h)(4) of the BHC Act if those 
securities or other instruments are specified types of government 
obligations, notwithstanding the prohibition on proprietary trading. 
See 12 U.S.C. 1851(d)(1)(A).
    \170\ The CFTC proposes that United States ``agencies'' for this 
purpose will include those agencies described in section 201.108(b) 
of the Board's Regulation A. See 12 CFR 201.108(b). The CFTC also 
notes that the terms of the exemption would encompass the purchase 
or sale of enumerated government obligations on a forward basis 
(e.g., in a to-be-announced market).
    \171\ Consistent with the statutory language, the proposed rule 
does not extend the government obligations exemption to transactions 
in obligations of an agency of any State or political subdivision 
thereof.
---------------------------------------------------------------------------

    The CFTC requests comment on the proposed rule's approach to 
implementing the government obligation exemption. In particular, the 
CFTC requests comment on the following questions:
    Question 119. Is the proposed rule's application to trading in 
government obligations sufficiently clear? Should such obligations 
expressly include, for example, instruments issued by third parties but 
insured or guaranteed by an enumerated government entity or

[[Page 8364]]

otherwise backed by its full faith and credit?
    Question 120. Should the CFTC adopt an additional exemption for 
proprietary trading in State or municipal agency obligations under 
section 13(d)(1)(J) of the BHC Act? If so, how would such an exemption 
promote and protect the safety and soundness of banking entities and 
the financial stability of the United States?
    Question 121. Should the CFTC adopt an additional exemption for 
proprietary trading in options or other derivatives referencing an 
enumerated government obligation under section 13(d)(1)(J) of the BHC 
Act? For example, should the CFTC provide an exemption for options or 
other derivatives with respect to U.S. government debt obligations? If 
so, how would such an exemption promote and protect the safety and 
soundness of banking entities and the financial stability of the United 
States?
    Question 122. Should the CFTC adopt an additional exemption for 
proprietary trading in the obligations of foreign governments and/or 
international and multinational development banks under section 
13(d)(1)(J) of the BHC Act? If so, what types of obligations should be 
exempt? How would such an exemption promote and protect the safety and 
soundness of banking entities and the financial stability of the United 
States?
    Question 123. Should the CFTC adopt an additional exemption for 
proprietary trading in any other type of government obligations under 
section 13(d)(1)(J) of the BHC Act? If so, how would such an exemption 
promote and protect the safety and soundness of banking entities and 
the financial stability of the United States?
    Question 124. Are the definitions of ``government security'' and 
``municipal security'' in sections 3(a)(42) and 3(a)(29) of the 
Exchange Act helpful in determining the proper scope of this exemption? 
If so, please explain their utility and how incorporating such 
definitions into the exemption would be consistent with the language 
and purpose of section 13 of the BHC Act.
b. Permitted Trading on Behalf of Customers
    Section 13(d)(1)(D) of the BHC Act permits a banking entity to 
purchase or sell a covered financial position on behalf of customers, 
notwithstanding the prohibition on proprietary trading. Section --
--.6(b) of the proposed rule implements this section. Because the 
statute does not specifically define when a transaction would be 
conducted ``on behalf of customers,'' the proposed rule identifies 
three categories of transactions that, while they may involve a banking 
entity acting as principal for certain purposes, appear to be on behalf 
of customers within the purpose and meaning of the statute. As 
proposed, only transactions meeting the terms of these three categories 
would be considered on behalf of customers for purposes of the 
exemption.
    Section ----.6(b)(i) of the proposed rule provides that a purchase 
or sale of a covered financial position is on behalf of customers if 
the transaction (i) is conducted by a banking entity acting as 
investment adviser, commodity trading advisor, trustee, or in a similar 
fiduciary capacity for a customer and for the account of that customer, 
and (ii) involves solely covered financial positions of which the 
banking entity's customer, and not the banking entity or any subsidiary 
or affiliate of the banking entity, is beneficial owner (including as a 
result of having long or short exposure under the relevant covered 
financial position). This category is intended to capture a wide range 
of trading activity conducted in the context of customer-driven 
investment or commodity advisory, trust, or fiduciary services, so long 
as that activity is structured in a way that the customer, and not the 
banking entity providing those services, benefits from any gains and 
suffers from any losses on such covered financial positions.\172\ A 
transaction that is structured so as to involve a listed form of 
relationship but nonetheless allows gains or losses from trading 
activity to inure to the benefit or detriment of the banking entity 
would fall outside the scope of this category.
---------------------------------------------------------------------------

    \172\ For example, in the case of a banking entity acting as 
investment adviser to a registered mutual fund, any trading by the 
banking entity in its capacity of investment adviser and on behalf 
of that fund would be permitted pursuant to Sec.  ----.6(b)(i) of 
the proposed rule, so long as the relevant criteria were met.
---------------------------------------------------------------------------

    Section ----.6(b)(ii) of the proposed rule provides that a 
transaction is on behalf of customers if the banking entity is acting 
as riskless principal. These type of transactions are similarly 
customer-driven and do not expose the banking entity to gains or losses 
on the value of the traded positions, notwithstanding the fact that the 
banking entity technically acts as principal. The CFTC notes that the 
proposed language describing riskless principal transactions generally 
mirrors that used in the Board's Regulation Y, OCC interpretive 
letters, and the SEC's Rule 3a5-1 under the Exchange Act.\173\
---------------------------------------------------------------------------

    \173\ See 12 CFR 225.28(b)(7)(ii); 17 CFR 240.3a5-1(b); OCC 
Interpretive Letter 626 (July 7, 1993).
---------------------------------------------------------------------------

    Section ----.6(b)(iii) of the proposed rule addresses trading for 
the separate account of insurance policyholders by a banking entity 
that is an insurance company. In particular, this part of the proposed 
rule provides that a purchase or sale of a covered financial position 
is on behalf of customers if:
    <bullet> The banking entity is an insurance company engaging in the 
transaction for a separate account;
    <bullet> The banking entity is directly engaged in the business of 
insurance and subject to regulation by a State insurance regulator or 
foreign insurance regulator;\174\
---------------------------------------------------------------------------

    \174\ The proposed rule provides definitions of the terms 
``State insurance regulator'' and ``foreign insurance regulator.'' 
See proposed rule Sec. Sec.  ----.3(c)(4), (13).
---------------------------------------------------------------------------

    <bullet> The banking entity purchases or sells the covered 
financial position solely for a separate account established by the 
insurance company in connection with one or more insurance policies 
issued by that insurance company;
    <bullet> All profits and losses arising from the purchase or sale 
of the covered financial position are allocated to the separate account 
and inure to the benefit or detriment of the owners of the insurance 
policies supported by the separate account, and not the banking entity; 
and
    <bullet> The purchase or sale is conducted in compliance with, and 
subject to, the insurance company investment and other laws, 
regulations, and written guidance of the State or jurisdiction in which 
such insurance company is domiciled.
    This category is included within the exemption for transactions on 
behalf of customers because such insurance-related transactions are 
generally customer-driven and do not expose the banking entity to gains 
or losses on the value of separate account assets, even though the 
banking entity may be treated as the owner of those assets for certain 
purposes. However, to limit the potential for abuse of the exemption, 
the proposed rule also includes related requirements designed to ensure 
that the separate account trading activity is subject to appropriate 
regulation and supervision under insurance laws and not structured so 
as to allow gains or losses from trading activity to inure to the 
benefit or detriment of the banking entity.\175\ The proposed rule 
defines a ``separate account'' as an account established or maintained 
by a regulated insurance company subject to regulation by a State 
insurance regulator or foreign insurance regulator under which

[[Page 8365]]

income, gains, and losses, whether or not realized, from assets 
allocated to such account, are, in accordance with the applicable 
contract, credited to or charged against such account without regard to 
other income, gains, or losses of the insurance company.\176\
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    \175\ The CFTC would not consider profits to inure to the 
benefit of the banking entity if the banking entity were solely to 
receive payment, out of separate account profits, of fees unrelated 
to the investment performance of the separate account.
    \176\ See proposed rule Sec.  ----.2(z).
---------------------------------------------------------------------------

    The CFTC requests comment on the proposed rule's approach to 
implementing the exemption for trading on behalf of customers. In 
particular, the CFTC requests comment on the following questions:
    Question 125. Is the proposed rule's articulation of three 
categories of transactions on behalf of customers effective and 
sufficiently clear? If not, what alternative would be more effective 
and/or clearer? Should any of the categories be eliminated? Should any 
additional categories be added? Please explain.
    Question 126. Is the proposed rule's exemption of certain 
investment adviser, commodity trading advisor, trustee or similar 
fiduciary transactions effective? What other types of relationships are 
or should be captured by the proposed rule's reference to ``similar 
fiduciary relationships,'' and why? Is application of this part of the 
exemption to particular transactions sufficiently clear? Should any 
other specific types of fiduciary or other relationships be specified 
in the rule? If so, what types and why? What impact will the proposed 
rule's implementation of the exemption have on the investment adviser, 
commodity trading advisor, trustee or similar fiduciary activities of 
banking entities? If such impacts are negative, how could they be 
mitigated or eliminated in a manner consistent with the purpose and 
language of the statute?
    Question 127. Is the proposed rule's exemption of riskless 
principal transactions effective? If not, what alternative would be 
more appropriate? Is the description of qualifying riskless principal 
activity sufficiently clear? If not, how should it be clarified? Should 
the riskless principal transaction exemption include a requirement that 
the banking entity must purchase (or sell) the covered financial 
position as principal at the same price to satisfy the customer buy (or 
sell) order, exclusive of any explicitly disclosed markup or markdown, 
commission equivalent, or other fee? Why or why not? Should the 
riskless principal exemption include a requirement with respect to the 
timeframe in which the principal transaction must be allocated to a 
riskless principal or customer account? Why or why not?
    Question 128. Is the proposed rule's exemption of trading for 
separate accounts by insurance companies effective? If not, what 
alternative would be more appropriate? Does the proposed exemption 
sufficiently address the variety of customer-driven separate account 
structures typically used? If not, how should it address such 
structures? Does the proposed exemption sufficiently address the 
variety of regulatory or supervisory regimes to which insurance 
companies may be subject?
    Question 129. What impact will the proposed rule's implementation 
of the exemption have on the insurance activities of insurance 
companies affiliated with banking entities? If such impacts are 
negative, how could they be mitigated or eliminated in a manner 
consistent with the purpose and language of the statute?
    Question 130. Should the term ``customer'' be defined for purposes 
of the exemption for transactions on behalf of customers? If so, how 
should it be defined? For example, would an appropriate definition be 
(i) a continuing relationship in which the banking entity provides one 
or more financial products or services prior to the time of the 
transaction, (ii) a direct and substantive relationship between the 
banking entity and a prospective customer prior to the transaction, or 
(iii) a relationship initiated by the banking entity to a prospective 
customer for purposes of the transaction?
    Question 131. Is the exemption for trading on behalf of customers 
in the proposed rule over- or under-inclusive? If it is under-
inclusive, please discuss any additional activities that should qualify 
as trading on behalf of customers under the rule. What are the 
mechanics of the particular trading activity and how does it qualify as 
being on behalf of customers? Are there certain requirements or 
restrictions that should be placed on the activity, if permitted by the 
rule, to prevent evasion of the prohibition on proprietary trading? How 
would permitting the activity be consistent with the purpose and 
language of section 13 of the BHC Act? If the proposed exemption is 
over-inclusive, please explain what aspect of the proposed exemption 
does not involve trading on behalf of customers within the language and 
purpose of the statute.
c. Permitted Trading by a Regulated Insurance Company
    Section ----.6(c) of the proposed rule implements section 
13(d)(1)(F) of the BHC Act,\177\ which permits a banking entity to 
purchase or sell a covered financial position if the banking entity is 
a regulated insurance company acting for its general account or an 
affiliate of an insurance company acting for the insurance company's 
general account, subject to certain conditions. Section ----.6(d) of 
the proposed rule generally restates the statutory requirements of the 
exemption, which provide that:
---------------------------------------------------------------------------

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

    <bullet> The insurance company must directly engage in the business 
of insurance and be subject to regulation by a State insurance 
regulator or foreign insurance regulator;
    <bullet> The insurance company or its affiliate must purchase or 
sell the covered financial position solely for the general account of 
the insurance company;
    <bullet> The purchase or sale must be conducted in compliance with, 
and subject to, the insurance company investment laws, regulations, and 
written guidance of the State or jurisdiction in which such insurance 
company is domiciled; and
    <bullet> The appropriate Federal banking agencies, after 
consultation with the Council and the relevant insurance commissioners 
of the States, must not have jointly determined, after notice and 
comment, that a particular law, regulation, or written guidance 
described above is insufficient to protect the safety and soundness of 
the banking entity or of the financial stability of the United 
States.\178\
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    \178\ The Federal banking agencies have not proposed at this 
time to determine, as part of the proposed rule, that the insurance 
company investment laws, regulations, and written guidance of any 
particular State or jurisdiction are insufficient to protect the 
safety and soundness of the banking entity, or of the financial 
stability of the United States. The Federal banking agencies expect 
to monitor, in conjunction with the Federal Insurance Office 
established under section 502 of the Dodd-Frank Act, the insurance 
company investment laws, regulations, and written guidance of States 
or jurisdictions to which exempt transactions are subject and make 
such determinations in the future, where appropriate.
---------------------------------------------------------------------------

    The proposed rule defines a ``general account'' as all of the 
assets of the insurance company that are not legally segregated and 
allocated to separate accounts under applicable State law.\179\
---------------------------------------------------------------------------

    \179\ See proposed rule Sec.  ----.3(c)(6).
---------------------------------------------------------------------------

    The CFTC requests comment on the proposed rule's approach to 
implementing the exemption for general account trading by insurance 
companies. In particular, the CFTC requests comment on the following 
questions:
    Question 132. Should any of the statutory requirements for the 
exemption be further clarified in the

[[Page 8366]]

proposed rule? If so, how? Should any additional requirements be added? 
If so, what requirements and why?
    Question 133. Does the proposed rule appropriately and clearly 
define a general account for these purposes? If not, what alternative 
definition would be more appropriate?
    Question 134. For purposes of the exemption, are the insurance 
company investment laws, regulations, and written guidance of any 
particular State or jurisdiction insufficient to protect the safety and 
soundness of the banking entity, or of the financial stability of the 
United States? If so, why?
    Question 135. What impact will the proposed rule's implementation 
of the exemption have on the insurance activities of insurance 
companies affiliated with banking entities? If such impacts are 
negative, how could they be mitigated or eliminated in a manner 
consistent with the purpose and language of the statute?
d. Permitted Trading Outside of the United States
    Section ----.6(d) of the proposed rule implements section 
13(d)(1)(H) of the BHC Act,\180\ which permits certain foreign banking 
entities to engage in proprietary trading that occurs solely outside of 
the United States.\181\ This statutory exemption limits the 
extraterritorial application of the prohibition on proprietary trading 
to the foreign activities of foreign firms, while preserving national 
treatment and competitive equality among U.S. and foreign firms within 
the United States. Consistent with the statute, the proposed rule 
defines both the type of foreign banking entities that are eligible for 
the exemption and the circumstances in which proprietary trading by 
such an entity will be considered to have occurred solely outside of 
the United States.
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    \180\ Section 13(d)(1)(H) of the BHC Act permits a banking 
entity to engage in proprietary trading, notwithstanding the 
prohibition on proprietary trading, if it is conducted by a banking 
entity pursuant to paragraph (9) or (13) of section 4(c) of the BHC 
Act and the trading occurs solely outside of the United States and 
the banking entity is not directly or indirectly controlled by a 
banking entity that is organized under the laws of the United States 
or of one or more States. See 12 U.S.C. 1851(d)(1)(H).
    \181\ This section's discussion of the concept ``solely outside 
of the United States'' is provided solely for purposes of the 
proposed rule's implementation of section 13(d)(1)(H) of the BHC 
Act, and does not affect a banking entity's obligation to comply 
with additional or different requirements under applicable 
securities, banking, or other laws.
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i. Foreign Banking Entities Eligible for the Exemption
    Section ----.6(d)(1)(i) of the proposed rule provides that, in 
order to be eligible for the foreign trading exemption, the banking 
entity must not be directly or indirectly controlled by a banking 
entity that is organized under the laws of the United States or of one 
or more States. This requirement limits the scope of the exemption to 
banking entities that are organized under foreign law and controlled 
only by entities organized under foreign law. Consistent with the 
statutory language, a banking entity organized under the laws of the 
United States or any State and the subsidiaries and branches of such 
banking entity (wherever organized or licensed) may not rely on the 
exemption.\182\ Similarly, a U.S. subsidiary or branch of a foreign 
banking entity would not qualify for the exemption.
---------------------------------------------------------------------------

    \182\ Under the proposal, a ``State'' means any State, territory 
or possession of the United States, and the District of Columbia. 
See proposed rule Sec.  ----.2(aa).
---------------------------------------------------------------------------

    Section ----.6(d)(1)(ii) of the proposed rule incorporates the 
statutory requirement that the banking entity must also conduct the 
transaction pursuant to sections 4(c)(9) or 4(c)(13) of the BHC Act. 
Section ----.6(d)(2) clarifies when a banking entity would meet that 
requirement, the criteria for which vary depending on whether or not 
the banking entity is a foreign banking organization.\183\
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    \183\ Section ----.6(d)(2) only addresses when a transaction 
will be considered to have been conducted pursuant to section 
4(c)(9) of the BHC Act. Although the statute also references section 
4(c)(13) of the BHC Act, the Board has applied the authority 
contained in that section solely to the foreign activities of U.S. 
banking organizations which, by the express terms of section 
13(d)(1)(H) of the BHC Act, are unable to rely on the foreign 
trading exemption.
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    Section 4(c)(9) of the BHC Act provides that the restrictions on 
interests in nonbanking organizations contained in that statute do not 
apply to the ownership of shares held or activities conducted by any 
company organized under the laws of a foreign country the greater part 
of whose business is conducted outside the United States, if the Board 
by regulation or order determines that, under the circumstances and 
subject to the conditions set forth in the regulation or order, the 
exemption would not be substantially at variance with the purposes of 
the BHC Act and would be in the public interest.\184\ The Board has 
implemented section 4(c)(9) as part of subpart B of the Board's 
Regulation K,\185\ which specifies a number of conditions and 
requirements that a foreign banking organization must meet in order to 
use such authority. Such conditions and requirements include, for 
example, a qualifying foreign banking organization test that requires 
the foreign banking organization to demonstrate that more than half of 
its worldwide business is banking and that more than half of its 
banking business is outside the United States. The proposed rule makes 
clear that if a banking entity is a foreign banking organization, it 
will qualify for the foreign trading exemption if the entity is a 
qualifying foreign banking organization that conducts the transaction 
in compliance with subpart B of the Board's Regulation K, and the 
transaction occurs solely outside of the United States.
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    \184\ See 12 U.S.C. 1843(c)(9).
    \185\ See 12 CFR 211.20 et seq.
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    Section 13 of the BHC Act also applies to foreign companies that 
control a U.S. insured depository institution but are not currently 
subject to the BHC Act generally or to the Board's Regulation K--for 
example, because the foreign company controls a savings association or 
an FDIC-insured industrial loan company. Accordingly, the proposed rule 
also clarifies when this type of foreign banking entity would be 
considered to have conducted a transaction ``pursuant to section 
4(c)(9)'' for purposes of the foreign trading exemption.\186\ In 
particular, the draft rule proposes that to qualify for the foreign 
trading exemption, such firms must meet at least two of three 
requirements that evaluate the extent to which the foreign entity's 
business is conducted outside the United States, as measured by assets, 
revenues, and income. This test largely mirrors the qualifying foreign 
banking organization test that is made applicable under section 4(c)(9) 
of the BHC Act and Sec.  211.23(a) of the Board's Regulation K, except 
that the test does not also require such a foreign entity to 
demonstrate that more than half of its banking business is outside the 
United States.\187\
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    \186\ The CFTC notes that the Board emphasizes that this 
clarification would be applicable solely in the context of section 
13(d)(1) of the BHC Act. The application of section 4(c)(9) to 
foreign companies in other contexts is likely to involve different 
legal and policy issues and may therefore merit different 
approaches.
    \187\ See 12 U.S.C. 1843(c)(9); 12 CFR 211.23(a); proposed rule 
Sec.  ----.6(d)(2). This difference reflects the fact that foreign 
entities subject to section 13 of the BHC Act, but not the BHC Act 
generally, are likely to be, in many cases, predominantly commercial 
firms. A requirement that such firms also demonstrate that more than 
half of their banking business is outside the United States would 
likely make the exemption unavailable to such firms and subject 
their global activities to the prohibition on proprietary trading, a 
result that the statute does not appear to have intended.

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[[Page 8367]]

ii. Trading Solely Outside of the United States
    The proposed rule also clarifies when a transaction will be 
considered to have occurred solely outside of the United States for 
purposes of the exemption. In interpreting this aspect of the statutory 
language, the proposal focuses on the extent to which material elements 
of the transaction occur within, or are conducted by personnel within, 
the United States. This focus seeks to avoid extraterritorial 
application of the prohibition of proprietary trading outside the 
United States while preserving competitive parity within U.S. markets. 
The proposed rule does not evaluate solely whether the risk of the 
transaction or management or decision-making with respect to the 
transaction rests outside the United States, as such an approach would 
appear to permit foreign banking entities to structure transactions so 
as to be ``outside of the United States'' for risk and booking purposes 
while engaging in transactions within U.S. markets that are prohibited 
for U.S. banking entities.
    In particular, Sec.  ----.6(d)(3) of the proposed rule provides 
that a transaction will be considered to have occurred solely outside 
of the United States only if four conditions are met:
    <bullet> The transaction is conducted by a banking entity that is 
not organized under the laws of the United States or of one or more 
States;
    <bullet> No party to the transaction is a resident of the United 
States;
    <bullet> No personnel of the banking entity that is directly 
involved in the transaction is physically located in the United States; 
\188\ and
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    \188\ Personnel directly involved in the transaction would 
generally not include persons performing purely administrative, 
clerical, or ministerial functions.
---------------------------------------------------------------------------

    <bullet> The transaction is executed wholly outside the United 
States.

These four criteria are intended to ensure that a transaction executed 
in reliance on the exemption does not involve U.S. counterparties, U.S. 
trading personnel, U.S. execution facilities, or risks retained in the 
United States. The presence of any of these factors would appear to 
constitute a sufficient locus of activity in the U.S. marketplace so as 
to preclude availability of the exemption.
    A resident of the United States is defined in Sec.  ----.2(t) of 
the proposed rule, and includes: (i) Any natural person resident in the 
United States; (ii) any partnership, corporation or other business 
entity organized or incorporated under the laws of the United States or 
any State; (iii) any estate of which any executor or administrator is a 
resident of the United States; (iv) any trust of which any trustee, 
beneficiary or, if the trust is revocable, settlor is a resident of the 
United States; (v) any agency or branch of a foreign entity located in 
the United States; (vi) any discretionary or non-discretionary account 
or similar account (other than an estate or trust) held by a dealer or 
fiduciary for the benefit or account of a resident of the United 
States; (vii) any discretionary account or similar account (other than 
an estate or trust) held by a dealer or fiduciary organized or 
incorporated in the United States, or (if an individual) a resident of 
the United States; or (viii) any partnership or corporation organized 
or incorporated under the laws of any foreign jurisdiction formed by or 
for a resident of the United States principally for the purpose of 
engaging in one or more transactions described in Sec.  ----.6(d)(1) or 
Sec.  ----.13(c)(1) of the proposed rule.\189\ The proposed definition 
is designed to capture the scope of U.S. counterparties, decision-
makers and personnel that, if involved in the transaction, would 
preclude that transaction from being considered to have occurred solely 
outside the United States. The Agencies note that the proposed 
definition is similar but not identical to the definition of ``U.S. 
person'' for purposes of the SEC's Regulation S, which governs 
securities offerings and sales outside of the United States that are 
not registered under the Securities Act.\190\
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    \189\ See proposed rule Sec.  ----.2(t).
    \190\ See 17 CFR 230.902(k).
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iii. Request for Comment
    The CFTC requests comment on the proposed rule's approach to 
implementing the foreign trading exemption. In particular, the CFTC 
requests comment on the following questions:
    Question 136. Is the proposed rule's implementation of the foreign 
trading exemption effectively delineated? If not, what alternative 
would be more effective and/or clearer?
    Question 137. Are the proposed rule's provisions regarding when an 
activity will be considered to have been conducted pursuant to section 
4(c)(9) of the BHC Act effective and sufficiently clear? If not, what 
alternative would be more effective and/or clearer? Do those provisions 
effectively address the application of the foreign trading exemption to 
foreign banking entities not subject to the BHC Act generally? If not, 
how should the proposed rule apply the exemption?
    Question 138. Are the proposed rule's provisions regarding when an 
activity will be considered to have occurred solely outside the United 
States effective and sufficiently clear? If not, what alternative would 
be more effective and/or clearer? Should any requirements be modified 
or removed? If so, which requirements and why? Should additional 
requirements be added? If so, what requirements and why?
    Question 139. Is the proposed rule's definition of ``resident of 
the United States'' effective and sufficiently clear? If not, what 
alternative would be more effective and/or clearer? Is the definition 
over- or under-inclusive? If so, why? Should the definition more 
closely track, or incorporate by reference, the definition of ``U.S. 
person'' under the SEC's Regulation S under the Securities Act? If so, 
why?
    Question 140. Does the proposed rule effectively define a resident 
of the United States for these purposes? If not, how should the 
definition be altered?
    Question 141. Should the CFTC use the authority provided in section 
13(d)(1)(J) of the BHC Act to allow U.S.-controlled banking entities to 
engage in proprietary trading pursuant to section 4(c)(13) of the BHC 
Act outside of the United States under certain circumstances? If so, 
under what circumstances should this be permitted and how would such 
activity promote and protect the safety and soundness of banking 
entities and the financial stability of the United States?
e. Discretionary Exemptions for Proprietary Trading Under Section 
13(d)(1)(J) of the BHC Act
    Section 13(d)(1)(J) of the BHC Act permits the CFTC to grant, by 
rule, other exemptions from the prohibition on proprietary trading if 
the CFTC determines that the exemption would promote and protect the 
safety and soundness of the banking entity and the financial stability 
of the United States.\191\ The CFTC has not, at this time, proposed any 
such discretionary exemptions with respect to the prohibition on 
proprietary trading. The CFTC requests comment as follows:
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    \191\ See 12 U.S.C. 1851(d)(1)(J). In addition to permitting the 
CFTC to provide additional exemptions from the prohibition on 
proprietary trading, section 13(d)(1)(J) also states that the CFTC 
may provide additional exemptions from the prohibition on investing 
in or sponsoring a covered fund, as discussed in Part III.C.5 of 
this SUPPLEMENTARY INFORMATION.
---------------------------------------------------------------------------

    Question 142. Should the CFTC adopt any exemption from the 
prohibition on proprietary trading under section 13(d)(1)(J) of the BHC 
Act? If so, what

[[Page 8368]]

exemption and why? How would such an exemption promote and protect the 
safety and soundness of banking entities and the financial stability of 
the United States?
5. Section ----.7: Reporting and Recordkeeping Requirements Applicable 
to Trading Activities
    Section ----.7 of the proposed rule, which implements in part 
section 13(e)(1) of the BHC Act,\192\ requires certain banking entities 
to comply with the reporting and recordkeeping requirements specified 
in Appendix A of the proposed rule. In addition, Sec.  ----.7 requires 
banking entities to comply with the recordkeeping requirements in Sec.  
----.20 of the proposed rule, related to the banking entity's 
compliance program,\193\ as well as any other reporting or 
recordkeeping requirements that the CFTC may impose to evaluate the 
banking entity's compliance with the proposed rule.\194\ Proposed 
Appendix A requires a banking entity with significant trading 
activities to furnish periodic reports to the CFTC regarding various 
quantitative measurements of its trading activities and create and 
retain records documenting the preparation and content of these 
reports. The measurements vary depending on the scope, type, and size 
of trading activities. In addition, proposed Appendix B contains a 
detailed commentary regarding the characteristics of permitted market 
making-related activities and how such activities may be distinguished 
from trading activities that, even if conducted in the context of a 
banking entity's market-making operations, would constitute prohibited 
proprietary trading.
---------------------------------------------------------------------------

    \192\ Section 13(e)(1) of the BHC Act requires the CFTC to issue 
regulations regarding internal controls and recordkeeping to ensure 
compliance with section 13. See 12 U.S.C. 1851(e)(1). Section --
--.20 and Appendix C of the proposed rule also implement section 
13(e)(1) of the BHC Act.
    \193\ See SUPPLEMENTARY INFORMATION, Part III.D.
    \194\ See proposed rule Sec.  ----.7.
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    A banking entity must comply with proposed Appendix A's reporting 
and recordkeeping requirements only if it has, together with its 
affiliates and subsidiaries, trading assets and liabilities the average 
gross sum of which (on a worldwide consolidated basis) is, as measured 
as of the last day of each of the four prior calendar quarters, equal 
to or greater than $1 billion.\195\ The CFTC has not proposed to extend 
the reporting and recordkeeping requirements to banking entities with 
smaller amounts of trading activity, as it appears that the more 
limited benefits of applying these requirements to such banking 
entities, whose trading activities are typically small, less complex, 
and easier to supervise, would not justify the burden associated with 
complying with the reporting and recordkeeping requirements.
---------------------------------------------------------------------------

    \195\ See proposed rule Sec.  ----.7(a). The CFTC notes that 
this $1 billion trading asset and liability threshold is the same 
standard that is used in the Market Risk Capital Rules for 
determining which bank holding companies and insured depository 
institutions must calculate their risk-based capital requirements 
for trading positions under those rules. These banking entities 
maintain large and complex portfolios of trading assets and are 
therefore the most likely to be engaged in the types of trading 
activities that will require significant oversight of compliance 
with the restrictions on proprietary trading.
---------------------------------------------------------------------------

a. General Approach to Reporting and Recordkeeping Requirements
    The reporting and recordkeeping requirements of Sec.  ----.7 and 
Appendix A of the proposed rule are an important part of the proposed 
rule's multi-faceted approach to implementing the prohibition on 
proprietary trading. These requirements are intended, in particular, to 
address some of the difficulties associated with (i) identifying 
permitted market making-related activities and distinguishing such 
activities from prohibited proprietary trading and (ii) identifying 
certain trading activities resulting in material exposure to high-risk 
assets or high-risk trading strategies. To do so, the proposed rule 
requires certain banking entities to calculate and report detailed 
quantitative measurements of their trading activity, by trading unit. 
These measurements will help banking entities and the CFTC in assessing 
whether such trading activity is consistent with permitted trading 
activities in scope, type and profile. The quantitative measurements 
that must be reported under the proposed rule are generally designed to 
reflect, and to provide meaningful information regarding, certain 
characteristics of trading activities that appear to be particularly 
useful in differentiating permitted market making-related activities 
from prohibited proprietary trading. For example, the proposed 
quantitative measurements measure the size and type of revenues 
generated, and the types of risks taken, by a trading unit. Each of 
these measurements appears to be useful in assessing whether a trading 
unit is (i) engaged in permitted market making-related activity or (ii) 
materially exposed to high-risk assets or high-risk trading strategies. 
Similarly, the proposed quantitative measurements also measure how much 
revenue is generated per such unit of risk, the volatility of a trading 
unit's profitability, and the extent to which a trading unit trades 
with customers. Each of those characteristics appears to be useful in 
assessing whether a trading unit is engaged in permitted market making-
related activity.
    However, the CFTC recognizes that no single quantitative 
measurement or combination of measurements can accurately identify 
prohibited proprietary trading without further analysis of the context, 
facts, and circumstances of the trading activity. In addition, certain 
quantitative measurements may be useful for assessing one type of 
trading activity, but not helpful in assessing another type of trading 
activity. As a result, the CFTC proposes to use a variety of 
quantitative measurements to help identify transactions or activities 
that warrant more in-depth analysis or review.
    To be effective, this approach requires identification of useful 
quantitative measurements as well as judgment regarding the type of 
measurement results that suggest a further review of the trading unit's 
activity is warranted. The CFTC intends to take a heuristic approach to 
implementation in this area that recognizes that quantitative 
measurements can only be usefully identified and employed after a 
process of substantial public comment, practical experience, and 
revision. In particular, the CFTC notes that, although a variety of 
quantitative measurements have traditionally been used by market 
participants and others to manage the risks associated with trading 
activities, these quantitative tools have not been developed, nor have 
they previously been utilized, for the explicit purpose of identifying 
trading activity that warrants additional scrutiny in differentiating 
prohibited proprietary trading from permitted market making-related 
activities. Additional study and analysis will be required before 
quantitative measurements may be effectively designed and employed for 
that purpose.
    Consistent with this heuristic approach, the proposed rule includes 
a large number of potential quantitative measurements on which public 
comment is sought, many of which overlap to some degree in terms of 
their informational value. Not all of these quantitative measurements 
may ultimately be adopted, depending on their relative strengths, 
weaknesses, costs, and benefits. The CFTC notes that some of the 
proposed quantitative measurements may not be relevant to all types of 
trading activities or may

[[Page 8369]]

provide only limited benefits, relative to cost, when applied to 
certain types of trading activities. In addition, certain quantitative 
measurements may be difficult or impracticable to calculate for a 
specific covered trading activity due to differences between asset 
classes, market structure, or other factors. The CFTC has therefore 
requested comment on a large number of issues related to the relevance, 
practicability, costs, and benefits of the quantitative measurements 
proposed. The CFTC also seeks comment on whether the quantitative 
measurements described in the proposal may be appropriate to use in 
assessing compliance with section 13 of the BHC Act.
    In addition to the proposed quantitative measurements, a banking 
entity may itself develop and implement other quantitative measurements 
in order to effectively monitor its covered trading activities for 
compliance with section 13 of the BHC Act and the proposed rule and to 
establish, maintain, and enforce an effective compliance program, as 
required by Sec.  ----.20 of the proposed rule and Appendix C. The CFTC 
notes that the proposed quantitative measurements in Appendix A are 
intended to assist banking entities and the CFTC in monitoring 
compliance with the proprietary trading restrictions and, thus, are 
related to the compliance program requirements in Sec.  ----.20 of the 
proposed rule and proposed Appendix C. Nevertheless, implementation of 
the proposed quantitative measurements under Appendix A would not 
necessarily provide all the data necessary for the banking entity to 
establish an effective compliance program, and a banking entity may 
need to develop and implement additional quantitative measurements. The 
CFTC recognizes that appropriate and effective quantitative 
measurements may differ based on the profile of the banking entity's 
businesses in general and, more specifically, of the particular trading 
unit, including types of instruments traded, trading activities and 
strategies, and history and experience (e.g., whether the trading desk 
is an established, successful market maker or a new entrant to a 
competitive market). In all cases, banking entities must ensure that 
they have robust measures in place to identify and monitor the risks 
taken in their trading activities, to ensure the activities are within 
risk tolerances established by the banking entity, and to monitor for 
compliance with the proprietary trading restrictions in the proposed 
rule.
    To the extent that data regarding measurements, as set forth in the 
proposed rule, are collected, the CFTC proposes to utilize the 
automatic two-year conformance period provided in section 13 of the BHC 
Act to carefully review that data, further study the design and utility 
of these measurements, and if necessary, propose changes to the 
reporting requirements as the CFTC believes are needed to ensure that 
these measurements are as effective as possible.\196\ This heuristic, 
gradual approach to implementing reporting requirements for 
quantitative measurements would be intended to ensure that the 
requirements are formulated in a manner that maximizes their utility 
for identifying trading activity that warrants additional scrutiny in 
assessing compliance with the prohibition on proprietary trading, while 
limiting the risk that the use of quantitative measurements could 
inadvertently curtail permissible market making-related activities that 
provide an important service to market participants and the capital 
markets at large.
---------------------------------------------------------------------------

    \196\ Section 13(c)(2) of the BHC Act provides banking entities 
two years from the date that the proposed rule becomes effective 
(with the possibility of up to three, one-year extensions) to bring 
their activities, investments, and relationships into compliance 
with section 13, including the prohibition on proprietary trading. 
See 12 U.S.C. 1851(c)(2).
---------------------------------------------------------------------------

    In addition, the CFTC requests comment on the use of numerical 
thresholds for certain quantitative measurements that, if reported by a 
banking entity, would require the banking entity to review its trading 
activities for compliance and summarize that review to the CFTC. The 
CFTC has not proposed specific numerical thresholds in the proposal 
because substantial public comment and analysis would be beneficial 
prior to formulating and proposing specific numerical thresholds. 
Instead, the CFTC intends to carefully consider public comments that 
are provided on this issue and to separately determine whether it would 
be appropriate to propose, subsequent to finalizing the current 
proposal, such numerical thresholds.
    The CFTC requests comment on the proposed approach to implementing 
reporting requirements for proprietary trading. In particular, the CFTC 
requests comment on the following questions:
    Question 143. Is the use of the proposed reporting requirements as 
part of the multi-faceted approach to implementing the prohibition on 
proprietary trading appropriate? Why or why not?
    Question 144. Is the proposed gradual approach to implementing 
reporting requirements effective? If not, what approach would be more 
effective? For example, should the CFTC defer reporting of quantitative 
measurements until banking entities have developed and refined their 
compliance programs through the supervision and examination process? 
What would be the costs and benefits of such an approach?
    Question 145. What role, if any, could or should the Office of 
Financial Research (``OFR'') play in receiving and analyzing banking 
entities' reported quantitative measurements? Should reporting to the 
OFR be required instead of reporting to the CFTC, and would such 
reporting be consistent with the composition and purpose of OFR? In the 
alternative, should reporting to either (i) only the CFTC or (ii) both 
the CFTC and OFR be required? If so, why? What are the potential costs 
and benefits of reporting quantitative measurements to the OFR? Please 
explain.
    Question 146. Is there an alternative manner in which the CFTC 
should develop and propose the reporting requirements for quantitative 
measurements? If so, how should they do so?
    Question 147. Does the proposed approach provide sufficient time 
for the development and implementation of effective reporting 
requirements? If not, what alternative approach would be preferable?
    Question 148. Should a trading unit be permitted not to furnish a 
quantitative measurement otherwise required under Appendix A if it can 
demonstrate that the measurement is not, as applied to that unit, 
calculable or useful in achieving the purposes of the Appendix with 
respect to the trading unit's covered trading activities? How might a 
banking entity make such a demonstration?
    Question 149. Is the manner in which the CFTC proposes to utilize 
the conformance period for review of collected data and refinement of 
the reporting requirements effective? If not, what process would be 
more effective?
    Question 150. Is the proposed $1 billion trading asset and 
liability threshold, which is also currently used in the Market Risk 
Capital Rules for purposes of identifying which banks and bank holdings 
companies must comply with those rules, an appropriate standard for 
triggering the reporting and recordkeeping requirements of the proposed 
rule? Why or why not? If not, what alternative standard would be a 
better benchmark for triggering the reporting and recordkeeping 
requirements?

[[Page 8370]]

    Question 151. What are the typical trading activities (e.g., market 
making-related activities) of a banking entity with less than $1 
billion in gross trading assets and liabilities? How complex are those 
trading activities?
    Question 152. Should the proposed $1 billion trading and asset 
liability threshold used for triggering the reporting and recordkeeping 
requirements adjust each time the thresholds for complying with the 
Market Risk Capital Rules adjust, or otherwise be adjusted over time? 
If not, how and when should the numerical threshold be adjusted?
    Question 153. Should all banking entities be required to comply 
with the reporting and recordkeeping requirements set forth in Appendix 
A in order to better protect against prohibited proprietary trading, 
rather than only those banking entities that meet the proposed $1 
billion trading asset and liability threshold? Why or why not?
    Question 154. Should banking entities that fall under the proposed 
$1 billion trading asset and liability threshold be required to comply 
with the reporting and recordkeeping provisions for a pilot period in 
order to help inform judgment regarding the levels of quantitative 
measurements at such entities and the appropriate frequency and scope 
of examination by the relevant Agency for such banking entities? Why or 
why not?
b. Proposed Appendix A--Purpose and Definitions
    Section I of proposed Appendix A describes the purpose of the 
appendix, which is to specify reporting requirements that are intended 
to assist banking entities that are engaged in significant trading 
activities and the CFTC in identifying trading activities that warrant 
further review or examination to verify compliance with the proprietary 
trading restrictions, including whether an otherwise-permitted activity 
under Sec. Sec.  ----.4 through ----.6(a) of the proposed rule is 
consistent with the requirement that such activity not result, directly 
or indirectly, in a material exposure by the banking entity to high-
risk assets and high-risk trading strategies. In particular, section I 
provides that the purpose of the appendix is to assist the CFTC and 
banking entities in:
    <bullet> Better understanding and evaluating the scope, type, and 
profile of the banking entity's covered trading activities;
    <bullet> Monitoring the banking entity's covered trading 
activities;
    <bullet> Identifying covered trading activities that warrant 
further review or examination by the banking entity to verify 
compliance with the proprietary trading restrictions;
    <bullet> Evaluating whether the trading activities of trading units 
engaged in market making-related activities under Sec.  ----.4(b) of 
the proposed rule are consistent with the requirements governing 
permitted market making-related activities;
    <bullet> Evaluating whether the trading activities of trading units 
that are engaged in permitted trading activity under Sec. Sec.  ----.4, 
----.5, or ----.6(a) of the proposed rule (e.g., permitted 
underwriting, market making-related activity, risk-mitigating hedging, 
or trading in certain government obligations) are consistent with the 
requirement that such activity not result, directly or indirectly, in a 
material exposure by the banking entity to high-risk assets and high-
risk trading strategies;
    <bullet> Identifying the profile of particular trading activities 
of the banking entity, and the individual trading units of the banking 
entity, to help establish the appropriate frequency and scope of 
examination by the CFTC of such activities; and
    <bullet> Assessing and addressing the risks associated with the 
banking entity's trading activities.
    The types of trading and market making-related activities in which 
banking entities engage is often highly complex, and any quantitative 
measurement is capable of producing both ``false negatives'' and 
``false positives'' that suggest that prohibited proprietary trading is 
occurring when it is not, or vice versa. Recognizing this, section I of 
proposed Appendix A makes clear that the quantitative measurements that 
may be required to be reported would not be intended to serve as a 
dispositive tool for identifying permissible or impermissible 
activities.
    Section II of proposed Appendix A defines relevant terms used in 
the appendix. These include certain definitions that clarify how and 
when certain calculations must be made, as well as a definition of 
``trading unit'' that governs the level of organization at which a 
banking entity must calculate quantitative measurements. The proposed 
definition of ``trading unit'' covers multiple organizational levels of 
a banking entity, including:
    <bullet> Each discrete unit engaged in the coordinated 
implementation of a revenue generation strategy that participates in 
the execution of any covered trading activity; \197\
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    \197\ As noted in Appendix A, the CFTC expects that this would 
generally be the smallest unit of organization used by the banking 
entity to structure and control its risk-taking activities and 
employees, and would include each unit generally understood to be a 
single ``trading desk.'' For example, if a banking entity has one 
set of employees engaged in market making-related activities in the 
equities of U.S. non-financial corporations, and another set of 
employees engaged in market making-related activities in the 
equities of U.S. financial corporations, the two sets of employees 
would appear to be part of a single trading unit if both sets of 
employees structure and control their trading activities together, 
making and executing highly coordinated decisions about required 
risk levels, inventory levels, sources of revenue growth and similar 
features. On the other hand, if the risk decisions and revenue 
strategies are considered and executed separately by the two sets of 
employees, with only loose coordination, they would appear to be two 
distinct trading units. In determining whether a set of employees 
constitute a single trading unit, important factors would likely 
include whether compensation is strongly linked to the group's 
performance, whether risk levels and trading limits are managed and 
set jointly or separately, and whether trades are booked together or 
separately.
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    <bullet> Each organizational unit used to structure and control the 
aggregate risk-taking activities and employees of one or more trading 
units described above;
    <bullet> All trading operations, collectively; and
    <bullet> Any other unit of organization specified by the CFTC with 
respect to a particular banking entity.\198\
---------------------------------------------------------------------------

    \198\ This latter prong of the definition has been included to 
ensure that the CFTC has the ability to require banking entities to 
report quantitative measurements in other ways to prevent a banking 
entity from organizing its trading operations so as to undermine the 
effectiveness of the reporting requirement.
---------------------------------------------------------------------------

    The definition of ``trading unit'' is intended to capture multiple 
layers of a banking entity's organization structure, including 
individual trading desks, intermediate divisions that oversee a variety 
of trading desks, and all trading operations in the aggregate. As 
described below, under the proposal, the quantitative measurements 
specified in section IV of proposed Appendix A must be calculated and 
reported for each such ``trading unit.'' Accordingly, the definition of 
trading unit is purposefully broad and captures multiple levels of 
organization so as to ensure that quantitative measurements provide 
meaningful information, at both a granular and aggregate level, to help 
banking entities and the CFTC evaluate the quantitative profile of 
trading operations in a variety of contexts.
    The CFTC expects that the scope and nature of trading units to 
which the quantitative measurements are applied would have an important 
impact on the informational content and utility of the resulting 
measurements. Applying a quantitative measurement to a trading unit at 
a level that aggregates a variety of distinct trading activities may 
obscure or ``smooth'' differences between distinct lines of business, 
asset

[[Page 8371]]

categories and risk management processes in a way that renders the 
measurement relatively uninformative, because it does not adequately 
reflect the specific characteristics of the trading activities being 
conducted. Similarly, applying a quantitative measurement to a trading 
unit at a highly granular level could, if it captured only a narrow 
portion of activity that is conducted as part of a broader business 
strategy, introduce meaningless ``noise'' into the measure or result in 
a measurement that is idiosyncratic in nature. This highly granular 
application could render the measurement relatively uninformative 
because it would not accurately reflect the entirety of the trading 
activities being conducted. In order to address the potential 
weaknesses of applying the quantitative measurements at an aggregate 
and a granular level, respectively, the proposal requires reporting at 
both levels. The informational inputs required to calculate any 
particular quantitative measurement at either level are the same. 
Consequently, it is expected that, depending on the nature of the 
systems of a particular institution, there may be little, if any, 
incremental burden associated with calculating and reporting 
quantitative measurements at multiple levels.
    The CFTC requests comment on the proposed reporting requirements in 
Appendix A. In particular, the CFTC requests comment on the following 
questions:
    Question 155. Are the ways in which the proposed rule would make 
use of reported quantitative measurements effective? If not, what uses 
would be more effective? Should the proposed rule instead use 
quantitative measurements as a dispositive tool for identifying 
prohibited proprietary trading? If so, what types of quantitative 
measurements should be employed, what numerical amount would indicate 
impermissible proprietary trading activity, and why? Should the 
quantitative measurements play a less prominent role than proposed in 
identifying prohibited proprietary trading and why?
    Question 156. Are the proposed definitions of terms provided in 
Appendix A effective? If not, how should the definitions be amended?
    Question 157. Is the proposed definition of ``trading unit'' 
effective? Is it sufficiently clear? If not, what alternative 
definition would be more effective and/or clearer? Should the 
definition include more or less granular levels of activity? If so, 
what specific criteria should be used to determine the appropriate 
level of granularity?
    Question 158. If you are a banking entity, how would your trading 
activity be categorized, in terms of quantity and type, under the 
proposed definition of trading unit in Appendix A? For each trading 
unit type, what categories of quantitative measurements (e.g., risk-
management measurements) or specific quantitative measurements (e.g., 
Stressed Value-at-Risk (``Stress VaR'')) are best suited to assist in 
distinguishing prohibited proprietary trading from permitted trading 
activity?
    Question 159. Is the proposed rule's requirement that quantitative 
measurements be reported at multiple levels of organization, including 
for quantitative measurements historically reported on an aggregate 
basis (e.g., Value-at-Risk (``VaR'') or Stress VaR) appropriate? If 
not, what alternative would be more effective? What burdens are 
associated with such a requirement? How might those burdens be reduced 
or limited? Please quantify your answers, to the extent feasible.
c. Proposed Appendix A--Scope of Required Reporting
    Part III of proposed Appendix A defines the scope of the reporting 
requirements. The proposed rule adopts a tiered approach that requires 
banking entities with the most extensive trading activities to report 
the largest number of quantitative measurements, while banking entities 
with smaller trading activities have fewer or no reporting 
requirements. This tiered approach is intended to reflect the 
heightened compliance risks of banking entities with extensive trading 
activities and limit the regulatory burden imposed on banking entities 
with relatively small or no trading activities, which appear to pose 
significantly less compliance risk.
Banking Entities With Gross Trading Assets and Liabilities of $5 
Billion or More
    For any banking entity that has, together with its affiliates and 
subsidiaries, trading assets and liabilities the average gross sum of 
which (on a worldwide consolidated basis), as measured as of the last 
day of each of the four prior calendar quarters, equals or exceeds $5 
billion, the proposal would require the banking entity to furnish 
quantitative measurements for all trading units of the banking entity 
engaged in trading activity subject to Sec. Sec.  ----.4, ----.5, or --
--.6(a) of the proposed rule (i.e., permitted underwriting and market 
making-related activity, risk-mitigated hedging, and trading in certain 
government obligations). The scope of data to be furnished depends on 
the activity in which the trading unit is engaged. First, for the 
trading units of such a banking entity that are engaged in market 
making-related activity pursuant to Sec.  ----.4(b) of the proposed 
rule, proposed Appendix A requires that a banking entity furnish 
seventeen quantitative measurements.\199\ Second, all trading units of 
such a banking entity engaged in trading activity subject to Sec. Sec.  
----.4(a), ----.5, or ----.6(a) of the proposed rule would be required 
to report five quantitative measurements designed to measure the 
general risk and profitability of the trading unit.\200\ The CFTC 
expects that each of these general types of measurements will be useful 
in assessing the extent to which any permitted trading activity 
involves exposure to high-risk assets or high-risk trading strategies. 
These requirements would apply to all type of trading units engaged in 
underwriting and market making-related activity, risk-mitigated 
hedging, and trading in certain government obligations. These 
additional measurements are designed to help evaluate the extent to 
which the quantitative profile of a trading unit's activities is 
consistent with permissible market making-related activities.
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    \199\ See proposed rule Appendix A.III.A. These seventeen 
quantitative measurements are discussed further below.
    \200\ See proposed rule Appendix A.III.A. These five 
quantitative measurements are: (i) Comprehensive Profit and Loss; 
(ii) Comprehensive Profit and Loss Attribution; (iii) VaR and Stress 
VaR; (iv) Risk Factor Sensitivities; and (v) Risk and Position 
Limits. Each of these and other quantitative measurements discussed 
in proposed Appendix A are discussed in detail below.
---------------------------------------------------------------------------

Banking Entities With Gross Trading Assets and Liabilities Between $1 
Billion and $5 Billion
    For any banking entity that has, together with its affiliates and 
subsidiaries, trading assets and liabilities the average gross sum of 
which (on a worldwide consolidated basis), as measured as of the last 
day of each of the four prior calendar quarters, equals or exceeds $1 
billion but is less than $5 billion, the proposal would require 
quantitative measurements to be furnished for trading units that are 
engaged in market making-related activity subject to Sec.  ----.4(b) of 
the proposed rule. Trading units of such banking entities that are 
engaged in market making-related activities must report eight 
quantitative measurements that are designed to help evaluate the extent 
to which the quantitative profile of a trading unit's activities is 
consistent with permissible market making-related

[[Page 8372]]

activities.\201\ The proposal applies a smaller number of measurements 
to a smaller universe of trading units for this class of banking 
entities because they are likely to pose lesser compliance risk and 
fewer supervisory and examination challenges. A less burdensome 
reporting regime, coupled with other elements of the proposal (e.g., 
the compliance program requirement), is likely to be equally as 
effective in ensuring compliance with section 13 of the BHC Act and the 
proposed rule for banking entities with smaller trading operations.
---------------------------------------------------------------------------

    \201\ See proposed rule Appendix A.III.A. These eight 
quantitative measurements are (i) Comprehensive Profit and Loss; 
(ii) Comprehensive Profit and Loss Attribution; (iii) Portfolio 
Profit and Loss; (iv) Fee Income and Expense; (v) Spread Profit and 
Loss; (vi) VaR; (vii) Volatility of Comprehensive Profit and Loss 
and Volatility of Portfolio Profit and Loss; and (viii) 
Comprehensive Profit and Loss to Volatility Ratio and Portfolio 
Profit and Loss to Volatility Ratio.
---------------------------------------------------------------------------

Frequency of Calculation and Reporting
    Section III.B of proposed Appendix A specifies the frequency of 
required calculation and reporting of quantitative measurements. Under 
the proposed rule, each required quantitative measurement must be 
calculated for each trading day. Required quantitative measurements 
must be reported to the CFTC on a monthly basis, within 30 days of the 
end of the relevant calendar month, or on such other reporting schedule 
as the CFTC may require. Section III.C of proposed Appendix A requires 
a banking entity to create and retain records documenting the 
preparation and content of any quantitative measurement furnished by 
the banking entity, as well as such information as is necessary to 
permit the CFTC to verify the accuracy of such measurements, for a 
period of 5 years. This would include records for each trade and 
position.
    Question 160. Is the proposed tiered approach to identifying which 
banking entities and trading units must comply with the reporting 
requirements effective? If not, what alternative would be more 
effective? Does the proposal strike the appropriate balance between the 
potential benefits of the reporting requirements for monitoring and 
assuring compliance and the potential costs of those reporting 
requirements? If not, how could that balance be improved? Should the 
relevant gross trading assets and liabilities threshold for any 
category be increased or reduced? If so, why?
    Question 161. Should the $1 billion and $5 billion gross trading 
assets and liabilities thresholds used to identify the extent to which 
a banking entity is required to furnish quantitative measurements be 
increased or reduced? If so, why? Should the thresholds be indexed in 
some way to account for fluctuations in capital markets activity over 
time? If so, what would be an appropriate method of indexation?
    Question 162. Is the proposed $5 billion trading asset and 
liability threshold an appropriate standard for triggering enhanced 
reporting requirements under the proposed rule? Why or why not? If not, 
what alternative standard would be a better benchmark for triggering 
enhanced reporting requirements?
    Question 163. Should the proposed $5 billion trading and asset 
liability threshold used for triggering enhanced reporting requirements 
under the proposed rule be subject to adjustment over time? If so, how 
and when should the numerical threshold be adjusted?
    Question 164. Is there a different criterion other than gross 
trading assets and liabilities that would be more appropriate for 
identifying banking entities that must furnish quantitative 
measurements? If so, what is the alternative criterion, and why would 
it be more appropriate? Are worldwide gross trading assets and 
liabilities the appropriate criterion for foreign-based banking 
entities? If not, what alternative criterion would be more appropriate, 
and why?
    Question 165. Are the quantitative measurements specified for the 
various types of banking entities and trading units effective? If not, 
what alternative set of measurements would be more effective? For each 
type of trading unit, does the proposal strike the appropriate balance 
between the potential benefits of the reporting requirements for 
monitoring and assuring compliance and the potential costs of those 
reporting requirements? If not, how could that balance be improved?
    Question 166. Should banking entities with gross trading assets and 
liabilities between $1 billion and $5 billion also be required to 
calculate and report some of the quantitative measurements proposed for 
banking entities meeting the $5 billion threshold for purposes of 
assessing whether the banking entity's underwriting, market making, 
risk-mitigating hedging, and trading in certain government obligations 
activities involve a material exposure to high-risk assets or high-risk 
trading strategies? If so, which quantitative measurements and why? If 
not, why not?
    Question 167. Is the proposed frequency of reporting effective? If 
not, what frequency would be more effective? Should the quantitative 
measurements be required to be reported quarterly, annually, or upon 
the request of the CFTC and why?
d. Proposed Appendix A--Quantitative Measurements
    Section IV of proposed Appendix A describes, in detail, the 
individual quantitative measurements that must be furnished. These 
measurements are grouped into the following five broad categories, each 
of which is described in more detail below:
    <bullet> Risk-management measurements--VaR, Stress VaR, VaR 
Exceedance, Risk Factor Sensitivities, and Risk and Position Limits;
    <bullet> 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;
    <bullet> 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;
    <bullet> Customer-facing activity measurements--Inventory Turnover, 
Inventory Aging, and Customer-facing Trade Ratio; and
    <bullet> Payment of fees, commissions, and spreads measurements--
Pay-to-Receive Spread Ratio.
    The CFTC has proposed these quantitative measurements because, 
taken together, these measurements appear useful for understanding the 
context in which trading activities occur and identifying activities 
that may warrant additional scrutiny to determine whether these 
activities involve prohibited proprietary trading because the trading 
activity either is inconsistent with permitted market making-related 
activities or presents a material exposure to high-risk assets or high-
risk trading strategies. As described below, different quantitative 
measurements are proposed to identify different aspects and 
characteristics of trading activity for the purpose of helping to 
identify prohibited proprietary trading, and the CFTC expects that the 
quantitative measurements will be most useful for this purpose when 
implemented and reviewed collectively, rather than in isolation. The 
CFTC believes that, in the aggregate, many banking entities already 
collect and review many of these

[[Page 8373]]

measurements as part of their risk management activities, and expect 
that many of the quantitative measurements proposed would be readily 
computed and monitored at the multiple levels of organization that are 
included in proposed Appendix A's definition of ``trading unit,'' to 
which they would apply.
    The first set of quantitative measurements relates to risk 
management, and includes VaR, Stress VaR, VaR Exceedance, Risk Factor 
Sensitivities, and Risk and Position Limits. These measurements are 
widely used by banking entities to measure and manage trading risks and 
activities. In the case of VaR, Stress VaR, VaR Exceedance, and Risk 
Factor Sensitivities, these measures provide internal, model-based 
assessments of overall risk, stated in terms of large but plausible 
losses that may occur or changes in revenue that would be expected to 
result from movements in underlying risk factors. In the case of Risk 
and Position Limits, the measure provides an explicit assessment of 
management's expectation of how much risk is required to perform 
permitted market-making and hedging activities. With the exception of 
Stress VaR, each of these measurements are routinely used to manage and 
control risk taking activities, and are also used by some banking 
entities for purposes of calculating regulatory capital and allocating 
capital internally. In the context of permitted market making-related 
activities, these risk management measures are useful in assessing 
whether the actual risk taken is consistent with the level of principal 
risk that a banking entity must retain in order to service the near-
term demands of customers. Significant, abrupt or inconsistent changes 
to key risk management measures, such as VaR, that are inconsistent 
with prior experience, the experience of similarly situated trading 
units and management's stated expectations for such measures may 
indicate impermissible proprietary trading. In addition, indicators of 
unanticipated or unusual levels of risk taken, such as a significant 
number of VaR Exceedance or breaches of internal Risk and Position 
Limits, may suggest behavior that is inconsistent with appropriate 
levels of risk and may warrant further scrutiny.
    The second set of quantitative measurements relates to the source 
of revenues, and includes Comprehensive Profit and Loss, Portfolio 
Profit and Loss, Fee Income, Spread Profit and Loss, and Comprehensive 
Profit and Loss Attribution. These measurements are intended to capture 
the extent, scope, and type of profits and losses generated by trading 
activities and provide important context for understanding how revenue 
is generated by trading activities. Because permitted market making-
related activities seek to generate profits by providing customers with 
intermediation and related services while maintaining, and to the 
extent practicable, minimizing the risks associated with any asset or 
risk inventory required to meet customer demands, these revenue 
measurements would appear to provide helpful information to banking 
entities and the CFTC regarding whether actual revenues are consistent 
with these expectations. The CFTC notes that although banking entities 
already routinely calculate and analyze the extent and source of 
revenues derived from their trading activities, calculating the 
proposed source of revenue measurements according to the specifications 
described in proposed Appendix A may require banking entities to 
implement new processes to calculate and furnish the required data.
    The third set of measurements relates to realized risks and revenue 
relative to realized risks, and includes Volatility of Profit and Loss, 
Comprehensive Profit and Loss to Volatility Ratio and Portfolio Profit 
and Loss to Volatility Ratio, Unprofitable Trading Days based on 
Comprehensive Profit and Loss and Unprofitable Trading Days based on 
Portfolio Profit and Loss, and Skewness of Portfolio Profit and Loss 
and Kurtosis of Portfolio Profit and Loss. These measurements are 
intended to provide banking entities and the Agencies with ex post, 
data-based assessments of risk, as a supplement to internal, model-
based assessments of risk, and give further context around the 
riskiness of underlying trading activities and the profitability of 
these activities relative to the risks taken. Some of these 
measurements, such as the skewness and kurtosis measurements, are 
proposed in order to capture asymmetric, ``fat tail'' risks that (i) 
are not well captured by simple volatility measures, (ii) may not be 
well captured by internal risk measurement metrics, such as VaR, and 
(iii) can be associated with proprietary trading strategies that seek 
to earn short-term profits by taking exposures to these types of risks. 
The CFTC expects that these realized-risk and revenue-relative-to-
realized-risk measurements would provide information useful in 
assessing whether trading activities are producing revenues that are 
consistent, in terms of the degree of risk that is being assumed, with 
typical market making-related activities. Market making and related 
activities seek to generate profitability primarily by generating fees, 
commissions, spreads and other forms of customer revenue that are 
relatively, though not completely, insensitive to market fluctuations 
and generally result in a high level of revenue relative to risk over 
an appropriate time frame. In contrast, proprietary trading strategies 
seek to generate revenue primarily through favorable changes in asset 
valuations. The CFTC notes that each of the proposed measurements 
relating to realized risks and revenues relative to realized risks are 
generally consistent with existing revenue, risk, and volatility data 
routinely collected by banking entities with large trading operations 
or are simple, standardized functions of such data.
    The fourth set of quantitative measurements relates to customer-
facing activity measurements, and includes Inventory Risk Turnover, 
Inventory Aging, and Customer-facing Trade Ratio. These measurements 
are intended to provide banking entities and the CFTC with meaningful 
information regarding the extent to which trading activities are 
directed at servicing the demands of customers. Quantitative 
measurements such as Inventory Risk Turnover and Inventory Aging assess 
the extent to which size and volume of trading activity is aimed at 
servicing customer needs, while the Customer-facing Trade Ratio 
provides directionally useful information regarding the extent to which 
trading transactions are conducted with customers. The CFTC expects 
that these measurements will be useful in assessing whether permitted 
market making-related activities are focused on servicing customer 
demands. Although the CFTC understands that banking entities typically 
measure inventory aging and turnover in the context of cash instruments 
(e.g., equity and debt securities), they note that applying these 
measurements, as well as the Customer-facing Trade Ratio generally, 
would require banking entities to implement new processes to calculate 
and furnish the related data.
    The fifth set of quantitative measurements relates to the payment 
of fees, commissions, and spreads, and includes the Pay-to-Receive 
Spread Ratio. This measurement is intended to measure the extent to 
which trading activities generate revenues for providing intermediation 
services, rather than generate expenses paid to other intermediaries 
for such services. Because market making-related activities ultimately 
focus on servicing customer demands, they typically generate 
substantially more fees,

[[Page 8374]]

spreads and other sources of customer revenue than must be paid to 
other intermediaries to support customer transactions. Proprietary 
trading activities, however, that generate almost no customer facing 
revenue will typically pay a significant amount of fees, spreads and 
commissions in the execution of trading strategies that are expected to 
benefit from short-term price movements. Accordingly, the CFTC expects 
that the proposed Pay-to-Receive Spread Ratio measurement will be 
useful in assessing whether permitted market making-related activities 
are primarily generating, rather than paying, fees, spreads and other 
transactional revenues or expenses. A level of fees, commissions, and 
spreads paid that is inconsistent with prior experience, the experience 
of similarly situated trading units and management's stated 
expectations for such measures could indicate impermissible proprietary 
trading.
    For each individual quantitative measurement, proposed Appendix A 
describes the measurement, provides general guidance regarding how the 
measurement should be calculated (where needed) and specifies the 
period over which each calculation should be made. The proposed 
quantitative measurements attempt to incorporate, wherever possible, 
measurements already used by banking entities to manage risks 
associated with their trading activities. Of the measurements proposed, 
the CFTC expects that a large majority of measurements proposed are 
either (i) already routinely calculated by banking entities or (ii) 
based solely on underlying data that are already routinely calculated 
by banking entities. However, calculating these measurements according 
to the specifications described in proposed Appendix A and at the 
various levels of organization mandated may require banking entities to 
implement new processes to calculate and furnish the required data.
    The extent of the burden associated with calculating and reporting 
quantitative measurements will likely vary depending on the particular 
measurements and differences in the sophistication of management 
information systems at different banking entities. As noted, the 
proposal tailors these data collections to the size and type of 
activity conducted by each banking entity in an effort to minimize the 
burden in particular on firms that engage in few or no trading 
activities subject to the proposed rule.
    The CFTC also has attempted to provide, to the extent possible, a 
standardized description and general method of calculating each 
quantitative measurement that, while taking into account the potential 
variation among trading practices and asset classes, would facilitate 
reporting of sufficiently uniform information across different banking 
entities so as to permit horizontal reviews and comparisons of the 
quantitative profile of trading units across firms.
    The CFTC requests comment on the proposed quantitative 
measurements. In particular, the CFTC requests comment on the following 
questions:
    Question 168. Are the proposed quantitative measurements 
appropriate in general? If not, what alternative(s) would be more 
appropriate, and why? Should certain quantitative measurements be 
eliminated, and if so, why? Should additional quantitative measurements 
be added? If so, which measurements and why? How would those additional 
measurements be described and calculated?
    Question 168.1. Should the proposed CFTC Rule include all of the 
required metrics? In particular, the Commission is interested in which 
metrics are most relevant for swaps, futures, and their related hedges. 
Please explain the rationale for including or excluding the provisions 
in the proposed CFTC Rule.
    Question 168.2. If the CFTC Rule reduces the number of required 
metrics, should both sets of covered banking entities described in 
sections III.A.(i) and III.A.(ii) of Appendix A be required to comply 
with the reduced number of required metrics?
    Question 169. How many of the proposed quantitative measurements do 
banking entities currently utilize? What are the current benefits and 
costs associated with calculating such quantitative measurements? Would 
the reporting and recordkeeping requirements proposed in Appendix A for 
such quantitative measurements impose any significant, additional 
benefits or costs?
    Question 170. Which of the proposed quantitative measurements do 
banking entities currently not utilize? What are the potential benefits 
and costs to calculating these quantitative measurements and complying 
with the proposed reporting and recordkeeping requirements? Please 
quantify your answers, to the extent feasible.
    Question 171. Is the scope and frequency of required reporting 
appropriate? If not, what alternatives would be more appropriate? What 
burdens would be associated with reporting quantitative measurements on 
that basis, and how could those burdens be reduced or eliminated in a 
manner consistent with the purpose and language of the statute? Please 
quantify your answers, to the extent feasible.
    Question 172. For each of the categories of quantitative 
measurements (e.g., quantitative measurements relating to risk 
management), what factors should be considered in order to further 
refine the proposed category of quantitative measurements to better 
distinguish prohibited proprietary trading from permitted trading 
activity? For example, should the timing of a calculation be considered 
significant in certain contexts (e.g., should specific quantitative 
measurements be calculated during the middle of a trading day instead 
of the end of the day)? Please quantify your answers, to the extent 
feasible.
    Question 173. In light of the size, scope, complexity, and risk of 
covered trading activities, do commenters anticipate the need to hire 
new staff with particular expertise in order to calculate the required 
quantitative measurements (e.g., collect data and make computations)? 
Do commenters anticipate the need to develop additional infrastructure 
to obtain and retain data necessary to compute the proposed 
quantitative measurements? Please explain and quantify your answers, to 
the extent feasible.
    Question 174. For each individual quantitative measurement that is 
proposed:
    <bullet> Is the use of the quantitative measurement to help 
distinguish between permitted and prohibited trading activities 
effective? If not, what alternative would be more effective? Does the 
quantitative measurement provide any additional information of value 
relative to other quantitative measurements proposed?
    <bullet> Is the use of the quantitative measurement to help 
determine whether an otherwise-permitted trading activity is consistent 
with the requirement that such activity must not result, directly or 
indirectly, in a material exposure by the banking entity to high-risk 
assets and high-risk trading strategies effective? If not, what 
alternative would be more effective?
    <bullet> What factors should be considered in order to further 
refine the proposed quantitative measurement to better distinguish 
prohibited proprietary trading from permitted trading activity? For 
example, should the timing of a calculation be considered significant 
in certain contexts (e.g., should specific quantitative measurements be 
calculated during the middle of a trading day instead of at the end of 
the day)?
    <bullet> If the quantitative measurement is proposed to be applied 
to a trading unit

[[Page 8375]]

that is engaged in activity pursuant to Sec. Sec.  ----.4(a), ----.5, 
or ----.6(a) of the proposed rule, is the quantitative measurement 
calculable in relation to such activity? Is the quantitative 
measurement useful for determining whether underwriting, risk-
mitigating hedging, or trading in certain government obligations is 
resulting, directly or indirectly, in a material exposure by the 
banking entity to high-risk assets or high-risk trading strategies?
    <bullet> Is the description of the quantitative measurement 
sufficiently clear? What alternative would be more appropriate or 
clearer? Is the description of the quantitative measurement 
appropriate, or is it overly broad or narrow? If it is overly broad, 
what additional clarification is needed? Should the CFTC provide this 
additional clarification in the appendix's description of the 
quantitative measurement? If the description is overly narrow, how 
should it be modified to appropriately describe the quantitative 
measurement, and why?
    <bullet> Is the general calculation guidance effective and 
sufficiently clear? If not, what alternative would be more effective or 
clearer? Is more or less specific calculation guidance necessary? If 
so, what level of specificity is needed to calculate the quantitative 
measurement? What are the different calculation options and 
methodologies that could be used to reach the desired level of 
specificity? What are the costs and benefits of these different 
options? If the proposed calculation guidance is not sufficiently 
specific, how should the calculation guidance be modified to reach the 
appropriate level of specificity? For example, rather than provide this 
level of specificity in proposed Appendix A, should the CFTC instead 
make each banking entity responsible for determining the best method of 
calculating the quantitative measurement at this level of specificity, 
based on the banking entity's business and profile, which would then be 
subject to supervision, review, or examination by the CFTC? If the 
proposed calculation guidance is overly specific, why is it too 
specific and how should the guidance be modified to reach the 
appropriate level of specificity?
    <bullet> Is the general calculation guidance for the measurement 
consistent with how banking entities currently calculate the 
quantitative measurement, if they do so? If not, how does the proposed 
guidance differ from methodology currently used by banking entities? 
What is the purpose of the current calculation methodology used by 
banking entities?
    <bullet> What operational or logistical challenges might be 
associated with performing the calculation of the quantitative 
measurement and obtaining any necessary informational inputs?
    <bullet> Is the quantitative measurement not calculable for any 
specific type of trading unit? If so, what type of trading unit, and 
why is the quantitative measurement not calculable for that type of 
trading unit? Is there an alternative quantitative measurement that 
would reflect the same trading activity but not pose the same 
calculation difficulty? Are there particular challenges to documenting 
that a specific quantitative measurement is not calculable?
    <bullet> Is the quantitative measurement substantially likely to 
frequently produce false negatives or false positives that suggest that 
prohibited proprietary trading is occurring when it is not, or vice 
versa? If so, why? If so, what alternative quantitative measurement 
would better help identify prohibited proprietary trading?
    <bullet> Should the quantitative measurement better account for 
distinctions among trading activities, trading strategies, and asset 
classes? If so, how? For example, should the quantitative measurements 
better account for distinctions between trading activities in cash and 
derivatives markets? If so, how? Are there any other distinctions for 
which the quantitative measurements may need to account? If so, what 
distinctions, and why?
    <bullet> Does the quantitative measurement provide useful 
information as applied to all types of trading activities, or only a 
certain subset of trading activities? If it only provides useful 
information for a subset of trading activities, how should this issue 
be addressed? How beneficial is the information that the quantitative 
measurement provides for this subset of trading activities? Do any of 
the other quantitative measurements provide the same level of 
beneficial information for this subset of trading activities? Should 
the quantitative measurement be required to be reported for all trading 
activities, only a relevant subset of trading activities, or not at 
all?
    <bullet> Does the quantitative measurement provide useful 
information as applied to all asset classes, or only a certain subset 
of asset classes? If it only provides useful information for a subset 
of asset classes, how should this issue be addressed? How beneficial is 
the information the quantitative measurement provides for this subset 
of asset classes? Do any of the other quantitative measurements provide 
the same level of beneficial information for this subset of asset 
classes? Should the quantitative measurement be required to be reported 
for all asset classes, only a relevant subset of asset classes, or not 
at all?
    <bullet> Is the calculation period effective and sufficiently 
clear? If not, what alternative would be more effective or clearer?
    <bullet> How burdensome and costly would it be to calculate the 
measurement at the specified calculation frequency and calculation 
period? Are there any difficulties or costs associated with calculating 
the measurement for particular trading units? How significant are those 
potential costs relative to the potential benefits of the measurement 
in monitoring for impermissible proprietary trading? Are there 
potential modifications that could be made to the measurement that 
would reduce the burden or cost? If so, what are those modifications? 
Please quantify your answers, to the extent feasible.
    Question 175. In light of the size, scope, complexity, and risk of 
covered trading activities, are there certain types of quantitative 
measurements that will not be appropriate for some types of banking 
entities, desks, or levels? If so, would it be appropriate to require 
only certain quantitative measurements for such banking entities, 
desks, or levels?
    Question 176. How might the number of quantitative measurements 
impact behavior of banking entities? Is there a cost of requiring more 
quantitative measurements, such as the cost of increased uncertainty 
regarding the combined results of such quantitative measurements? To 
what extent and in what ways might uncertainty as to how the 
quantitative measurements are applied and evaluated impact behavior?
Proposed Appendix B--Commentary Regarding Identification of Permitted 
Market Making-Related Activities
    Proposed Appendix B provides commentary that is intended to assist 
a banking entity in distinguishing permitted market making-related 
activities from trading activities that, even if conducted in the 
context of a banking entity's market making operations, would 
constitute prohibited proprietary trading. As noted in Part I of 
proposed Appendix B, the commentary applies to all banking entities 
that are engaged in market making-related activities in reliance on 
Sec.  ----.4(b) of the proposed rule. Part II of proposed Appendix B 
clarifies that all defined terms used in Appendix B have the meaning 
given those terms in Sec. Sec.  ----.2 and ----.3 of the proposed rule 
and Appendix A.

[[Page 8376]]

    The commentary regarding identification of permitted market making-
related activities, which is contained in Part III of proposed Appendix 
B, includes three principal components. The first component provides an 
overview of market making-related activities and describes, in detail, 
typical practices in which market makers engage and typical 
characteristics of market making-related activities, articulating the 
general framework within which the CFTC views market making-related 
activities.\202\ For example, the commentary provides that market 
making-related activities, in the context of a banking entity acting as 
principal, generally involve either (i) in the case of market making in 
a security that is executed on an organized trading facility or 
exchange, passively providing liquidity by submitting resting orders 
that interact with the orders of others on an organized trading 
facility or exchange and acting as a registered market maker, where 
such exchange or organized trading facility provides the ability to 
register as a market maker, or (ii) in other cases, providing an 
intermediation service to its customers by assuming the role of a 
counterparty that stands ready to buy or sell a position that the 
customer wishes to sell or buy. The second component of the commentary 
provides an overview of prohibited proprietary trading activities, 
which describes the general framework within which the CFTC views 
prohibited proprietary trading and contrasts that activity to the 
practices and characteristics of market making-related activities.\203\ 
The third component describes certain challenges that arise in 
distinguishing permitted market making-related activities and 
prohibited proprietary trading, particularly in cases in which both of 
these activities occur within the context of a market making 
operation,\204\ and proposes guidance that the CFTC would apply in 
distinguishing permitted market making-related activities from 
prohibited proprietary trading. This guidance includes six factors that 
would cause a banking entity to be considered, absent explanatory 
circumstances, to be engaged in prohibited proprietary trading, and not 
permitted market making-related activity. The six factors are:
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    \202\ See proposed rule Appendix B, Sec.  III.A. The practices 
and characteristics that are described generally reinforce and 
augment the specific requirements that a banking entity must meet in 
order to rely on the market-making exemption under Sec.  ----.4(b) 
of the proposed rule.
    \203\ See proposed rule Appendix B, Sec.  III.B.
    \204\ See proposed rule Appendix B, Sec.  III.C. Proposed 
Appendix B notes, for example, that it may be difficult to 
distinguish (i) inventory positions that appropriately support 
market making-related activities from (ii) positions taken for 
proprietary purposes. See id.
---------------------------------------------------------------------------

    <bullet> Trading activity in which a trading unit retains risk in 
excess of the size and type required to provide intermediation services 
to customers; \205\
---------------------------------------------------------------------------

    \205\ For simplicity and ease of reading, the CFTC has used the 
term ``customer'' throughout the discussion of market making-related 
activity. However, as discussed in proposed Appendix B, a market 
maker's ``customers'' generally vary depending on the asset class 
and market in which the market maker is providing intermediation 
services. In the context of market making in a security that is 
executed on an organized trading facility or an exchange, a 
``customer'' is any person on behalf of whom a buy or sell order has 
been submitted by a broker-dealer or any other market participant. 
In the context of market making in a covered financial position in 
an over-the-counter market, a ``customer'' generally would be a 
market participant that makes use of the market maker's 
intermediation services, either by requesting such services or 
entering into a continuing relationship with the market maker with 
respect to such services. In certain cases, depending on the 
conventions of the relevant market (e.g., the over-the-counter 
derivatives market), such a ``customer'' may consider itself or 
refer to itself more generally as a ``counterparty.''
---------------------------------------------------------------------------

    <bullet> Trading activity in which a trading unit primarily 
generates revenues from price movements of retained principal positions 
and risks, rather than customer revenues;
    <bullet> Trading activity in which a trading unit: (i) Generates 
only very small or very large amounts of revenue per unit of risk 
taken; (ii) does not demonstrate consistent profitability; or (iii) 
demonstrates high earnings volatility;
    <bullet> Trading activity in which a trading unit either (i) does 
not transact through a trading system that interacts with orders of 
others or primarily with customers of the banking entity's market 
making desk to provide liquidity services, or (ii) holds principal 
positions in excess of reasonably expected near term customer demands;
    <bullet> Trading activity in which a trading unit routinely pays 
rather than earns fees, commissions, or spreads; and
    <bullet> The use of compensation incentives for employees of a 
particular trading activity that primarily reward proprietary risk-
taking.\206\
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    \206\ See proposed rule Appendix B, Sec.  III.C.1-6. The CFTC 
notes that each of these six criteria is directly related to the 
overview of market making-related activities provided in section 
III.A. of proposed Appendix B.
---------------------------------------------------------------------------

    The proposed commentary makes clear that the enumerated factors are 
subject to certain facts and circumstances that may explain why a 
trading activity may meet one or more factors but does not involve 
prohibited proprietary trading, and provides a range of examples of 
such explanatory facts and circumstances.\207\ The CFTC emphasizes that 
these examples are not meant to be exhaustive, as a variety of other 
circumstances may exist to explain why a particular trading activity, 
even if meeting one of the factors, may nonetheless be a permitted 
market making-related activity.\208\
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    \207\ The proposed commentary does not contemplate explanatory 
facts and circumstances for the compensation incentives factor, 
given that the choice of compensation incentives provided to trading 
personnel is under the full control of the banking entity.
    \208\ The CFTC also notes that, although a particular trading 
activity may not meet the requirements applicable to permitted 
market making-related activities, it may still be exempt under 
another available exemption.
---------------------------------------------------------------------------

    In addition, for each of these six factors, the proposed rule 
provides general guidance as to (i) the types of facts and 
circumstances on which the CFTC may base any determination that a 
banking entity's trading activity met the relevant factor and (ii) 
which quantitative measurements, if furnished by a banking entity 
pursuant to Appendix A, the CFTC would use to help assess the extent to 
which a banking entity's activities met the relevant factor.
    The CFTC requests comment on the proposed commentary regarding 
identification of permitted market making-related activities. In 
particular, the CFTC requests comment on the following questions:
    Question 177. Is the overview of permitted market making-related 
activities and prohibited proprietary trading proposed in Appendix B 
accurate? If not, what alternative overview would be more accurate? 
Does the overview appropriately account for differences in market 
making-related activities across different asset classes? If not, which 
type of market making-related activity does the overview not 
sufficiently describe or account for?
    Question 177.1. Should the proposed CFTC Rule include the entire 
Appendix B (e.g., description of market-making in liquid exchange-
traded equity)? Please explain the rationale for including or excluding 
certain provisions of Appendix B in the proposed CFTC Rule.
    Question 178. Is the requirement that a market maker engaged in 
market making that is executed on an exchange or an organized trading 
facility must be a registered market maker, provided the relevant 
exchange or organized trading facility provides the ability to 
register, appropriate, or is it over- or under-inclusive? Please 
discuss and provide detailed examples of any such markets where 
registering as a market maker is not feasible or should not be required 
for purposes of this rule, and

[[Page 8377]]

unregistered market makers provide similar services or perform similar 
functions.
    Question 179. With respect to market making that is executed on an 
exchange or an organized trading facility, what potential impact or 
unintended consequences might result from limiting the market making 
exemption to registered market makers when the relevant exchange or 
organized trading facility registers market makers? Would such a 
requirement result in any potential decrease in the passive provision 
of liquidity by the submission of resting orders? Do you anticipate 
that any such decrease would be exacerbated in times of market stress? 
If yes, please describe the impact on liquidity and the marketplace in 
general. Please discuss whether and how any potential decrease in 
liquidity could be mitigated. In addition, would such a requirement 
result in additional costs that would be borne by market participants 
purchasing and selling on an exchange or organized trading facility? 
Please identify and discuss any other additional costs. Please discuss 
whether and how any such consequences can be mitigated.
    Question 180. In addition to benefits discussed in the 
Supplementary Information, are there other benefits that would be 
achieved by requiring that a market maker be registered with respect to 
market making on an exchange or an organized trading facility? Is there 
a way to amplify these benefits? Could these benefits be realized 
through alternative means? If so, how?
    Question 181. In addition to registered market makers on exchanges 
or organized trading facilities, what other classes of liquidity 
providers exist? Are their obligations and activities similar to, or 
different than those of registered market makers? If so, how? Are the 
compensated in a different manner?
    Question 182. How much liquidity is provided by registered market 
makers versus other liquidity providers by asset class (e.g., equities, 
etc.) with respect to trading on an exchange or an organized trading 
facility? The CFTC encourages commenters to provide data, or studies, 
in support of comments.
    Question 183. Is there any specific element of market making-
related activity that the overview does not take into account in its 
description of market making? If so, how should the overview account 
for this element? Are there any descriptions of market making-related 
activity in the overview that should not be considered to be market 
making-related activity? If so, why? Is there any specific element of 
prohibited proprietary trading activity that the overview does not take 
into account in its description of prohibited proprietary trading? If 
so, how should the overview account for this element? Are there any 
descriptions of prohibited proprietary trading activity in the overview 
that should not be considered to be prohibited proprietary trading? If 
so, why?
    Question 184. Are each of the six factors specified for helping to 
distinguish permitted market making-related activity from prohibited 
proprietary trading appropriate? If not, how should they be changed, 
and why? Should any factors be eliminated or added? If so, which ones 
and why? Could any of the proposed factors occur as a result of the 
banking entity engaging in one of the other permitted activities (e.g., 
underwriting, trading on behalf of customers)? If so, would the facts 
and circumstances that the CFTC proposes to consider be sufficient to 
determine and verify that the banking entity is not engaged in 
prohibited proprietary trading? If not, how should this issue be 
addressed?
    Question 185. Are the facts and circumstances that would be used to 
determine whether a banking entity's activities satisfy a certain 
factor appropriate? If not, how should they be changed, and why? Should 
any be eliminated or added? If so, which ones, and why?
    Question 186. Are the identified quantitative measurements that the 
CFTC would use to help assess a particular factor appropriate? If not, 
how should they be changed, and why? Should any be eliminated or added? 
If so, which ones, and why?
e. Incorporation of Numerical Thresholds in the Commentary Regarding 
Identification of Permitted Market Making-Related Activities
    As noted above, the CFTC is currently requesting comment on whether 
to incorporate, as part of the proposed rule, numerical thresholds for 
certain quantitative measurements, and if so, how to do so. For 
example, the proposed rule could include one or more numerical 
thresholds that, if met by a banking entity, would require the banking 
entity to review its trading activities for compliance and summarize 
that review to the CFTC.
    The primary purpose of using some form of threshold would be to 
provide banking entities with a clear standard regarding trading 
activity that presented a quantitative profile sufficiently 
questionable to warrant further review and explanation to the CFTC. 
Such clarity would appear to provide significant benefits both to 
banking entities in conducting their trading activities in conformance 
with the proposed rule and to the CFTC in monitoring trading activities 
and obtaining additional, more detailed information in circumstances 
warranting closer scrutiny. In addition to the benefits of 
transparency, thresholds would also encourage consistent review by 
banking entities and the CFTC of transactions, both within a banking 
entity and across all banking entities. The purpose of such thresholds 
would not be to serve as bounds of permitted conduct or as a 
comprehensive, dispositive tool for determining whether prohibited 
proprietary trading has occurred.
    Numerical thresholds have not been included in the proposed rule 
because the CFTC believes that public comment and further review is 
warranted before numerical thresholds and specific numerical amounts 
may be proposed. Instead, the CFTC requests comment on whether such 
thresholds would be desirable and, if so, what particular form such 
thresholds should take and what specific numerical thresholds would be 
appropriate. To facilitate the comment process, this request for 
comment includes a number of illustrative examples of numerical 
thresholds on which specific comment is sought.
    In particular, the CFTC requests comment on the following 
questions:
    Question 187. What are the potential benefits and costs of 
incorporating into the proposed rule one or more numerical thresholds 
for certain quantitative measurements that, if reported by a banking 
entity, would require the banking entity to review its trading 
activities for compliance and summarize that review to the CFTC? Would 
such thresholds provide useful clarity to banking entities and/or 
market participants regarding the types of trading activities that 
merit additional scrutiny? Should numerical thresholds be used for any 
purposes other than highlighting trading activities that should be 
reviewed, the results of which would be reported to the CFTC? If so, 
for what purpose, and how and why?
    Question 188. For which of the relevant quantitative measurements 
might it be appropriate and effective to include a numerical threshold 
that would trigger banking entity review and explanation? How should a 
numerical threshold be formulated, and why? Should a numerical 
threshold for a single quantitative measurement be applied 
individually, or should the threshold instead be triggered by exceeding 
some combination of numerical thresholds for different

[[Page 8378]]

measurements? For any particular threshold, what numerical amount 
should be used, and why? How would such numerical amount be consistent 
with a level at which further review and explanation is warranted? 
Should the amount vary by asset class or other characteristic? If so, 
how?
    Question 189. For each of the following illustrative examples of 
potential thresholds, is the threshold formulated effectively? If not, 
what alternative formulation would be more effective? Should the 
threshold formulation vary by asset class or other characteristic? If 
so, how and why? If the threshold was utilized, what actual numerical 
amount should be specified, and why? How would such numerical amount be 
consistent with a level at which further review and explanation is 
warranted? Should the numerical amount vary by asset class or other 
characteristic? If so, how and why?
    <bullet> ``If a trading unit reports an increase in VaR, Stress 
VaR, or Risk Factor Sensitivities greater than [----] over a period of 
[----] months, or such other threshold as the CFTC may require, the 
banking entity must (i) promptly review and investigate the trading 
unit's activities to verify whether the trading unit is operating in 
compliance with the proprietary trading restrictions and (ii) report to 
the CFTC a summary of such review, including any explanatory 
circumstances.''
    <bullet> ``If a trading unit reports an average Comprehensive 
Profit and Loss that is less than [----] times greater than the 
Portfolio Profit and Loss, exclusive of Spread Profit and Loss, for [--
--] consecutive months, or such other threshold as the CFTC may 
require, the banking entity must (i) promptly review and investigate 
the trading unit's activities to verify whether the trading unit is 
operating in compliance with the proprietary trading restrictions and 
(ii) report to the CFTC a summary of such review, including any 
explanatory circumstances.''
    <bullet> ``If a trading unit reports a Comprehensive Profit and 
Loss to Volatility Ratio that is less than [----] times greater than 
that trading desk's Portfolio Profit and Loss to Volatility Ratio over 
a period of [----] months, or such other threshold as the CFTC may 
require, the banking entity must (i) promptly review and investigate 
the trading unit's activities to verify whether the trading unit is 
operating in compliance with the proprietary trading restrictions and 
(ii) report to the CFTC a summary of such review, including any 
explanatory circumstances.''
    <bullet> ``If a trading unit reports a number of Unprofitable 
Trading Days Based on Portfolio Profit and Loss that is less than [----
] times greater than the number of Unprofitable Trading Days Based on 
Comprehensive Profit and Loss for [----] consecutive months, or such 
other threshold as [Agency] may require, the banking entity must (i) 
promptly review and investigate the trading unit's activities to verify 
whether the trading unit is operating in compliance with the 
proprietary trading restrictions and (ii) report to [Agency] a summary 
of such review, including any explanatory circumstances.''
    <bullet> ``If a trading unit reports a Pay-to-Receive Spread Ratio 
that is less than [----] over a period of [----] months, or such other 
threshold as [Agency] may require, the banking entity must (i) promptly 
review and investigate the trading unit's activities to verify whether 
the trading unit is operating in compliance with the proprietary 
trading restrictions and (ii) report to [Agency] a summary of such 
review, including any explanatory circumstances.''
6. Section ----.8: Limitations on permitted trading activities
    Section ----.8 of the proposed rule implements section 13(d)(2) of 
the BHC Act, which places certain limitations on the permitted trading 
activities (e.g., permitted market making-related activities, risk-
mitigating hedging, etc.) in which a banking entity may engage.\209\ 
Consistent with the statute, Sec.  ----.8(a) of the proposed rule 
provides that no transaction, class of transactions, or activity is 
permissible under Sec. Sec.  ----.4 through ----.6 of the proposed rule 
if the transaction, class of transactions, or activity would:
---------------------------------------------------------------------------

    \209\ See 12 U.S.C. 1851(d)(2).
---------------------------------------------------------------------------

    <bullet> Involve or result in a material conflict of interest 
between the banking entity and its clients, customers, or 
counterparties;
    <bullet> Result, directly or indirectly, in a material exposure by 
the banking entity to a high-risk asset or a high-risk trading 
strategy; or
    <bullet> Pose a threat to the safety and soundness of the banking 
entity or U.S. financial stability.
    The proposed rule further defines ``material conflict of 
interest,'' ``high-risk asset,'' and ``high-risk trading strategy'' for 
these purposes.
a. Scope of ``Material Conflict of Interest''
    Section ----.8(b) of the proposed rule defines the scope of 
material conflicts of interest which, if arising in connection with a 
permitted trading activity, are prohibited under the proposal.\210\ 
Conflicts of interest may arise in a variety of circumstances related 
to permitted trading activities. For example, a banking entity may 
acquire substantial amounts of nonpublic information about the 
financial condition of a particular company or issuer through its 
lending, underwriting, investment advisory or other activities which, 
if improperly transmitted to and used in trading operations, would 
permit the banking entity to use such information to its customers', 
clients' or counterparties' disadvantage. Similarly, a banking entity 
may conduct a transaction that places the banking entity's own 
interests ahead of its obligations to its customers, clients or 
counterparties, or it may seek to gain by treating one customer 
involved in a transaction more favorably than another customer involved 
in that transaction. Concerns regarding conflicts of interest are 
likely to be elevated when a transaction is complex, highly structured 
or opaque, involves illiquid or hard-to-value instruments or assets, 
requires the coordination of multiple internal groups (such as multiple 
trading desks or affiliated entities), or involves a significant 
asymmetry of information or transactional data among participants.\211\ 
In all cases, the existence of a material conflict of interest depends 
on the specific facts and circumstances.
---------------------------------------------------------------------------

    \210\ Section ----.17(b) of the proposed rule defines the scope 
of material conflicts of interest which, if arising in connection 
with permitted covered fund activities, are prohibited.
    \211\ See, e.g., U.S. Senate Permanent Subcommittee on 
Investigations, Wall Street and the Financial Crisis: Anatomy of a 
Financial Collapse (Apr. 13, 2011), available at http://hsgac.senate.gov/public/_files/Financial_Crisis/FinancialCrisisReport.pdf.
---------------------------------------------------------------------------

    To address these types of material conflicts of interest, Sec.  --
--.8(b) of the proposed rule specifies that a material conflict of 
interest between a banking entity and its clients, customers, or 
counterparties exists if the banking entity engages in any transaction, 
class of transactions, or activity that would involve or result in the 
banking entity's interests being materially adverse to the interests of 
its client, customer, or counterparty with respect to such transaction, 
class of transactions, or activity, unless the banking entity has 
appropriately addressed and mitigated the conflict of interest, where 
possible, and subject to specific requirements provided in the 
proposal, through either (i) timely and effective disclosure, or (ii) 
informational barriers.\212\ Unless the conflict of interest is 
addressed and mitigated in one of the two ways specified in the 
proposal, the related transaction, class of transactions or

[[Page 8379]]

activity would be prohibited under the proposed rule, notwithstanding 
the fact that it may be otherwise permitted under Sec. Sec.  ----.4 
through ----.6 of the proposed rule.\213\
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    \212\ See proposed rule Sec.  ----.8(b)(1).
    \213\ The CFTC notes that a banking entity subject to Appendix C 
must implement a compliance program that includes, among other 
things, policies and procedures that explain how the banking entity 
monitors and prohibits conflicts of interest with clients, 
customers, and counterparties. Further, as noted in the discussion 
of the definition of ``material conflict of interest'' in Part 
III.B.6 of this Supplemental Information, the discussion of that 
definition is provided solely for purposes of the proposed rule's 
definition of material conflict of interest, and does not affect the 
scope of that term in other contexts or a banking entity's 
obligation to comply with additional or different requirements with 
respect to a conflict under applicable securities, banking, or other 
laws (e.g., section 27B of the Securities Act, which governs 
conflicts of interest relating to certain securitizations; section 
206 of the Investment Advisers Act of 1940, which applies to 
conflicts of interest between investment advisers and their clients; 
or 12 CFR 9.12, which applies to conflicts of interest in the 
context of a national bank's fiduciary activities).
---------------------------------------------------------------------------

    However, while these conflicts may be material for purposes of the 
proposed rule, the mere fact that the buyer and seller are on opposite 
sides of a transaction and have differing economic interests would not 
be deemed a ``material'' conflict of interest with respect to 
transactions related to bona fide underwriting, market making, risk-
mitigating hedging or other permitted activities, assuming the 
activities are conducted in a manner that is consistent with the 
proposed rule and securities and banking laws and regulations.
    Section ----.8(b)(1) of the proposed rule describes the two 
requirements that must be met in cases where a banking entity addresses 
and mitigates a material conflict of interest through timely and 
effective disclosure. First, Sec.  ----.8(b)(1)(i) of the proposed rule 
requires that the banking entity, prior to effecting the specific 
transaction or class or type of transactions, or engaging in the 
specific activity, for which a conflict may arise, make clear, timely, 
and effective disclosure of the conflict or potential conflict of 
interest, together with any other necessary information.\214\ This 
would also require such disclosure to be provided in reasonable detail 
and in a manner sufficient to permit a reasonable client, customer, or 
counterparty to meaningfully understand the conflict of interest.\215\ 
Disclosure that is only general or generic, rather than specific to the 
individual, class, or type of transaction or activity, or that omits 
details or other information that would be necessary to a reasonable 
client's, customer's, or counterparty's understanding of the conflict 
of interest, would not meet this standard. Second, Sec.  --
--.8(b)(1)(ii) of the proposed rule requires that the disclosure be 
made explicitly and effectively, and in a manner that provides the 
client, customer, or counterparty the opportunity to negate, or 
substantially mitigate, any materially adverse effect on the client, 
customer, or counterparty that was created or would be created by the 
conflict or potential conflict.\216\
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    \214\ See proposed rule Sec.  ----.8(b)(1)(A).
    \215\ See id.
    \216\ See proposed rule Sec.  ----.8(b)(1)(B).
---------------------------------------------------------------------------

    The CFTC notes that, in order to provide the requisite opportunity 
for the client, customer or counterparty to negate or substantially 
mitigate the disadvantage created by the conflict, the disclosure would 
need to be provided sufficiently close in time to the client's, 
customer's, or counterparty's decision to engage in the transaction or 
activity to give the client, customer, or counterparty an opportunity 
to meaningfully evaluate and, if necessary, take steps that would 
negate or substantially mitigate the conflict. Disclosure provided far 
in advance of the individual, class, or type of transaction, such that 
the client, customer, or counterparty is unlikely to take that 
disclosure into account when evaluating a transaction, would not 
suffice. Conversely, disclosure provided without a sufficient period of 
time for the client, customer, or counterparty to evaluate and act on 
the information it receives, or disclosure provided after the fact, 
would also not suffice under the proposal. The CFTC notes that the 
proposed definition would not prevent or require disclosure with 
respect to transactions or activities that align the interests of the 
banking entity with its clients, customers, or counterparties or that 
otherwise do not involve ``material'' conflicts of interest as 
discussed above.
    The proposed disclosure standard reflects the fact that some types 
of conflicts may be appropriately resolved through the disclosure of 
clear and meaningful information to the client, customer, or 
counterparty that provides such party with an informed opportunity to 
consider and negate or substantially mitigate the conflict. However, in 
the case of a conflict in which a client, customer, or counterparty 
does not have sufficient information and opportunity to negate or 
mitigate the materially adverse effect on the client, customer, or 
counterparty created by the conflict, the existence of that conflict of 
interest would prevent the banking entity from availing itself of any 
exemption (e.g., the underwriting or market-making exemptions) with 
respect to the relevant transaction, class of transactions, or 
activity. The CFTC notes that the proposed disclosure provisions are 
provided solely for purposes of the proposed rule's definition of 
material conflict of interest, and do not affect a banking entity's 
obligation to comply with additional or different disclosure or other 
requirements with respect to a conflict under applicable securities, 
banking, or other laws (e.g., section 27B of the Securities Act, which 
governs conflicts of interest relating to certain securitizations; 
section 206 of the Investment Advisers Act of 1940, which governs 
conflicts of interest between investment advisers and their clients; or 
12 CFR 9.12, which applies to conflicts of interest in the context of a 
national bank's fiduciary activities).
    Section ----.8(b)(2) of the proposed rule describes the 
requirements that must be met in cases where a banking entity uses 
information barriers that are reasonably designed to prevent a material 
conflict of interest from having a materially adverse effect on a 
client, customer or counterparty. Information barriers can be used to 
restrict the dissemination of information within a complex organization 
and to prevent material conflicts by limiting knowledge and 
coordination of specific business activities among units of the entity. 
Examples of information barriers include, but are not limited to, 
restrictions on information sharing, limits on types of trading, and 
greater separation between various functions of the firm. Information 
barriers may also require that banking entity units or affiliates have 
no common officers or employees. Such information barriers have been 
recognized in Federal securities laws and rules as a means to address 
or mitigate potential conflicts of interest or other inappropriate 
activities.\217\
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    \217\ For example, information barriers have been used in 
complying with the requirement in section 15(g) of the Exchange Act 
that registered brokers and dealers establish, maintain and enforce 
written policies and procedures reasonably designed, taking into 
consideration the nature of such broker's or dealer's business, to 
prevent the misuse of material, nonpublic information by such broker 
or dealer or any person associated with such broker or dealer.
---------------------------------------------------------------------------

    In order to address and mitigate a conflict of interest through the 
use of the information barriers pursuant to Sec.  ----.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

[[Page 8380]]

consideration the nature of the banking entity's business, to prevent 
the conflict of interest from involving or resulting in a materially 
adverse effect on a client, customer or counterparty.\218\ Importantly, 
the proposed rule also provides that, notwithstanding a banking 
entity's establishment of such information barriers, if the banking 
entity knows or should reasonably know that a material conflict of 
interest arising out of a specific transaction, class or type of 
transactions, or activity may involve or result in a materially adverse 
effect on a client, customer, or counterparty, the banking entity may 
not rely on those information barriers to address and mitigate any 
conflict of interest. In such cases, the transaction or activity would 
be prohibited, unless the banking entity otherwise complies with the 
requirements of Sec.  ----.8(b)(1).\219\ This aspect of the proposal is 
intended to make clear that, in specific cases in which a banking 
entity has established an information barrier but knows or should 
reasonably know that it has failed or will fail to prevent a conflict 
of interest arising from a specific transactions or activity that 
disadvantages a client, customer, or counterparty, the information 
barrier is insufficient to address that conflict and the transaction 
would be prohibited, unless the banking entity is otherwise able to 
address and mitigate the conflict through timely and effective 
disclosure under the proposal.\220\
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    \218\ See proposed rule Sec.  ----.8(b)(2). As part of 
maintaining and enforcing information barriers, a banking entity 
should have processes to review, test, and modify information 
barriers on a continuing basis. In addition, banking entities should 
have ongoing monitoring to maintain and to enforce information 
barriers, for example by identifying whether such barriers have not 
prevented unauthorized information sharing and addressing instances 
in which the barriers were not effective. This may require both 
remediating any identified breach as well as updating the 
information barriers to prevent further breaches, as necessary. 
Periodic assessment of the effectiveness of information barriers and 
periodic review of the written policies and procedures are also 
important to the maintenance and enforcement of effective 
information barriers and reasonably designed policies and 
procedures. Such assessments can be done either (i) internally by a 
qualified employee or (ii) externally by a qualified independent 
party.
    \219\ See proposed rule Sec.  ----.8(b)(2).
    \220\ In addition, if a conflict occurs to the detriment of a 
client, customer, or counterparty despite an information barrier, 
the CFTC would also expect the banking entity to review the 
effectiveness of its information barrier and make adjustments, as 
necessary, to avoid future occurrences, or review whether such 
information barrier is appropriate for that type of conflict.
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    The CFTC notes that the proposed definition of material conflict of 
interest does not address instances in which a banking entity has made 
a material misrepresentation to its client, customer, or counterparty 
in connection with a transaction, class of transactions, or activity, 
as such transactions or activity appears to involve fraud rather than a 
conflict of interest. However, the CFTC notes that such 
misrepresentations are generally illegal under a variety of Federal and 
State regulatory schemes (e.g., the Federal securities laws). In 
addition, the CFTC notes that any activity involving a material 
misrepresentation to, or other fraudulent conduct with respect to, a 
client, customer, or counterparty would not be permitted under the 
proposed rule in the first instance. For example, a trading activity 
involving a material misrepresentation to a client, customer, or 
counterparty would fail, on its face, to satisfy the proposed terms of 
the underwriting or market-making exemption.
b. Definition of ``High-Risk Asset'' and ``High-Risk Trading Strategy''
    Section ----.8(c) of the proposed rule defines ``high-risk asset'' 
and ``high-risk trading strategy'' for proposes of Sec.  ----.8's 
proposed limitations on permitted trading activities. Section --
--.8(c)(1) defines a ``high-risk asset'' as an asset or group of assets 
that would, if held by the banking entity, significantly increase the 
likelihood that the banking entity would incur a substantial financial 
loss or would fail. Section ----.8(c)(2) defines a ``high-risk trading 
strategy'' as a trading strategy that would, if engaged in by the 
banking entity, significantly increase the likelihood that the banking 
entity would incur a substantial financial loss or would fail.\221\
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    \221\ The CFTC notes that a banking entity subject to proposed 
Appendix C must implement a compliance program that includes, among 
other things, policies and procedures that explain how the banking 
entity monitors and prohibits exposure to high-risk assets and high-
risk trading strategies, and identifies a variety of assets and 
strategies (e.g., assets or strategies with significant embedded 
leverage).
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c. Request for Comment
    The CFTC requests comment on the proposed limitations on permitted 
trading activities. In particular, the CFTC requests comment on the 
following questions:
    Question 190. Is the manner in which the proposed rule implements 
the limitations of section 13(d)(2) of the BHC Act effective and 
sufficiently clear? If not, what alternative would be more effective 
and/or clearer?
    Question 191. Is the proposed rule's definition of material 
conflict of interest effective and sufficiently clear? If not, what 
alternative would be more effective and/or clearer?
    Question 192. Is the proposed definition of material conflict of 
interest over- or under-inclusive? If so, how should the definition be 
broader or narrower? Is there an alternative definition that would be 
appropriate? If so, what definition? Why would that alternative 
definition better define material conflict of interest for purposes of 
implementing section 13 of the BHC Act?
    Question 193. Would the proposed definition of material conflict of 
interest have any unintended chilling effect on underwriting, market 
making, risk-mitigating hedging or other permitted activities? If so, 
what alternatives might limit such an effect?
    Question 194. Would the proposed definition of material conflict of 
interest lead to unintended consequences? If so, what unintended 
consequences and why? Please suggest modifications to the proposed 
definition that would mitigate those consequences.
    Question 195. Is it likely that the proposed definition of material 
conflict of interest would anticipate all future material conflicts of 
interest, particularly as the financial markets evolve and change? If 
not, what alternative definition would better anticipate future 
material conflicts of interest?
    Question 196. Does the proposed rule provide sufficient guidance 
for determining when a material conflict of interest exists? If not, 
what additional detail should be provided? Should the CFTC adopt an 
approach similar to that under the securities laws, in which a material 
conflict of interest is not specifically defined?
    Question 197. Are there transactions, classes or types of 
transactions, or activities inherent in underwriting, market-making, 
risk-mitigating hedging or other permitted activities that should not 
be prohibited but may be captured by the proposed definition of 
material conflict of interest? If so, what transactions and activities? 
Should they be permitted under the proposed rule? If so, why and under 
what conditions, if any? Conversely, are there transactions or 
activities that would be permitted under the proposed rule that should 
be prohibited? If so, what transactions and activities? Why should they 
be prohibited under the proposed rule?
    Question 198. Please discuss the inherent conflicts of interest 
that arise from bona fide underwriting, market making-related activity, 
risk-mitigating hedging, or any other permitted activity, and provide 
specific examples of such inherent conflicts. Do you believe that such 
conflicts ever result in a materially

[[Page 8381]]

adverse interest between a banking entity and a client, customer, or 
counterparty? How should the proposal address inherent conflicts that 
result from otherwise-permitted activities?
    Question 199. Is the manner in which the proposed rule permits the 
use of disclosure in certain cases to address and mitigate conflicts of 
interest appropriate? Why or why not? Should additional or alternative 
requirements be placed on the use of disclosure to address and mitigate 
conflicts? If so, what additional and alternative requirements, and 
why? Is the level of detail and specificity required by the proposed 
rule with respect to disclosure appropriate? If not, what alternative 
level of detail and specificity would be more appropriate?
    Question 200. Should the proposed rule require written disclosure 
to a client, customer, or counterparty regarding a material conflict of 
interest? If so, please explain why written disclosure should be 
required. Are there certain circumstances where written disclosure 
should be required, but others where oral disclosure should be 
sufficient? For example, should oral disclosure be permitted for 
transactions in certain fast-moving markets or transactions with 
sophisticated clients, customers, or counterparties? If oral disclosure 
is permitted under certain circumstances, should subsequent written 
disclosure be required? Please explain.
    Question 201. Should the proposed rule provide further detail 
regarding the types of conflicts of interest that cannot be addressed 
and mitigated through disclosure? If so, what type of additional detail 
would be helpful, and why? Should the proposed rule enumerate an 
exhaustive or non-exhaustive list of conflicts that cannot be addressed 
and mitigated through disclosure? If so, what conflicts should that 
list include, and why?
    Question 202. Should the proposed rule provide further detail 
regarding the frequency at which disclosure must be made? Should 
general disclosure be permitted for certain types of transactions, 
classes of transactions, or activities? For example, should a banking 
entity be permitted to make a one-time, written disclosure to a client, 
customer, or counterparty prior to engaging in a certain type of 
transaction or activity? Should general disclosure be permitted for 
certain types of clients, customers, or counterparties (e.g., highly 
sophisticated parties)? Please explain why specific disclosure (i.e., 
prior to each transaction, class of transaction, or activity) would not 
be necessary under the identified circumstances. Are there any clients, 
customers, or counterparties that should be able to waive a material 
conflict of interest under certain circumstances? If so, under what 
circumstances would a waiver approach be appropriate and consistent 
with the statute? Please explain.
    Question 203. Should the proposed definition of material conflict 
of interest deem certain potential conflicts of interest to not be 
material conflicts of interest if a banking entity establishes, 
maintains, and enforces policies and procedures (other than information 
barriers) reasonably designed to prevent transactions, classes of 
transactions, or activities that would involve or result in a material 
conflict of interest? If so, for what types of potential conflicts? 
What policies and procedures would be appropriate? How would this 
approach be consistent with the purpose and language of the statute? 
Should such policies and procedures only be considered effective if 
they prevent the banking entity from receiving an advantage to the 
disadvantage of the client, customer, or counterparty?
    Question 204. Are there any particular types of clients, customers, 
or counterparties for whom disclosure of a material conflict of 
interest should not be required under the proposal, consistent with the 
statute? Please identify the types of clients, customers, or 
counterparties for whom disclosure might not be necessary and explain. 
Why might disclosures be useful for some clients, customers, or 
counterparties, but not others? Please explain. What characteristics 
should a firm use in determining whether or not a client, customer, or 
counterparty needs a particular disclosure?
    Question 205. Are there additional steps that a banking entity that 
seeks to manage conflicts of interest through the use of disclosure 
should be required to take with regard to disclosure? If so, what 
steps?
    Question 206. Are there circumstances in which disclosure might be 
impracticable or ineffective? If so, what circumstances, and why?
    Question 207. Is the manner in which the proposed rule permits the 
use of information barriers to address and mitigate conflicts of 
interest appropriate? Why or why not? Should additional or alternative 
requirements be placed on the use of information barriers to address 
and mitigate conflicts? If so, what additional and alternative 
requirements, and why?
    Question 208. Should the proposed rule mandate the use of other 
means of managing potential conflicts of interest? If so, what specific 
means should be considered? How effective are any such methods as 
currently used? Can such methods be circumvented? If so, in what ways?
    Question 209. What burdens or costs might be associated with the 
disclosure-related or information barrier-related requirements 
contained in the proposed definition of material conflict of interest? 
How might these burdens or costs be eliminated or reduced in a manner 
consistent with the purpose and language of section 13 of the BHC Act?
    Question 210. Are there specific transactions, classes of 
transactions or activities that should be managed through consent? If 
so, what transactions or activities, and why? What form of consent 
should be required? What level of detail should any such consent 
include? Should consent only apply to certain conflicts and not others? 
If so, which conflicts? Are there circumstances in which obtaining 
consent might be impracticable or ineffective? Should consent be 
limited to certain types of clients, customers, or counterparties? If 
so, which clients, customers, or counterparties? Are there certain 
types of clients, customers, or counterparties for whom consent would 
never be sufficient? Are there additional steps that a banking entity 
that seeks to manage conflicts of interest through the use of consent 
should be required to take? Please specify such steps.
    Question 211. What is the potential relationship between, and 
interplay of, the proposed rule and Section 621 of the Dodd-Frank Act 
regarding conflicts of interest relating to certain securitizations 
which contains a prohibition on material conflicts of interest?
    Question 212. Should the proposed rule provide for specific types 
of procedures that would be more effective in managing and mitigating 
conflicts of interest than others? Do banking entities currently use 
certain procedures that effectively manage and mitigate material 
conflicts of interest? If so, please describe such procedures and 
explain why such procedures are effective. Is the proposed rule 
consistent with such procedures? Why or why not? What are the costs and 
benefits of modifying your current procedures in response to the 
proposed rule?
    Question 213. Is the proposed rule's definition of a high-risk 
asset effective and sufficiently clear? If not, what alternative would 
be more effective and/or clearer? Should the proposed rule specify 
particular assets that are deemed high-risk per se? If so, what assets 
and why?

[[Page 8382]]

    Question 214. Is the proposed rule's definition of a high-risk 
trading strategy effective and sufficiently clear? If not, what 
alternative would be more effective and/or clearer? Should the proposed 
rule specify particular trading strategies that are deemed high-risk 
per se? If so, what trading strategies and why?

C. Subpart C--Covered Fund Activities and Investments

    As noted above, except as otherwise permitted, section 13(a)(1)(B) 
of the BHC Act prohibits a banking entity from acquiring or retaining 
any ownership in, or acting as sponsor to, a covered fund.\222\ Subpart 
C of the proposed rule applies those portions of section 13 of the BHC 
Act that operate as a prohibition or restriction on a banking entity's 
ability, as principal, directly or indirectly, to acquire or retain an 
ownership interest in, act as sponsor to, or have certain relationships 
with, a covered fund. Subpart C also implements the permitted activity 
and investment authorities provided for under section 13(d)(1) of the 
BHC Act related to covered fund activities and investments, as well as 
the rule of construction related to the sale and securitization of 
loans under section 13(g)(2) of that Act. Additionally, subpart C 
contains a discussion of the internal controls, reporting and 
recordkeeping requirements applicable to covered fund activities and 
investments, and incorporates by reference the minimum compliance 
standards for banking entities contained in subpart D of the proposed 
rule, as well as Appendix C, to the extent applicable.
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    \222\ See 12 U.S.C. 1851(a)(1)(B).
---------------------------------------------------------------------------

1. Section ----.10: Prohibition of Acquisition or Retention of 
Ownership Interests in, and Certain Relationships With, a Covered Fund
    Section ----.10 of the proposed rule defines the scope of the 
prohibition on acquisition or retention of ownership interests in, and 
certain relationships with, a covered fund, as well as defines a number 
of key terms related to such prohibition.
a. Prohibition Regarding Covered Fund Activities and Investments
    Section ----.10(a) of the proposed rule implements section 
13(a)(1)(B) of the BHC Act and prohibits a banking entity from, as 
principal, directly or indirectly, acquiring or retaining an equity, 
partnership, or other ownership interest in, or acting as sponsor to, a 
covered fund, unless otherwise permitted under subpart C of the 
proposed rule.\223\ This prohibition reflects the statute's purpose and 
effect of limiting a banking entity's ability to invest in or have 
exposure to a covered fund.
---------------------------------------------------------------------------

    \223\ See proposed rule Sec.  ----.10(a).
---------------------------------------------------------------------------

    The CFTC notes that the general prohibition in Sec.  ----.10(a) of 
the proposed rule applies solely to a banking entity's acquisition or 
retention of an ownership interest in or acting as sponsor to a covered 
fund ``as principal, directly or indirectly.'' \224\ As such, the 
proposed rule would not prohibit the acquisition or retention of an 
ownership interest (including a general partner or membership interest) 
in a covered fund: (i) By a banking entity in good faith in a fiduciary 
capacity, except where such ownership interest is held under a trust 
that constitutes a company as defined in section (2)(b) of the BHC Act; 
(ii) by a banking entity in good faith in its capacity as a custodian, 
broker, or agent for an unaffiliated third party; (iii) by a 
``qualified plan,'' as that term is defined in section 401 of the 
Internal Revenue Code of 1956 (26 U.S.C. 401), if the ownership 
interest would be attributed to a banking entity solely by operation of 
section 2(g)(2) of the BHC Act; or (iv) by a director or employee of a 
banking entity who acquires the interest in his or her personal 
capacity and who is directly engaged in providing advisory or other 
services to the covered fund, unless the banking entity, directly or 
indirectly, extended credit for the purpose of enabling the director or 
employee to acquire the ownership interest in the fund and the credit 
was used to acquire such ownership interest in the fund.
---------------------------------------------------------------------------

    \224\ The CFTC notes that this language is intended to prevent a 
banking entity from evading the restrictions contained in section 
13(a)(1)(B) of the BHC Act on acquiring or retaining an ownership 
interest in a covered fund.
---------------------------------------------------------------------------

    Among other things, Sec.  ----.10(b) of the proposed rule defines 
the term ``covered fund.'' \225\ This definition explains the universe 
of entities to which the prohibition contained in Sec.  ----.10(a) 
applies unless the activity is specifically permitted under an 
available exemption contained in subpart C of the proposed rule. Other 
related terms, including ``ownership interest,'' ``prime brokerage 
transaction,'' ``sponsor,'' and ``trustee,'' are in turn defined in 
Sec. Sec.  ----.10(b)(2) through ----.10(b)(6) of the proposed rule.
---------------------------------------------------------------------------

    \225\ See proposed rule Sec.  ----.10(b)(1). The term banking 
entity, which is discussed above in Part III.A.2 of this 
Supplementary Information, is defined in Sec.  ----.2(e).
---------------------------------------------------------------------------

b. ``Covered Fund'' and Related Definitions
i. Definition of ``Covered Fund''
    Section 13(h)(2) of the BHC Act defines the terms ``hedge fund'' 
and ``private equity fund'' to mean ``any issuer that would be an 
investment company, as defined in the [Investment Company Act], but for 
section 3(c)(1) or 3(c)(7) of that Act,'' or such similar funds as the 
Agencies may by rule determine.\226\ Given that the statute defines a 
``hedge fund'' and ``private equity fund'' synonymously, the proposed 
rule implements this statutory definition by combining the terms into 
the definition of a ``covered fund.'' \227\
---------------------------------------------------------------------------

    \226\ 12 U.S.C. 1851(h)(2). Sections 3(c)(1) and 3(c)(7) of the 
Investment Company Act, in relevant part, provide two exclusions 
from the definition of ``investment company'' for, as appropriate, 
(1) any issuer whose outstanding securities are beneficially owned 
by not more than one hundred persons and which is not making and 
does not presently propose to make a public offering of its 
securities (other than short-term paper), or (2) any issuer, the 
outstanding securities of which are owned exclusively by persons 
who, at the time of acquisition of such securities, are qualified 
purchasers, and which is not making and does not at that time 
proposes to make a public offering of such securities. See 15 U.S.C. 
80a-3(c)(1) and (c)(7).
    \227\ See proposed rule Sec.  ----.10(b)(1).
---------------------------------------------------------------------------

    Sections 3(c)(1) and 3(c)(7) of the Investment Company Act are 
exclusions from the definition of ``investment company'' in that Act 
and are commonly relied on by a wide variety of entities that would 
otherwise be covered by the broad definition of ``investment company'' 
contained in that Act. As a result, the statutory definition in section 
13(h)(2) of the BHC Act could potentially include within its scope many 
entities and corporate structures that would not usually be thought of 
as a ``hedge fund'' or ``private equity fund.'' For instance, joint 
ventures, acquisition vehicles, certain wholly-owned subsidiaries, and 
other widely-utilized corporate structures typically rely on the 
exclusion contained in section 3(c)(1) or 3(c)(7) of the Investment 
Company Act. These types of entities are generally not used to engage 
in investment or trading activities. Additionally, as noted in Part 
II.H of this Supplementary Information, certain securitization vehicles 
may be included in this definition.
    The proposed rule follows the scope of the statutory definition by 
covering an issuer only if it would be an investment company, as 
defined in the Investment Company Act, but for section 3(c)(1) or 
3(c)(7) of that Act.\228\

[[Page 8383]]

Additionally, the proposed rule incorporates the statutory application 
of the rule to ``such similar funds as the Agencies may determine by 
rule as provided in section 13(b)(2) of the BHC Act.'' \229\ The CFTC 
has proposed to include as ``similar funds'' a commodity pool,\230\ as 
well as the foreign equivalent of any entity identified as a ``covered 
fund.'' \231\ These entities have been included in the proposed rule as 
``similar funds'' given that they are generally managed and structured 
similar to a covered fund, except that they are not generally subject 
to the Federal securities laws due to the instruments in which they 
invest or the fact that they are not organized in the United States or 
one or more States.
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    \228\ See proposed rule Sec.  ----.10(b)(1)(i). Under the 
proposed rule, if an issuer (including an issuer of asset-backed 
securities) may rely on another exclusion or exemption from the 
definition of ``investment company'' under the Investment Company 
Act other than the exclusions contained in section 3(c)(1) or 
3(c)(7) of that Act, it would not be considered a covered fund, as 
long as it can satisfy all of the conditions of an alternative 
exclusion or exemption for which it is eligible.
    \229\ 12 U.S.C. 1851(b)(2).
    \230\ ``Commodity pool'' is defined in the Commodity Exchange 
Act to mean any investment trust, syndicate, or similar form of 
enterprise operated for the purpose of trading in commodity 
interests, including any: (i) Commodity for future delivery, 
security futures product, or swap; (ii) agreement, contract, or 
transaction described in section 2(c)(2)(C)(i) or 2(c)(2)(D)(i) of 
the Commodity Exchange Act; (iii) commodity option authorized under 
section 4c of the Commodity Exchange Act; or (iv) leverage 
transaction authorized under section 23 of the Commodity Exchange 
Act. See 7 U.S.C. 1a(10).
    \231\ See proposed rule Sec.  ----.10(b)(1)(iii). The proposed 
rule makes clear that any issuer, as defined in section 2(a)(22) of 
the Investment Company Act, (15 U.S.C. 80a-2(a)(22)), that is 
organized or offered outside of the United States, would qualify as 
a covered fund if, were it organized or offered under the laws, or 
offered for sale or sold to a resident, of the United States or of 
one or more States, it would be either: (i) An investment company, 
as defined in the Investment Company Act, but for section 3(c)(1) or 
3(c)(7) of that Act; (ii) a commodity pool; or (iii) any such 
similar fund as the appropriate Federal banking agencies, the SEC, 
and the CFTC may determine, by rule, as provided in section 13(b)(2) 
of the BHC Act.
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ii. Definition of ``Ownership Interest''
    The proposed rule defines ``ownership interest'' in order to make 
clear the scope of section 13(a)(1)(B) of the BHC Act and Sec.  --
--.10(a)'s prohibition on a banking entity acquiring or retaining any 
equity, partnership, or other ownership interest in a covered fund. The 
definition of ownership interest includes a description of what 
interests constitute an ownership interest, as well as an exclusion 
from the definition of ownership interest for carried interest.\232\ 
The proposed rule defines ownership interest to mean, with respect to a 
covered fund, any equity, partnership, or other similar interest 
(including, without limitation, a share, equity security, warrant, 
option, general partnership interest, limited partnership interest, 
membership interest, trust certificate, or other similar interest) in a 
covered fund, whether voting or nonvoting, as well as any derivative of 
such interest. This definition focuses on the attributes of the 
interest and whether it provides a banking entity with economic 
exposure to the profits and losses of the covered fund, rather than its 
form. To the extent that a debt security or other interest of a covered 
fund exhibits substantially the same characteristics as an equity or 
other ownership interest (e.g., provides the holder with voting rights, 
the right or ability to share in the covered fund's profits or losses, 
or the ability, directly or pursuant to a contract or synthetic 
interest, to earn a return based on the performance of the fund's 
underlying holdings or investments), the Agencies could consider such 
instrument an ownership interest as an ``other similar instrument.''
---------------------------------------------------------------------------

    \232\ See proposed rule Sec.  ----.10(b)(3).
---------------------------------------------------------------------------

    Many banking entities that serve as investment adviser or commodity 
trading advisor to a covered fund are compensated for services they 
provide to the fund through receipt of so-called ``carried interest.'' 
In recognition of the manner in which such compensation is 
traditionally provided, the proposed rule also clarifies that an 
ownership interest with respect to a covered fund does not include an 
interest held by a banking entity (or an affiliate, subsidiary or 
employee thereof) in a covered fund for which the banking entity (or an 
affiliate, subsidiary or employee thereof) serves as investment 
manager, investment adviser or commodity trading advisor, so long as: 
(i) The sole purpose and effect of the interest is to allow the banking 
entity (or the affiliate, subsidiary or employee thereof) to share in 
the profits of the covered fund as performance compensation for 
services provided to the covered fund by the banking entity (or the 
affiliate, subsidiary or employee thereof), provided that the banking 
entity (or the affiliate, subsidiary or employee thereof) may be 
obligated under the terms of such interest to return profits previously 
received; (ii) all such profit, once allocated, is distributed to the 
banking entity (or the affiliate, subsidiary or employee thereof) 
promptly after being earned or, if not so distributed, the reinvested 
profit of the banking entity (or the affiliate, subsidiary or employee 
thereof) does not share in the subsequent profits and losses of the 
covered fund; (iii) the banking entity (or the affiliate, subsidiary or 
employee thereof) does not provide funds to the covered fund in 
connection with acquiring or retaining this carried interest; and (iv) 
the interest is not transferable by the banking entity (or the 
affiliate, subsidiary or employee thereof) except to an affiliate or 
subsidiary.\233\ The proposed rule therefore permits a banking entity 
to receive an interest as performance compensation for services 
provided by it or one of its affiliates, subsidiaries, or employees to 
a covered fund, but only if the enumerated conditions are met.
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    \233\ See proposed rule Sec.  ----.10(b)(3)(ii).
---------------------------------------------------------------------------

iii. Definition of ``Prime Brokerage Transaction''
    Section 13(f)(3) of the BHC Act permits a banking entity to enter 
into a prime brokerage transaction with a covered fund in which a 
covered fund managed, organized, or sponsored by such banking entity 
(or an affiliate or subsidiary thereof) has taken an ownership 
interest.\234\ However, section 13 of the BHC Act does not define what 
qualifies as a prime brokerage transaction. In order to provide clarity 
regarding the types of services and relationships that are permitted as 
a prime brokerage transaction, the proposed rule defines a ``prime 
brokerage transaction'' to mean one or more products or services 
provided by a banking entity to a covered fund, such as custody, 
clearance, securities borrowing or lending services, trade execution, 
or financing, data, operational, and portfolio management support.\235\
---------------------------------------------------------------------------

    \234\ See 12 U.S.C. 1851(f)(3).
    \235\ See proposed rule Sec.  ----.10(b)(4).
---------------------------------------------------------------------------

iv. Definition of ``Sponsor'' and ``Trustee''
    The proposed rule defines ``sponsor'' in the same manner as section 
13(h)(5) of the BHC Act.\236\ Section ----.10(b)(5) of the proposed 
rule defines the term ``sponsor'' as an entity that: (i) serves as a 
general partner, managing member, trustee, or commodity pool operator 
of a covered fund; (ii) in any manner selects or controls (or has 
employees, officers, or directors, or agents who constitute) a majority 
of the directors, trustees, or management of a covered fund; or (iii) 
shares with a covered fund, for the corporate, marketing, promotional, 
or other purposes, the same name or a variation of the same name.\237\
---------------------------------------------------------------------------

    \236\ See 12 U.S.C. 1851(h)(5).
    \237\ See proposed rule Sec.  ----.10(b)(5).
---------------------------------------------------------------------------

    The definition of ``sponsor'' contained in section 13(h)(5) of the 
BHC Act focuses on the ability to control the decision-making and 
operational

[[Page 8384]]

functions of the fund. In keeping with this focus, the proposed rule 
defines the term ``trustee'' (which is a part of the definition of 
``sponsor'') to exclude trustee that does not exercise investment 
discretion with respect to a covered fund, including a directed 
trustee, as that term is used in section 403(a)(1) of the Employee's 
Retirement Income Security Act (29 U.S.C. 1103(a)(1)). The proposed 
rule provides that a ``trustee'' includes any banking entity that 
directs a directed trustee, or any person who possesses authority and 
discretion to manage and control the assets of the covered fund.\238\
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    \238\ See proposed rule Sec.  ----.10(b)(6)(ii).
---------------------------------------------------------------------------

v. Request for Comment
    The CFTC requests comment on the proposed rule's approach to 
defining the terms covered fund, ownership interest, and other related 
terms. In particular, the CFTC requests comment on the following 
questions:
    Question 215. Is the proposed rule's approach to applying section 
13 of the BHC Act's restrictions related to covered fund activities and 
investments to those instances where a banking entity acts ``as 
principal or beneficial owner'' effective? If not, why? What 
alternative approach might be more effective in light of the language 
and purpose of the statute?
    Question 216. Does the proposed rule effectively address the 
circumstances under which an investment by a director or employee of a 
banking entity in a covered fund would be attributed to a banking 
entity? If not, why? What alternative might be more effective?
    Question 217. Does the proposed rule's definition of ``covered 
fund'' effectively implement the statute? What alternative definitions 
might be more effective in light of the language and purpose of the 
statute?
    Question 218. Is specific inclusion of commodity pools within the 
definition of ``covered fund'' effective and consistent with the 
language and purpose of the statute? Why or why not?
    Question 218.1. The proposed CFTC Rule defines a ``covered fund'' 
to include a commodity pool, as defined in section 1a(10) of the 
Commodity Exchange Act. Is the use of this definition of ``commodity 
pools'' too broad? For example, will this definition potentially pull 
in additional pools that may be outside the intent of the proposed 
regulations?
    Question 219. The proposed definition of ``sponsor'' focuses on 
``the ability to control the decision-making and operational functions 
of the fund.'' In the securitization context, is this an appropriate 
manner to determine the identity of the sponsor? If not, what factors 
should be used to determine the identity of the sponsor in the 
securitization context for purposes of the proposed rule and why? Is 
the definition of ``sponsor'' set forth in the SEC's Regulation AB 
\239\ an appropriate party to treat as sponsor for purposes of the 
proposed rule? Is additional guidance necessary with respect to how the 
proposed definition of ``sponsor'' should be applied to a 
securitization transaction?
---------------------------------------------------------------------------

    \239\ See 17 CFR 229.1101(l).
---------------------------------------------------------------------------

    Question 220. Should the application of the proposed definition of 
``sponsor'' mean that the servicer or investment manager in a 
securitization transaction would be considered the sponsor for purposes 
of the proposed rule? What impact would this interpretation of the 
proposed definition have on existing securitizations?
    Question 221. Should the definition of ``covered fund'' focus on 
the characteristics of an entity rather than whether it would be an 
investment company but for section 3(c)(1) or 3(c)(7) of the Investment 
Company Act? If so, what characteristics should be considered and why? 
Would a definition focusing on an entity's characteristics rather than 
its form be consistent with the language and purpose of the statute?
    Question 222. Instead of adopting a unified definition of ``covered 
fund'' for those entities included under section 13(h)(2) of the BHC 
Act, should the Agencies consider having separate definitions for 
``hedge fund'' and ``private equity fund''? If so, which definitions 
and why?
    Question 223. Should the CFTC consider using the authority provided 
under section 13(d)(1)(J) of the BHC Act to exempt the acquisition or 
retention of an ownership interest in a covered fund with certain 
attributes or characteristics, including, for example: (i) A 
performance fee or allocation to an investment manager's equity account 
calculated by taking into account income and realized and unrealized 
gains; (ii) borrowing an amount in excess of one-half of its total 
capital commitments or has gross notional exposure in excess of twice 
its total capital commitments; (iii) sells securities or other assets 
short; (iv) has restricted or limited investor redemption rights; (v) 
invests in public and non-public companies through privately negotiated 
transactions resulting in private ownership of the business; (vi) 
acquires the unregistered equity or equity-like securities of such 
companies that are illiquid as there is no public market and third 
party valuations are not readily available; (vii) requires holding 
those investments long-term; (viii) has a limited duration of ten years 
or less; or (ix) returns on such investments are realized and the 
proceeds of the investments are distributed to investors before the 
anticipated expiration of the fund's duration? Which, if any, of these 
characteristics are appropriate to describe a hedge fund or private 
equity fund that should be considered a covered fund for purposes of 
this rule? Are there any other characteristics that would be more 
appropriate to describe a covered fund? If so, which characteristics 
and why?
    Question 224. Is specific inclusion of certain non-U.S. entities as 
a ``covered fund'' under Sec.  ----.10(b)(1)(iii) of the proposed rule 
necessary, or would such entities already be considered to be a 
``covered fund'' under Sec.  ----.10(b)(1)(i) of the proposed rule? If 
so, why? Does the proposed rule's language on non-U.S. entities 
correctly describe those non-U.S. entities, if any, that should be 
included in the definition of ``covered fund''? Why or why not? What 
alternative language would be more effective? Should the CFTC define 
non-U.S. funds by reference to the following structural 
characteristics: whether they are limited in the number or type of 
investors; whether they operate without regard to statutory or 
regulatory requirements relating to the types of instruments in which 
they may invest or the degree of leverage they may incur? Why or why 
not?
    Question 225. Are there any entities that are captured by the 
proposed rule's definition of ``covered fund,'' the inclusion of which 
does not appear to be consistent with the language and purpose of the 
statute? If so, which entities and why?
    Question 226. Are there any entities that are not captured by the 
proposed rule's definition of ``covered fund,'' the exclusion of which 
does not appear to be consistent with the language and purpose of the 
statute? If so, which entities and why?
    Question 227. Do the proposed rule's definitions of ``covered 
fund'' and/or ``ownership interest'' pose unique concerns or challenges 
to issuers of asset-backed securities and/or securitization vehicles? 
If so, why? Do certain types of securitization vehicles (trusts, LLCs, 
etc.) typically issue asset-backed securities which would be included 
in the proposed definition of ownership interest? What would be the 
impact of the application of the proposed rules to these securitization

[[Page 8385]]

vehicles? Are certain asset classes (collateralized debt obligations, 
future flows, corporate debt repackages, etc.) more likely to be 
impacted by the proposed definition of ``covered fund'' because the 
issuer cannot rely on an exemption other than 3(c)(1) or 3(c)(7) of the 
Investment Company Act?
    Question 227.1. Should the proposed CFTC Rule cover securitization 
vehicles? Please explain the rationale for including or excluding 
securitization vehicles in the proposed CFTC Rule.
    Question 228. How many existing issuers of asset-backed securities 
would be included in the proposed definition of ``covered fund?'' What 
would be the legal and economic impact of the proposed rule on holders 
of asset-backed securities issued by existing securitization vehicles 
that would be included in the proposed definition of covered fund?
    Question 229. Are there entities that issue asset-backed securities 
(as defined in Section 3(a) of the Exchange Act) that should be 
exempted from the requirements of the proposed rule? How would such an 
exemption promote and protect the safety and soundness of the banking 
entity and the financial stability of the United States as required by 
section 13(d)(1)(J) of the BHC Act?
    Question 230. Since certain existing asset-backed securities may 
have a term that exceeds the conformance or extended transition periods 
provided for under section 13(c) of the BHC Act, should the CFTC 
consider using the authority contained in section 13(d)(1)(J) of that 
Act to exclude those existing asset-backed securities from the proposed 
definition of ``ownership interest'' and/or should the rule permit a 
banking entity to acquire or retain an ownership interest in existing 
asset-backed issuers? If so, how would either approach be consistent 
with the language and purpose of the statute?
    Question 231. 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). If the proposed definition of ``covered fund'' were to 
exempt any entity issuing asset-backed securities, would this allow for 
interests in hedge funds or private equity funds to be structured as 
asset-backed securities and circumvent the proposed rule? If this 
approach is taken, how should the proposal address this concern?
    Question 232. Are the structural similarities between an entity 
that issues asset-backed securities and hedge funds and private equity 
funds of sufficient concern that the CFTC should not exclude any entity 
that issues asset-backed securities from the definition of covered 
fund?
    Question 233. Should entities that rely on a separate exclusion 
from the definition of investment company other than sections 3(c)(1) 
or 3(c)(7) of the Investment Company Act be included in the definition 
of ``covered fund''? Why or why not?
    Question 234. Do the proposed rule's definitions of ``ownership 
interest'' and ``carried interest'' effectively implement the statute? 
What alternative definitions might be more appropriate in light of the 
language and purpose of the statute? Are there other types of 
instruments that should be included or excluded from the definition of 
``ownership interest''? Does the proposed definition of ownership 
interest capture most interests that are typically viewed as ownership 
interests? Is the proposed rule's exemption of carried interest from 
the definition of ownership interest with respect to a covered fund 
appropriate? Does the exemption adequately address existing 
compensation arrangements and the way in which a banking entity becomes 
entitled to carried interest? Is it consistent with the current tax 
treatment of these arrangements?
    Question 235. In the context of asset-backed securities, the 
distinction between debt and equity may be complicated (e.g., trust 
certificates issued in a residential mortgage backed security 
transaction) and the legal, accounting and tax treatment may differ for 
the same instrument. Is guidance necessary with respect to the 
application of the definition of ownership interest for asset-backed 
securitization transactions?
    Question 236. In many securitization transactions, the residual 
interest represents the ``equity'' in the transaction. As this often 
constitutes the portion of the securitization transaction with the most 
risk, because it may absorb any losses experienced by the underlying 
assets before any other interests issued by the securitization vehicle, 
should the CFTC instead use their authority under section 13(d)(1)(J) 
of the BHC Act to exempt the buying and selling of any ownership 
interest in a securitization vehicle that is a covered fund other than 
the residual interest?
    Question 237. For purposes of limiting either an exclusion for 
issuers of asset-backed securities from the proposed definition of 
``covered fund'' and/or an exclusion of asset-backed securities from 
the proposed definition of ``ownership interest,'' what definition of 
asset-backed security most effectively implements the language of 
section 13 of the BHC Act? Section 3(a)(77) of the Exchange Act and the 
SEC's Regulation AB \240\ provide two possible definitions. Is either 
of these definitions sufficient, and if so why? If one of the 
definitions is too narrow, what additional entities/securities should 
be included and why? If one of the definitions is too broad, what 
entities/securities should be excluded and why? Would some other 
definition of asset-backed security be more consistent with the 
language and purpose of section 13 of the BHC Act?
---------------------------------------------------------------------------

    \240\ See 17 CFR 229.1101(c).
---------------------------------------------------------------------------

    Question 238. Are there special concerns raised by not including as 
an ownership interest the residual interests in a securitization 
vehicle? Should the CFTC instead exempt the buying and selling of any 
ownership interest in a securitization vehicle that is a covered fund 
other than the residual interest?
    Question 239. Should the legal form of a beneficial interest be a 
determining factor for deciding whether a beneficial interest is an 
``ownership interest''? For example, should pass-through trust 
certificates issued as part of a securitization transaction be excluded 
from the definition of ``ownership interest''? Should the definition of 
ownership interest explicitly include debt instruments with equity 
features (e.g., voting rights, profit participations, etc.)?
    Question 240. How should the proposed rule address those instances 
in which both debt and equity interests are issued, and the debt 
interests receive all of the economic benefits and all of the control 
rights? Should the debt interests (other than the residual interest) be 
counted as ownership interests even though they are not legally 
ownership and do not receive any profit participation? Should the 
equity interests be counted as ownership interests even though the 
holder does not receive economic benefits or have any control rights? 
Should the residual interest be considered the only ``ownership 
interest'' for purposes of the proposed rule? Should mezzanine 
interests that lack both control rights and profit participation be 
considered an ownership interest? If the mezzanine interests obtain 
control rights (because more senior classes have been repaid), should 
they become ``ownership interests'' at that time for purposes of the 
proposed rule? If both debt and equity interests are counted as 
ownership interests, how should percentages of ownership interests be 
calculated when the units of measurement do not match (e.g., a

[[Page 8386]]

single trust certificate, a single residual certificate with no face 
value and multiple classes of currency-denominated notes)?
    Question 241. Does the proposed rule's definition of ``prime 
brokerage transaction'' effectively implement the statute? What other 
types of transactions or services, if any, should be included in the 
definition? Should any types of transactions or services be excluded 
from the definition? Would an alternative definition be more effective, 
and if so, why?
    Question 242. Do the proposed rule's definitions of ``sponsor'' and 
``trustee'' effectively implement the statute? Is the exclusion of 
``directed trustee'' from the definition of ``trustee'' appropriate?
    Question 243. Do the proposed rule's other definitions in Sec.  --
--.10(b) effectively implement the statute? What alternative 
definitions might be more effective in light of the language and 
purpose of the statute? Are additional definitions needed, and if so, 
what definition(s)?
2. Section --.11: Permitted Organizing and Offering of a Covered Fund
    Section ----.11 of the proposed rule implements section 13(d)(1)(G) 
of the BHC Act and permits a banking entity to organize and offer a 
covered fund, including acting as sponsor of the fund, if certain 
criteria are met.\241\ This exemption is designed to permit a banking 
entity to be able to engage in certain traditional asset management and 
advisory businesses in compliance with section 13 of the BHC Act.\242\
---------------------------------------------------------------------------

    \241\ See proposed rule Sec.  ----.11.
    \242\ 156 Cong. Rec. S5889 (daily ed. July 15, 2010) (statement 
of Sen. Hagan).
---------------------------------------------------------------------------

a. Required Criteria for Permitted Organizing and Offering of Covered 
Funds
    Section ----.11 of the proposed rule provides for and describes the 
conditions that must be met in order to enable a banking entity to 
qualify for the exemption to organize and offer a covered fund.\243\ 
These conditions include: (i) The banking entity must provide bona fide 
trust, fiduciary, investment advisory, or commodity trading advisory 
services;\244\ (ii) the covered fund must be organized and offered only 
in connection with the provision of bona fide trust, fiduciary, 
investment advisory, or commodity trading advisory services and only to 
persons that are customers of such services of the banking entity; 
(iii) the banking entity may not acquire or retain an ownership 
interest in the covered fund except as permitted under subpart C of the 
proposed rule; (iv) the banking entity must comply with the 
restrictions governing relationships with covered funds under Sec.  --
--.16 of the proposed rule; (v) the banking entity may not, directly or 
indirectly, guarantee, assume, or otherwise insure the obligations or 
performance of the covered fund or of any covered fund in which such 
covered fund invests; (vi) the covered fund, for corporate, marketing, 
promotional, or other purposes, (A) may not share the same name or a 
variation of the same name with the banking entity (or an affiliate or 
subsidiary thereof), and (B) may not use the word ``bank'' in its name; 
(vii) no director or employee of the banking entity may take or retain 
an ownership interest in the covered fund, except for any director or 
employee of the banking entity who is directly engaged in providing 
investment advisory or other services to the covered fund; and (viii) 
the banking entity must (A) clearly and conspicuously disclose, in 
writing, to any prospective and actual investor in the covered fund 
(such as through disclosure in the covered fund's offering documents) 
the enumerated disclosures contained in Sec.  ----.11(h) of the 
proposed rule, and (B) comply with any additional rules of the CFTC or 
other Agencies, designed to ensure that losses in such covered fund are 
borne solely by investors in the covered fund and not by the banking 
entity.\245\ These requirements are explained in detail below.
---------------------------------------------------------------------------

    \243\ See proposed rule Sec. Sec.  ----.11(a)--(h).
    \244\ While section 13(d)(1)(G) of the BHC Act does not 
explicitly mention ``commodity trading advisory services,'' the CFTC 
has proposed to include commodity pools within the definition of 
``covered fund'' and commodity trading advisory services in the same 
way as investment advisory services because commodity trading 
advisory services are the functional equivalent of investment 
advisory services to commodity pools.
    \245\ See id. at Sec.  ----.11(a)-(h). The CFTC is not proposing 
any such additional rules at this time, although they may do so in 
the future.
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i. Bona Fide Services
    Section ----.11(a) of the proposed rule requires that, in order to 
qualify for the exemption related to organizing and offering a covered 
fund, a banking entity provide bona fide trust, fiduciary, investment 
advisory, or commodity trading advisory services.\246\ Banking entities 
provide a wide range of customer-oriented services which may qualify as 
bona fide trust, fiduciary, investment advisory, or commodity trading 
advisory services.\247\ Additionally, depending on the type of banking 
entity that conducts the activity or provides the service, variations 
in the precise services involved may occur. For example, a national 
bank and an SEC-registered investment adviser may provide substantially 
similar investment advisory services to clients, but be subject to 
different statutory and regulatory requirements. In recognition of 
potential variations in services and functional regulation, the 
proposed rule does not specify what services would qualify as ``bona 
fide trust, fiduciary, investment advisory, or commodity trading 
advisory services'' under Sec.  ----.11(a) of the proposed rule. 
Instead, the proposed rule largely mirrors the statutory language of 
section 13(d)(1)(G)(i) of the BHC Act and reflects the intention that 
so long as a banking entity provides trust, fiduciary, investment 
advisory, or commodity trading advisory services in compliance with 
relevant statutory and regulatory requirements, the requirement 
contained in Sec.  ----.11(a) of the proposed rule would generally be 
deemed to be satisfied.
---------------------------------------------------------------------------

    \246\ See 12 U.S.C. 1851(d)(1)(G)(i); proposed rule Sec.  --
--.11(a).
    \247\ See, e.g., 12 U.S.C. 1843(c)(4), (c)(8), (k),12 CFR 
225.28(b)(5) and (6), 12 CFR 225.86, 12 CFR 225.125 (with respect to 
a bank holding company); 12 U.S.C. 24 (Seventh), 92a, 12 CFR Part 9 
(with respect to a national bank); 12 U.S.C. 1831a, 12 CFR Part 362 
(with respect to a state nonmember bank).
---------------------------------------------------------------------------

ii. ``Customers of Such Services'' Requirement
    Section 13(d)(1)(G)(ii) of the BHC Act requires that a banking 
entity organize and offer a covered fund ``only in connection with'' 
the provision of qualified services to persons that are customers of 
such services of the banking entity.\248\ Section ----.11(b) of the 
proposed rule implements the statute and reflects the statutory 
requirement that there are two independent conditions contained in 
section 13(d)(1)(G)(ii) of the BHC Act: (i) A covered fund must be 
organized and offered in connection with bona fide trust, fiduciary, 
investment advisory, or commodity trading advisory services, and (ii) 
the banking entity providing those services may offer the covered fund 
only to persons that are customers of those services of the banking 
entity.\249\ Requiring a customer relationship in connection with 
organizing and offering a covered fund helps to ensure that a banking 
entity is engaging in the covered fund activity for others and not on 
the banking entity's own behalf.\250\
---------------------------------------------------------------------------

    \248\ See 12 U.S.C. 1851(d)(1)(G)(ii).
    \249\ See proposed rule Sec.  ----.11(b).
    \250\ See 156 Cong. Rec. at S5897 (daily ed. July 15, 2010) 
(statement of Sen. Merkley).
---------------------------------------------------------------------------

    Section 13(d)(1)(G)(ii) of the BHC Act does not explicitly require 
that the customer relationship be pre-existing.

[[Page 8387]]

Accordingly, the proposed rule provides that it may be established 
through or in connection with the banking entity's organization and 
offering of a covered fund, so long as that fund is a manifestation of 
the provision by the banking entity of bona fide trust, fiduciary, 
investment advisory or commodity trading advisory services to the 
customer. This application of the customer requirements is consistent 
with the manner in which trust, fiduciary, investment advisory, and 
commodity trading advisory services are provided by banking entities. 
Historically, banking entities have raised capital commitments for 
covered funds from existing customers as well as individuals or 
entities that have no pre-existing relationship with the banking 
entity.
    Banking entities commonly organize and offer funds to customers of 
the banking entity's trust, fiduciary, and investment advisory or 
commodity trading advisory services as a way of ensuring the efficient 
and consistent provision of these services. For example, a person often 
obtains the investment advisory services of the banking entity by 
acquiring an interest in a fund organized and offered by the banking 
entity. This is distinguished from a fund organized and offered by a 
banking entity for the purpose of itself investing as principal, 
indirectly through its investment in the fund, in assets held by the 
fund. Under the proposed rule, a banking entity could, consistent with 
past practice, provide a covered fund to persons that are customers of 
such services for purposes of the exemption so long as the fund is 
organized and offered as a means of providing bona fide trust, 
fiduciary, investment advisory, or commodity trading advisory services 
to customers. The banking entity may not organize and offer a covered 
fund as a means of itself investing in the fund or assets held in the 
fund.\251\
---------------------------------------------------------------------------

    \251\ The proposed rule does not change any requirement imposed 
by separate statute, regulation, or other law, if applicable. For 
instance, a banking entity that conducts a private placement of a 
covered fund pursuant to the SEC's Regulation D pertaining to 
private offerings would still be expected to comply with the 
relevant requirements related to such offering, including the 
limitations related to the manner in which and types of persons to 
whom it may offer or sell interests in such fund. See 12 CFR 230.501 
et seq.
---------------------------------------------------------------------------

    The CFTC notes that a banking entity could, through organizing and 
offering a covered fund pursuant to the authority contained in Sec.  --
--.11 of the proposed rule that itself makes investments or engages in 
trading activity, seek to evade the restrictions contained in section 
13 of the BHC Act and the proposed rule. In order to address these 
concerns, the proposed rule provides that a banking entity relying on 
the authority contained in Sec.  ----.11 must organize and offer a 
covered fund pursuant to a credible plan or similar documentation 
outlining how the banking entity intends to provide advisory or similar 
services to its customers through organizing and offering such fund.
iii. Compliance With Investment Limitations
    Section 13(d)(1)(G)(iii) of the BHC Act limits the ability of a 
banking entity that organizes and offers a covered fund to acquire or 
retain an ownership interest in that covered fund.\252\ Separately, 
other provisions of section 13 of the BHC Act provide independent 
exemptions which permit a banking entity to acquire or retain an 
ownership interest in a covered fund.\253\ Section ----.11(c) of the 
proposed rule incorporates these statutory provisions by prohibiting a 
banking entity from acquiring or retaining an ownership interest in a 
covered fund that it organizes and offers except as permitted under 
subpart C of the proposed rule.\254\ The limits on a banking entity's 
ability to invest in a covered fund that it organizes and offers are 
described in Sec.  ----.12 of the proposal.
---------------------------------------------------------------------------

    \252\ See 12 U.S.C. 1851(d)(1)(G)(iii).
    \253\ See, e.g., id. at 1851(d)(1)(C).
    \254\ See proposed rule Sec.  ----.11(c).
---------------------------------------------------------------------------

iv. Compliance With Section 13(f) of the BHC Act
    Section ----.11(d) of the proposed rule requires that the banking 
entity comply with the limitations on certain relationships with 
covered funds.\255\ These limitations apply in several contexts, and 
are contained in Sec.  ----.16 of the proposed rule, discussed in 
detail below. In general, Sec.  ----.16 of the proposed rule prohibits 
certain transactions or relationships that would be covered by section 
23A of the FR Act, and provides that any permitted transaction is 
subject to section 23B of the FR Act, in each instance as if such 
banking entity were a member bank and such covered fund were an 
affiliate thereof.\256\
---------------------------------------------------------------------------

    \255\ 12 U.S.C. 1851(d)(1)(G)(iv); proposed rule Sec.  --
--.11(d).
    \256\ See SUPPLEMENTARY INFORMATION, Part III.C.7.
---------------------------------------------------------------------------

v. No Guarantees or Insurance of Fund Performance
    Section ----.11(e) of the proposed rule prohibits the banking 
entity from, directly or indirectly, guaranteeing, assuming or 
otherwise insuring the obligations or performance of the covered fund 
or any covered fund in which such covered fund invests.\257\ This prong 
implements section 13(d)(1)(G)(iv) of the BHC Act and is intended to 
prevent a banking entity from engaging in bailouts of a covered fund in 
which it has an interest.\258\
---------------------------------------------------------------------------

    \257\ 12 U.S.C. 1851(d)(1)(G)(v); proposed rule Sec.  --
--.11(e).
    \258\ See 156 Cong. Rec. S5897 (daily ed. July 15, 2010) 
(statement of Sen. Merkley).
---------------------------------------------------------------------------

vi. Limitation on Name Sharing With a Covered Fund
    Section ----.11(f) of the proposed rule prohibits the covered fund 
from sharing the same name or a variation of the same name with the 
banking entity, for corporate, marketing, promotional, or other 
purposes.\259\ This section implements section 13(d)(1)(G)(v) of the 
BHC Act and addresses the concern that name-sharing could undermine 
market discipline and encourage a banking entity to bail out a covered 
fund it organizes and offers in order to preserve the entity's 
reputation.\260\ Thus, under Sec.  ----.11(f) of the proposed rule, a 
covered fund would be prohibited from sharing the same name or 
variation of the same name with a banking entity that organizes and 
offers or serves as sponsor to that fund (or an affiliate or subsidiary 
of such banking entity). A covered fund would also be prohibited under 
the proposed rule from using the word ``bank'' in its name.\261\
---------------------------------------------------------------------------

    \259\ 12 U.S.C. 1851(d)(1)(G)(vi); proposed rule Sec.  --
--.11(f).
    \260\ 156 Cong. Rec. S5897 (daily ed. July 15, 2010) (statement 
of Sen. Merkley).
    \261\ Similar restrictions on a fund sharing the same name, or 
variation of the same name, with an insured depository institution 
or company that controls an insured depository institution or having 
the word ``bank'' in its name, have been used previously in order to 
prevent customer confusion regarding the relationship between such 
companies and a fund. See, e.g., Bank of Ireland, 82 Fed. Res. Bull. 
1129 (1996).
---------------------------------------------------------------------------

vii. Limitation on Ownership by Directors and Employees
    Section ----.11(g) of the proposed rule implements section 
13(d)(1)(G)(vii) of the BHC Act. The provision prohibits any director 
or employee of the banking entity from acquiring or retaining an 
ownership interest in the covered fund, except for any director or 
employee of the banking entity who is directly engaged in providing 
investment advisory or other services to the covered fund.\262\ This 
allows an individual acting as fund manager or adviser and employed by 
a banking entity to acquire or retain an ownership interest in a 
covered fund that aligns the manager or adviser's incentives with those 
of its

[[Page 8388]]

customers by allowing the individual to have ``skin in the game'' with 
respect to a covered fund for which that individual provides management 
or advisory services (which customers or clients often request).\263\
---------------------------------------------------------------------------

    \262\ See 12 U.S.C. 1851(d)(1)(G)(vii); proposed rule Sec.  --
--.11(g).
    \263\ See 156 Cong. Rec. S5897 (daily ed. July 15, 2010) 
(statement of Sen. Merkley).
---------------------------------------------------------------------------

    The CFTC recognizes that director or employee investments in a 
covered fund may provide an opportunity for a banking entity to evade 
the limitations regarding the amount or value of ownership interests a 
banking entity may acquire or retain in a covered fund or funds 
contained in section 13(d)(4) of the BHC Act and Sec.  ----.12 of the 
proposed rule. In order to address this concern, the proposed rule 
would generally attribute an ownership interest in a covered fund 
acquired or retained by a director or employee to such person's 
employing banking entity, if the banking entity either extends credit 
for the purpose of allowing the director or employee to acquire such 
ownership interest, guarantees the director or employee's purchase, or 
guarantees the director or employee against loss on the investment.
viii. Disclosure Requirements
    Section ----.11(h) of the proposed rule requires that, in 
connection with organizing and offering a covered fund, the banking 
entity (i) clearly and conspicuously disclose, in writing, to 
prospective and actual investors in the covered fund (such as through 
disclosure in the covered fund's offering documents) that ``any losses 
in [such covered fund] will be borne solely by investors in [the 
covered fund] and not by [the banking entity and its affiliates or 
subsidiaries]; therefore, [the banking entity's and its affiliates' or 
subsidiaries'] losses in [such covered fund] will be limited to losses 
attributable to the ownership interests in the covered fund held by 
[the banking entity and its affiliates or subsidiaries] in their 
capacity as investors in [the covered fund],'' and (ii) comply with any 
additional rules of the CFTC as provided in section 13(b)(2) of the BHC 
Act designed to ensure that losses in any such covered fund are borne 
solely by the investors in the covered fund and not by the banking 
entity.\264\ The proposed rule also provides, as an additional 
disclosure requirement related to organizing and offering a covered 
fund, that a banking entity clearly and conspicuously disclose, in 
writing, to any prospective and actual investor (such as through 
disclosure in the covered fund's offering documents): (i) That such 
investor should read the fund offering documents before investing in 
the covered fund; (ii) that the ``ownership interests in the covered 
fund are not insured by the FDIC, and are not deposits, obligations of, 
or endorsed or guaranteed in any way, by any banking entity'' (unless 
that happens to be the case); and (iii) the role of the banking entity 
and its affiliates, subsidiaries, and employees in sponsoring or 
providing any services to the covered fund. As noted above, the 
proposed rule clarifies that a banking entity may satisfy the 
requirements of this prong with respect to a covered fund by making the 
required disclosures, in writing, in the covered fund's offering 
documents.\265\
---------------------------------------------------------------------------

    \264\ 12 U.S.C. 1851(d)(1)(G)(viii); proposed rule Sec.  --
--.11(h).
    \265\ As contemplated in Sec.  ----.11(a)(8)(ii) of the proposed 
rule, to the extent that any additional rules are issued to ensure 
that losses in a covered fund are borne solely by the investors in 
the covered fund and not by the banking entity, a banking entity 
would be required to comply with those as well in order to satisfy 
the requirements of section 13(d)(1)(G)(viii) of the BHC Act.
---------------------------------------------------------------------------

ix. Request for Comment
    The CFTC requests comment on the proposed rule's approach with 
respect to implementing the exemption permitting banking entities to 
organize and offer a covered fund. In particular, the CFTC requests 
comment on the following questions:
    Question 244. Is the proposed rule's approach to implementing the 
exemption for organizing and offering a covered fund effective? If not, 
what alternative approach would be more effective and why?
    Question 245. Should the approach include other elements? If so, 
what elements and why? Should any of the proposed elements be revised 
or eliminated? If so, why and how?
    Question 246. Is the proposed rule's approach to implementing the 
scope of bona fide trust, fiduciary, investment advisory and commodity 
trading advisory services consistent with the statute? If not, what 
alternative approach would be more effective? Should the scope of such 
services be broader or, in the alternative, more limited? Are there 
specific services which should be included but which are not currently 
under the proposed rule?
    Question 247. Does the proposed rule effectively implement the 
``customers of such services'' requirement? If not, what alternative 
approach would be more effective and why? Is the proposed rule's 
approach consistent with the statute? Why or why not? How do banking 
entities currently sell or provide interests in covered funds? Do 
banking entities rely on a concept of ``customer'' by reference to 
other laws or regulations, and if so, what laws or regulations?
    Question 248. Does the proposed rule effectively and clearly 
recognize the manner in which banking entities provide trust, 
fiduciary, investment advisory, or commodity trading advisory services 
to customers? If not, how should the proposed rule be modified to be 
more effective or clearer?
    Question 249. Should the CFTC consider adopting a definition of 
``customer of such services'' for purposes of implementing the 
exemption related to organizing and offering a covered fund? If so, 
what criteria should be included in such definition? For example, 
should the customer requirement specify that the relationship be pre-
existing? Should the CFTC consider adopting an existing definition 
related to ``customer'' and if so, what definitions (for instance, the 
SEC's ``pre-existing, substantive relationship'' concept applicable to 
private offerings under its Regulation D) would provide for effective 
implementation of the customer requirement in section 13(d)(1)(G) of 
the BHC Act? If so, why and how? How should the customer requirement be 
applied in the context of non-U.S. covered funds? Is there an 
equivalent concept used for such non-U.S. covered fund offerings?
    Question 250. Should the CFTC distinguish between direct and 
indirect customer relationships for purposes of implementing section 
13(d)(1)(G) of the BHC Act? Should the rule differentiate between a 
customer relationship established by a customer as opposed to a banking 
entity? If so, why?
    Question 251. Does the proposed rule effectively implement the 
prohibition on a banking entity guaranteeing or insuring the 
obligations or performance of certain covered funds? If not, what 
alternative approach would be more effective, and why?
    Question 252. Does the proposed rule effectively implement the 
requirement that a banking entity comply with the limitation on certain 
relationships with a covered fund contained in Sec.  ----.16 of the 
proposed rule? If not, what alternative approach would be more 
effective, and why?
    Question 253. Does the proposed rule effectively implement the 
prohibition on a covered fund sharing the same name or variation of the 
same name with a banking entity? If not, what alternative approach 
would be more effective and why? Should the prohibition on a covered 
fund sharing the same name be limited to specific

[[Page 8389]]

types of banking entities (e.g., insured depository institutions and 
bank holding companies) or only to the banking entity that organizes 
and offers the fund, and if so why?
    Question 254. Does the proposed rule effectively implement the 
limitation on director or employee investments in a covered fund 
organized and offered by a banking entity? If not, what alternative 
approach would be more effective and why? Should the agencies provide 
additional guidance on what ``other services'' should be included for 
purposes of satisfying Sec.  ----.11(g)? Why or why not?
    Question 255. Are the disclosure requirements related to organizing 
and offering a covered fund appropriate? If not, what alternative 
disclosure requirement(s) should the proposed rule include? Should the 
CFTC consider adoption of a model disclosure form related to this 
requirement? Does the timing of the proposed disclosure requirement 
adequately address disclosure to secondary market purchasers?
3. Section ----.12: Permitted Investment in a Covered Fund
    Section ----.12 of the proposed rule describes the limited 
circumstances under which a banking entity may acquire or retain, as an 
investment, an ownership interest in a covered fund that the banking 
entity or one of its subsidiaries or affiliates organizes and offers. 
This section implements section 13(d)(4) of the BHC Act and related 
provisions, and describes the statutory limits on both (i) the amount 
and value of an investment by a banking entity in a covered fund, and 
(ii) the aggregate value of all investments in all covered funds made 
by the banking entity.
    As described below, a banking entity that makes or retains an 
investment in a covered fund under Sec.  ----.12 of the proposed rule 
is generally subject to three principal limitations related to such 
investment. First, the banking entity's investment in a covered fund 
may not represent more than 3 percent of the total outstanding 
ownership interests of such fund (after the expiration of any seeding 
period provided under the rule). Second, the banking entity's 
investment in a covered fund may not result in more than 3 percent of 
the losses of the covered fund being allocable to the banking entity's 
investment. Third, a banking entity may invest no more than 3 percent 
of its tier 1 capital in covered funds.\266\
---------------------------------------------------------------------------

    \266\ See, e.g., proposed rule Sec. Sec.  ----.12(b)(2), (c).
---------------------------------------------------------------------------

a. Authority and Limitations on Permitted Investments
    Section 13(d)(4) of the BHC Act permits a banking entity to acquire 
and retain an ownership interest in a covered fund that the banking 
entity organizes and offers pursuant to section 13(d)(1)(G), for the 
purposes of (i) establishing the covered fund and providing the fund 
with sufficient initial equity for investment to permit the fund to 
attract unaffiliated investors, or (ii) making a de minimis investment 
in the covered fund in compliance with applicable requirements.\267\ 
Section ----.12 of the proposed rule implements this authority and 
related limitations.
---------------------------------------------------------------------------

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

    Consistent with this statutory provision, the proposed rule 
requires a banking entity to (i) actively seek unaffiliated investors 
to ensure that the banking entity's investment conforms with the limits 
of Sec.  ----.12, and (ii) reduce through redemption, sale, dilution, 
or other methods the aggregate amount and value of all ownership 
interests of the banking entity in a single fund held under Sec.  --
--.12 to an amount that does not exceed 3 percent of the total 
outstanding ownership interests of the fund not later than 1 year after 
the date of establishment of the fund (or such longer period as may be 
provided by the Board) (the ``per-fund limitation''). Additionally, 
Sec.  ----.12 of the proposed rule implements the statutory requirement 
that the aggregate value of all ownership interests of the banking 
entity in all covered funds held as an investment not exceed 3 percent 
of the tier 1 capital of the banking entity (the ``aggregate funds 
limitation'').\268\
---------------------------------------------------------------------------

    \268\ See proposed rule at Sec.  ----.12(a)(2)(ii). The process 
and manner in which a banking entity's 3 percent tier 1 capital 
limit is determined for purposes of the proposed rule is discussed 
in detail below in Part III.C.3 of this SUPPLEMENTARY INFORMATION.
---------------------------------------------------------------------------

b. Permitted Investment in a Single Covered Fund
    Section ----.12(b) of the proposed rule describes the limitations 
and restrictions on a banking entity's ability to make or retain an 
investment in a single covered fund. This section implements the 
requirements of section 13(d)(4) of the BHC Act.\269\
---------------------------------------------------------------------------

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

    Section ----.12 of the proposed rule describes the manner in which 
the limitations on the amount and value of ownership interests in a 
covered fund must be calculated, in recognition of the fact that a 
covered fund may have multiple classes of ownership interests which 
possess different characteristics or values that impact a person's 
ownership in that fund. A banking entity must apply the limits to both 
the total value and amount of its investment in a covered fund. For 
purposes of applying these limits, the banking entity must calculate 
(without regard to committed funds not yet called for investment): (i) 
The value of all investments or capital contributions made with respect 
to any ownership interest by the banking entity in a covered fund, 
divided by the value of all investments or capital contributions made 
by all persons in that covered fund, and (ii) the total number of 
ownership interests held as an investment by the banking entity in a 
covered fund divided by the total number of ownership interests held by 
all persons in that covered fund.\270\ Therefore, under the proposed 
rule, such calculation would include as the numerator the amount or 
value of a banking entity's investment in a covered fund, and as the 
denominator the amount or value (matched to the unit of measurement in 
the numerator) of all classes of ownership interests held by all 
persons in that covered fund. As noted above, the banking entity's 
investment in a covered fund also may not result in more than 3 percent 
of the losses of the covered fund being allocable to the banking 
entity's investment.\271\
---------------------------------------------------------------------------

    \270\ See proposed rule Sec.  ----.12(b)(2).
    \271\ Under the proposed rule, a banking entity's investment in 
a covered fund may not result in more than 3 percent of the losses 
of the covered fund being allocable to the banking entity's 
investment since the banking entity's permitted investment in a 
covered fund may be no more than 3 percent of the value and amount 
of such fund's total ownership interests, and the banking entity may 
not, directly or indirectly, guarantee, assume, or otherwise insure 
the obligations or performance of the covered fund. See 12 U.S.C. 
1851(d)(1)(G)(v); proposed rule Sec.  ----.11(e).
---------------------------------------------------------------------------

    In order to ensure that a banking entity calculates its investment 
in a covered fund accurately and does not evade the per-fund investment 
limitation, the proposed rule requires that the banking entity must 
calculate its investment in the same manner and according to the same 
standards utilized by the covered fund for determining the aggregate 
value of the fund's assets and ownership interests in the covered 
fund.\272\
---------------------------------------------------------------------------

    \272\ See proposed rule Sec.  ----.12(b)(4).
---------------------------------------------------------------------------

    Under the proposed rule, the amount and value of a banking entity's 
investment in any single covered fund is (i) the total amount or value 
held by the banking entity directly and through any entity that is 
controlled, directly or indirectly, by the banking entity,\273\ plus 
(ii) the pro rata amount or value of any

[[Page 8390]]

covered fund held by any entity (other than certain operating entities 
noted below) that is not controlled, directly or indirectly, by the 
banking entity but in which the banking entity owns, controls, or holds 
with the power to vote more than 5 percent of the voting shares.\274\
---------------------------------------------------------------------------

    \273\ See proposed rule Sec.  ----.12(b)(1)(A).
    \274\ See proposed rule Sec.  ----.12(b)(1)(B). As noted above, 
whether or not an investment is controlled or noncontrolled will be 
determined consistent with the BHC Act, as implemented by the Board. 
See 12 U.S.C. 1841(a)(2); 12 CFR 225.2(e).
---------------------------------------------------------------------------

    Additionally, the proposed rule provides that, to the extent that a 
banking entity is contractually obligated to directly invest in, or is 
found to be acting in concert through knowing participation in a joint 
activity or parallel action toward a common goal of investing in, one 
or more investments with a covered fund that is organized and offered 
by the banking entity (whether or not pursuant to an express 
agreement), such investment shall be included in the calculation of a 
banking entity's per-fund limitation.\275\ In this way, the proposed 
rule prevents a banking entity from evading the limitations under Sec.  
----.12 of the proposed rule through committed co-investments.
---------------------------------------------------------------------------

    \275\ See proposed rule Sec.  ----.12(b)(2)(B).
---------------------------------------------------------------------------

    Section ----.12(b)(3) of the proposed rule provides that the amount 
and value of a banking entity's investment in a covered fund may at no 
time exceed the 3 percent limits contained in Sec.  ----.12(b) of the 
proposed rule after the conclusion of any conformance period, if 
applicable.\276\ In cases where a fund calculates its value or stands 
ready to issue or redeem interests frequently (e.g., daily), a banking 
entity must calculate its per-fund limitation no less frequently than 
the fund performs such calculation or issues or redeems interests. In 
recognition of the fact that not every covered fund may calculate or 
determine its valuation daily (for instance, if it does not allow 
redemptions except infrequently or invests principally in illiquid 
assets for which no market price is readily available), the proposed 
rule would not require a daily calculation of value for such fund 
(unless a daily calculation is determined by the fund).\277\ In such 
cases, the calculation of the amount and value of a banking entity's 
per-fund limitation must be made no less frequently than at the end of 
every quarter.\278\ Additionally, since a banking entity must organize 
and offer any covered fund in which it invests, the CFTC expects that 
such banking entity would closely and regularly monitor not only the 
value of such fund's interests, but also any changes in the fund's 
investors' relative ownership percentages.\279\
---------------------------------------------------------------------------

    \276\ See proposed rule Sec.  ----.12(b)(3).
    \277\ With respect to an issuer of asset-backed securities, 
depending on the transaction structure, such calculation may need to 
be made each time a payment is made to any holder of the issuer's 
asset-backed securities.
    \278\ The CFTC notes that while calculation of a banking 
entity's ownership interest in a covered fund must be determined no 
less frequently than at the end of every quarter, it is possible 
that no change in a banking entity's ownership interest (e.g., no 
redemptions or other changes in investor composition) may occur 
during every quarter.
    \279\ For instance, where a banking entity acts as sponsor to a 
covered fund, in connection with the organizing and offering of that 
fund it may include a requirement (such as a ``tag-along'' 
redemption right) in the fund's organizational documents in order to 
assist the banking entity in complying with the per-fund investment 
limitation.
---------------------------------------------------------------------------

c. Aggregate Permitted Investments in All Covered Funds and Calculation 
of a Banking Entity's Tier 1 Capital
    In addition to a limit on investments in a single covered fund, 
section 13(d)(4) of the BHC Act requires the banking entity to comply 
with the aggregate funds limitation on investments in all covered 
funds.\280\ As required under section 13(d)(4)(B)(ii)(II) of the BHC 
Act, the proposed rule provides that the aggregate of a banking 
entity's ownership interests in all covered funds that are held under 
Sec.  ----.12 of the proposed rule may not exceed 3 percent of the tier 
1 capital of a banking entity.\281\ In order to maintain equality in 
application of the aggregate funds limitation, the proposed rule 
provides that, for purposes of determining compliance with Sec.  --
--.12 of the proposed rule, the aggregate of all of a banking entity's 
investments in all covered funds under Sec.  ----.12 of the proposed 
rule must be valued pursuant to applicable accounting standards.\282\ 
This value calculation is separate and in addition to the required 
calculation of the value of a banking entity's investment in a covered 
fund as part of determining compliance with the per-fund limitation.
---------------------------------------------------------------------------

    \280\ As noted in the discussion regarding the per-fund 
limitation, the proposed rule provides that, for purposes of 
determining compliance with Sec.  ----.12, the banking entity's 
permitted investment in a covered fund shall be calculated in the 
same manner and according to the same standards utilized by the 
covered fund for determining the aggregate value of the fund's 
assets and ownership interests. However, the value of a banking 
entity's aggregate permitted investments in all covered funds shall 
be determined in accordance with applicable accounting standards. 
See proposed rule Sec.  ----.12(c)(1).
    \281\ See 12 U.S.C. 1851(d)(4)(B)(ii)(II); proposed rule Sec.  
----.12(a)(2)(ii).
    \282\ See proposed rule Sec.  ----.12(c)(1).
---------------------------------------------------------------------------

    Tier 1 capital is a banking law concept that, in the United States, 
is calculated and reported by certain depository institutions and bank 
holding companies in order to determine their compliance with 
regulatory capital standards. Accordingly, the proposed rule clarifies 
that for purposes of the aggregate funds limitation in Sec.  ----.12, a 
banking entity that is a bank, a bank holding company, a company that 
controls an insured depository institution that reports tier 1 capital, 
or uninsured trust company that reports tier 1 capital (each a 
``reporting banking entity'') must apply the reporting banking entity's 
tier 1 capital as of the last day of the most recent calendar quarter 
that has ended, as reported to the relevant Federal banking 
agency.\283\
---------------------------------------------------------------------------

    \283\ See proposed rule Sec.  ----.12(c)(1)(A).
---------------------------------------------------------------------------

    However, not all entities subject to section 13 of the BHC Act 
calculate and report tier 1 capital. In order to provide a measure of 
equality related to the aggregate funds limitation contained in section 
13(d)(4)(B)(ii)(II) of the BHC Act and Sec.  ----.12(c) of the proposed 
rule, the proposed rule clarifies how the aggregate funds limitation 
shall be calculated for entities that are not required to calculate and 
report tier 1 capital in order to determine compliance with regulatory 
capital standards. Under the proposed rule, with respect to any banking 
entity that is not affiliated with a reporting banking entity and not 
itself required to report capital in accordance with the risk-based 
capital rules of a Federal banking agency, the banking entity's tier 1 
capital for purposes of the aggregate funds limitation shall be the 
total amount of shareholders' equity of the top-tier entity within such 
organization as of the last day of the most recent calendar quarter 
that has ended, as determined under applicable accounting 
standards.\284\ For a banking entity that is not itself required to 
report tier 1 capital but is a subsidiary of a reporting banking entity 
that is a depository institution (e.g., a subsidiary of a national 
bank), the aggregate funds limitation shall be the amount of tier 1 
capital reported by such depository institution.\285\ For a banking 
entity that is not itself required to report tier 1 capital but is a 
subsidiary of a reporting banking entity that is not a depository 
institution (e.g., a nonbank subsidiary of a bank holding company), the 
aggregate funds limitation shall be the amount of tier 1 capital 
reported by the top-tier affiliate of such banking entity that holds 
and reports tier 1 capital.\286\ Thus,

[[Page 8391]]

for purposes of calculating the aggregate funds limitation under Sec.  
----.12(c)(2) of the proposed rule, the tier 1 capital for the 
different types of banking entities would be as follows:
---------------------------------------------------------------------------

    \284\ See proposed rule Sec.  ----.12(c)(2)(ii)(B)(2).
    \285\ See proposed rule Sec.  ----.12(c)(2)(ii)(A).
    \286\ See proposed rule Sec.  ----.12(c)(1)(B).

------------------------------------------------------------------------
                                          Tier 1 capital for purposes of
         Type of banking entity                   Sec.   ----.12
------------------------------------------------------------------------
Depository institution that is a         Tier 1 capital of the
 reporting banking entity (or a           depository institution as of
 subsidiary thereof).                     the last day of the most
                                          recent calendar quarter that
                                          has ended, as reported to the
                                          relevant Federal banking
                                          agency.
Bank holding company or a subsidiary     Tier 1 capital of the bank
 thereof (other than a reporting          holding company as of the last
 banking entity).                         day of the most recent
                                          calendar quarter that has
                                          ended, as reported to the
                                          Board.
Company that controls an insured         Tier 1 capital of the top tier
 depository institution and that is a     entity within such
 reporting banking entity (or a           organization as of the last
 subsidiary thereof other than a          day of the most recent
 reporting banking entity).               calendar quarter that has
                                          ended, as reported to the
                                          Board.
Other banking entity (including an       Shareholders' equity of the top-
 industrial loan company holding          tier entity within such
 company, thrift holding company, or a    organization as of the last
 subsidiary thereof).                     day of the most recent
                                          calendar quarter that has
                                          ended, under applicable
                                          accounting standards.
------------------------------------------------------------------------

Additionally, in the case of a depository institution that is itself a 
reporting banking entity and is also a subsidiary or affiliate of a 
reporting banking entity, the aggregate of all investments in all 
covered funds held by the depository institution (including investments 
by its subsidiaries) may not exceed 3 percent of either the tier 1 
capital of the depository institution or of the top-tier reporting 
banking entity that controls such depository institution.\287\
---------------------------------------------------------------------------

    \287\ If the aggregate value of all investments in all covered 
funds attributable to such a depository institution is less than 3 
percent of its tier 1 capital, then that amount of capital which is 
greater than the amount supporting the depository institution's 
investments (or those held by its subsidiaries) in a covered fund, 
but less than 3 percent of the depository institution's tier 1 
capital, may be used to support an investment in a covered fund by 
an affiliated banking entity that is not itself a depository 
institution that holds and reports tier 1 capital or controlled, 
directly or indirectly, by such a depository institution.
---------------------------------------------------------------------------

d. Deduction of an Investment in a Covered Fund From Tier 1 Capital
    Section 12(d) of the proposed rule also implements the provision 
contained in section 13(d)(4)(b)(iii) of the BHC Act regarding the 
deduction of a banking entity's aggregate investment in a covered fund 
held under section 13(d)(4) of that Act from the assets and tangible 
equity of the banking entity. The statute also provides that the amount 
of the deduction must increase commensurate with the leverage of the 
underlying fund.\288\
---------------------------------------------------------------------------

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

    Section ----.12(d) of the proposal requires a banking entity to 
deduct the aggregate value of its investments in covered funds from 
tier 1 capital. Since Sec.  ----.12 of the proposed rule implements the 
authorities contained in section 13(d)(4) of the BHC Act related to an 
investment in a fund organized and offered by the banking entity (or an 
affiliate or subsidiary thereof), the deduction contained in Sec.  --
--.12(d) applies only to those ownership interests held as an 
investment by a banking entity pursuant to Sec.  ----.12 of the 
proposed rule.\289\ For instance, a banking entity that acquires or 
retains an ownership interest in a covered fund as a permitted risk-
mitigating hedge under Sec.  ----.13(b) of the proposed rule, or that 
acquires or retains an ownership interest in the course of collecting a 
debt previously contracted in good faith, would not be required to 
deduct the value of such ownership interest from its tier 1 
capital.\290\ The deduction required under Sec.  ----.12(d) of the 
proposed rule must be calculated consistent with other like deductions 
under the applicable risk-based capital rules.\291\
---------------------------------------------------------------------------

    \289\ See proposed rule Sec.  ----.12(d).
    \290\ The CFTC notes that since this deduction from capital 
implements Section 13(d)(4)(B)(iii) of the BHC Act, it is being 
included in this proposed rule which deals with Section 13 of the 
BHC Act. However, the CFTC may relocate this deduction as part of 
any later revised capital rules if, in the future, it is determined 
that inclusion in such rules is more appropriate.
    \291\ See 12 CFR part 208, Appendices A, E, and F (for a state 
member bank); 12 CFR part 225, Appendices A, E, and G (for a bank 
holding company); 12 CFR part 3, Appendices A, B, and C (for a 
national bank); 12 CFR part 325, Appendices A, C, and D (for a state 
nonmember bank); and 12 CFR part 167, Appendix C (for a federal 
thrift).
---------------------------------------------------------------------------

e. Extension of Time To Divest an Ownership Interest in a Single 
Covered Fund
    Section 13(d)(4)(C) of the BHC Act permits the Board, upon 
application by a banking entity, to extend for up to 2 additional years 
the period of time within which a banking entity must reduce its 
attributable ownership interests in a covered fund to no more than 3 
percent of such fund's total ownership interests.\292\ The statute 
provides the possibility of an extension only with respect to the per-
fund limitation, and not to the aggregate funds limitation.\293\ 
Section ----.12(e) of the proposed rule implements this provision of 
the statute. In order to grant any extension, the Board must determine 
that the extension would be consistent with safety and soundness and 
would not be detrimental to the public interest.\294\
---------------------------------------------------------------------------

    \292\ 12 U.S.C. 1851(d)(4)(C).
    \293\ See id.
    \294\ As noted in Part III.C.2.a.ii of this SUPPLEMENTARY 
INFORMATION, the CFTC recognizes the potential for evasion of the 
restrictions contained in section 13 of the BHC Act through 
organizing and offering a covered fund pursuant to the authority 
contained in Sec.  ----.11 of the proposed rule. Therefore, in 
addition to taking action against a banking entity that does not 
actively seek unaffiliated investors to reduce or dilute the 
investment of the banking entity as provided under Sec.  --
--.12(a)(2) of the proposed rule, the CFTC expects that if a banking 
entity is habitually or routinely seeking an extension of the one-
year period provided under Sec.  ----.12(a)(2)(i)(B), this could be 
evidence of seeking to evade the restrictions contained in the 
proposed rule and, as appropriate, the CFTC may take action against 
such banking entity.
---------------------------------------------------------------------------

    Section ----.12(e) of the proposed rule requires any banking entity 
that seeks an extension of this conformance period to submit a written 
request to the Board. Under the proposal, any such request must: (i) Be 
submitted in writing to the Board at least 90 days prior to the 
expiration of the applicable time period; (ii) provide the reasons why 
the banking entity believes the extension should be granted; and (iii) 
provide a detailed explanation of the banking entity's plan for 
reducing or conforming its investment(s).
    In addition, the proposed rule provides that any extension request 
by a banking entity must address each of the following matters (to the 
extent they are relevant): (i) Whether the investment would--(A) 
involve or result in material conflicts of interest between the banking 
entity and its clients, customers or counterparties; (B) result, 
directly or indirectly, in a material exposure by the

[[Page 8392]]

banking entity to high-risk assets or high-risk trading strategies; (C) 
pose a threat to the safety and soundness of the banking entity; or (D) 
pose a threat to the financial stability of the United States; (ii) 
market conditions; (iii) the contractual terms governing the banking 
entity's interest in the covered fund; (iv) the date on which the 
covered fund is expected to have attracted sufficient investments from 
investors unaffiliated with the banking entity to enable the banking 
entity to comply with the limitations in section 12(a)(2)(i)(B) of the 
proposed rule; (v) the total exposure of the banking entity to the 
investment and the risks that disposing of, or maintaining, the 
investment in the covered fund may pose to the banking entity or the 
financial stability of the United States; (vi) the cost to the banking 
entity of divesting or disposing of the investment within the 
applicable period; (vii) whether the divestiture or conformance of the 
investment would involve or result in a material conflict of interest 
between the banking entity and unaffiliated clients, customers or 
counterparties to which it owes a duty; (viii) the banking entity's 
prior efforts to divest or sell interests in the covered fund, 
including activities related to the marketing of interests in such 
covered fund; and (ix) any other factor that the Board believes 
appropriate.\295\ Under the proposed rule, the Board would consider 
requests for an extension in light of all relevant facts and 
circumstances, including the factors described above.
---------------------------------------------------------------------------

    \295\ See proposed rule Sec.  ----.12(e)(1)(ii).
---------------------------------------------------------------------------

    Section ----.12(e) of the proposed rule also would allow the Board 
to impose conditions on any extension granted under the proposed rule 
if the Board determines conditions are necessary or appropriate to 
protect the safety and soundness of banking entities or the financial 
stability of the United States, address material conflicts of interest 
or other unsound practices, or otherwise further the purposes of 
section 13 of the BHC Act and the proposed rule.\296\ In cases where 
the banking entity is primarily supervised by the CFTC, the Board would 
consult with the CFTC both in connection with its review of the 
application and, if applicable, prior to imposing conditions in 
connection with the approval of any request by the banking entity for 
an extension of the conformance period under the proposed rule.\297\
---------------------------------------------------------------------------

    \296\ Nothing in section 13 of the BHC Act or the proposed rule 
limits or otherwise affects the authority that the Board, the other 
Federal banking agencies, the SEC, or the CFTC may have under other 
provisions of law. In the case of the Board, these authorities 
include, but are not limited to, section 8 of the Federal Deposit 
Insurance Act and section 8 of the BHC Act. See 12 U.S.C. 1818, 
1847.
    \297\ See proposed rule Sec. Sec.  ----.12(e)(iii) and (iv).
---------------------------------------------------------------------------

f. Request for Comment
    The CFTC requests comment on the proposed rule's approach to 
implementing the exemption which allows a banking entity to make or 
retain a permitted investment in a covered fund that it organizes and 
offers. In particular, the CFTC requests comment on the following 
questions:
    Question 256. Is the proposed rule's approach to implementing the 
exemption that allows a banking entity to make or retain a permitted 
investment in a covered fund effective? If not, what alternative 
approach would be more effective and why?
    Question 257. Should the approach include other elements? If so, 
what elements and why? Should any of the proposed elements be revised 
or eliminated? If so, why and how?
    Question 258. Should the proposed rule specify at what point a 
covered fund will be considered to have been ``established'' for 
purposes of commencing the period in which a banking entity may own 
more than 3 percent of the total outstanding ownership interests in 
such fund? If so, why and how?
    Question 259. Does the proposed rule effectively implement the 
requirement that a banking entity comply with the limitations on an 
investment in a single covered fund? If not, what alternative approach 
would be more effective and why?
    Question 260. Does the proposed rule effectively implement the 
requirement that a banking entity comply with the limitations on the 
aggregate of all investments in all covered funds? If not, what 
alternative approach would be more effective and why?
    Question 261. Is the proposed rule's approach to calculating a 
banking entity's investment in a covered fund effective? Should the 
per-fund calculation be based on committed capital, rather than 
invested capital? Why or why not? Is the timing of the calculation of a 
banking entity's ownership interest in a single covered fund 
appropriate? If not, why not, and what alternative approach would be 
more effective and why? For example, should the per-fund calculation be 
required on a less-frequent basis (e.g., monthly) for funds that 
compute their value and allow purchases and redemptions on a daily 
basis (e.g., daily)? Why or why not?
    Question 262. Is the proposed rule's approach to parallel 
investments effective? Why or why not? Should this provision require a 
contractual obligation and/or knowing participation? Why or why not? 
How else could the proposed rule define parallel investments? What 
characteristics would more closely achieve the scope and intended 
purposes of section 13 of the BHC Act?
    Question 263. Is the proposed rule's treatment of investments in a 
covered fund by employees and directors of a banking entity effective? 
If not, what alternative approach would be more effective and why?
    Question 264. Is the proposed rule's approach to differentiating 
between controlled and noncontrolled investments in a covered fund 
unduly complex or burdensome? If so, what alternative approach, if any, 
would be more effective and why?
    Question 265. Is the proposed rule's approach to valuing an 
investment in a covered fund according to the same standards utilized 
by the covered fund for determining the aggregate value of its assets 
and ownership interests effective? If not, what alternative valuation 
approach would be more effective and why? Should the rule specify one 
methodology for valuing an investment in a covered fund?
    Question 266. Is the proposed rule's approach regarding when to 
require the calculation of a banking entity's aggregate investments in 
all covered funds effective? What is the potential impact of 
calculating a banking entity's aggregate investment limit under the 
proposed rule on a quarterly basis as opposed to solely at the time an 
investment in a covered fund is made? Would calculation of the 
aggregate investment limit solely at the time an investment in a 
covered fund is made be consistent with the language and purpose of the 
statute? Does the proposed rule provide sufficient guidance for an 
issuer of asset-backed securities about how and when to make such 
calculation? Why or why not?
    Question 267. Is the proposed rule's approach to determining and 
calculating a banking entity's relevant tier 1 capital limit effective? 
If not, what alternative approach would be more effective and why? With 
respect to applying the aggregate funds limitation to a banking entity 
that is not affiliated with an entity that is required to hold and 
report tier 1 capital, is total shareholder equity on a consolidated 
basis as of the last day of the most recent calendar quarter that has 
ended an effective proxy for tier 1 capital? If not, what alternative 
approach would be more effective and why?

[[Page 8393]]

    Question 268. Should the proposed rule be modified to permit a 
banking entity to bring its investments in covered funds into 
compliance with the proposed rule within a reasonable period of time 
if, for example, the banking entity's aggregate permitted investments 
in covered funds exceeds 3 percent of its tier 1 capital for reasons 
unrelated to additional investments (e.g., a banking entity's tier 1 
capital decreases)? Why or why not?
    Question 269. Does the proposed rule effectively and appropriately 
implement the deduction from capital for an investment in a covered 
fund contained in section 13(d)(4)(B)(iii) of the BHC Act? If not, what 
alternative approach would be more effective or appropriate, given the 
statutory language of the BHC Act and overall structure of section 
13(d)(4), and why? What effect, if any, should the CFTC give to the 
cross-reference in section 13(d)(4) to section 13(d)(3) of the BHC Act, 
which provides the CFTC with discretion to require additional capital, 
if appropriate, to protect the safety and soundness of banking entities 
engaged in activities permitted under section 13 of the BHC Act? How, 
if at all, should a banking entity's deduction of its investment in a 
covered fund be increased commensurate with the leverage of the covered 
fund? Should the amount of the deduction be proportionate to the 
leverage of the covered fund? For example, instead of a dollar-for-
dollar deduction, should the deduction be set equal to the banking 
entity's investment in the covered fund times the difference between 1 
and the covered fund's equity-to-assets ratio?
    Question 270. Does the proposed rule effectively implement the 
Board's statutory authority to grant an extension of the period of time 
a banking entity may retain in excess of 3 percent of the ownership 
interests in a single covered fund? Are the enumerated factors that the 
Board may consider in connection with reviewing such an extension 
appropriate (including factors related to the effect of an extension of 
the covered fund), and if not, why not? Are there additional factors 
that the Board should consider in reviewing such a request? Are there 
specific additional conditions or limitations that the Board should, by 
rule, impose in connection with granting such an extension? If so, what 
conditions or limitations would be more effective?
    Question 271. Given that the statute does not provide for an 
extension of time for a banking entity to comply with the aggregate 
funds limitation, within what period of time should a banking entity be 
required to bring its investments into conformance with the aggregate 
funds limit? Should the proposed rule expressly contain a grace period 
for complying with these limits? Why or why not? If yes, what grace 
period would be most effective and why?
    Question 272. Does the proposed rule effectively implement the 
prohibition on a banking entity guaranteeing or insuring the 
obligations or performance of certain covered funds? If not, what 
alternative approach would be more effective and why?
    Question 273. In the context of securitization transactions, 
control and ownership are often completely separated. Is additional 
guidance necessary with respect to how control should be determined 
with respect to issuers of asset-backed securities for purposes of 
determining the calculation of the per-fund and aggregate ownership 
limitations?
    Question 274. In many securitization transactions, the voting 
rights of investors are extremely limited and management may be 
contractually delegated to a third party (because issuers of asset-
backed securities rarely have a board with any authority or any 
employees). The servicer or manager has the ``ability to control the 
decision-making and operational functions of the fund.'' When 
calculating the per-fund and aggregate ownership limitations, to whom 
should the proposed rule allocate ``control'' in this type of 
situation? Which participants in a securitization transaction would 
need to include the activities of an issuer of asset-backed securities 
in their calculations of per-fund and aggregate ownership, and what is 
the potential impact of such inclusion?
    Question 275. For purposes of calculating the per-fund and 
aggregate ownership limitations, how should the proposed rule address 
those instances in which equity is issued, but the equity holder does 
not receive economic benefits or have any control rights? For instance, 
in order to enhance or achieve bankruptcy remoteness, a single purpose 
trust without an owner (i.e., an orphan trust) may hold all of the 
equity interests in a securitization vehicle. Such interests often do 
not have any meaningful economic or control rights.
4. Section ----.13: Other Permitted Covered Fund Activities and 
Investments
    Section 13 of the proposed rule implements the statutory exemptions 
described in sections 13(d)(1)(C), (E), and (I) of the BHC Act that 
permit a banking entity: (i) To acquire an ownership interest in, or 
act as sponsor to, one or more SBICs, a public welfare investment, or a 
certain qualified rehabilitation expenditure; \298\ (ii) to acquire or 
retain an ownership interest in a covered fund as a risk-mitigating 
hedging position; and (iii) in the case of a non-U.S. banking entity, 
to acquire or retain an ownership interest in or sponsor a foreign 
covered fund. Additionally, Sec.  ----.13 of the proposed rule 
implements in part the rule of construction related to the sale and 
securitization of loans contained in section 13(g)(2) of the BHC Act. 
Similar to Sec.  ----.6 of the proposed rule (which implements certain 
permitted proprietary trading activities), Sec.  ----.13 contains only 
the statutory exemptions contained in section 13(d)(1) of the BHC Act 
that the CFTC has determined apply, either by plain language or by 
implication, to investments in or relationships with a covered 
fund.\299\
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    \298\ Section ----.13(a) of the proposed rule also implements a 
proposed determination by the CFTC under section 13(d)(1)(J) of the 
BHC Act that a banking entity may not only invest in such entities 
as provided under section 13(d)(1)(E) of the BHC Act, but also may 
sponsor an entity described in that paragraph and that such 
activity, since it generally would facilitate investment in small 
businesses and support the public welfare, would promote and protect 
the safety and soundness of banking entities and the financial 
stability of the United States.
    \299\ In particular, Sec.  ----.13 of the proposed rule does not 
include: (i) The exemption in section 13(d)(1)(A) of the BHC Act for 
trading in certain permitted government obligations; (ii) the 
exemption in section 13(d)(1)(H) of the BHC Act for certain foreign 
proprietary trading activities; and (iii) the exemption contained in 
section 13(d)(1)(B) of the BHC Act related to underwriting and 
market-making related activities. Each of these exemptions appear 
relevant only to covered trading activities and not to covered fund 
activities.
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a. Permitted Investments in SBICs and Related Funds
    Section ----.13(a) of the proposed rule implements sections 
13(d)(1)(E) and (J) of the BHC Act \300\ and permits a banking entity 
to acquire or retain any ownership interest in, or act as sponsor to: 
(i) One or more SBICs, as defined in section 102 of the Small Business 
Investment Act of 1958 (12 U.S.C. 662); (ii) an investment that is 
designed primarily to promote the public welfare, of the type permitted 
under paragraph (11) of section 5136 of the Revised Statutes of the 
United States (12 U.S.C. 24), including the welfare of low- and 
moderate-income communities or families (such as providing housing,

[[Page 8394]]

services, or jobs); and (iii) an investment that is a qualified 
rehabilitation expenditure with respect to a qualified rehabilitation 
building or certified historic structure, as such terms are defined in 
section 47 of the Internal Revenue Code of 1986 or a similar State 
historic tax credit program.\301\ Since section 13(d)(1)(E) of the BHC 
Act does not limit a banking entity's investment to a limited 
partnership or other non-controlling investment, Sec.  ----.13(a) of 
the proposed rule would permit a banking entity to be a shareholder, 
general partner, managing member, or trustee of an SBIC without regard 
to whether the interest is a controlling or noncontrolling 
interest.\302\
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    \300\ Section 13(d)(1)(E) of the BHC Act permits a banking 
entity to make investments in one or more SBICs, investments 
designed primarily to promote the public welfare, investments of the 
type permitted under 12 U.S.C. 24 (eleventh), and investments that 
are qualified rehabilitation expenditures with respect to a 
qualified rehabilitated building or certified historic structure. 
See 12 U.S.C. 1851(d)(1)(E).
    \301\ See proposed rule Sec.  ----.13(a).
    \302\ Pursuant to the exemption contained in Sec.  ----.13(a) of 
the proposed rule, a banking entity may acquire an ownership 
interest in, or act as sponsor to, a low income housing credit fund, 
if such fund qualifies as an SBIC, public welfare investment or 
qualified rehabilitation expenditure.
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    In addition to the acquisition or retention of an ownership 
interest, permitting a banking entity to act as sponsor to these types 
of public interest investments will provide valuable expertise and 
services to these types of entities, as well as help enable banking 
entities to provide valuable funding and assistance to small business 
and low- and moderate-income communities. Therefore, the Agencies 
believe this exemption would be consistent with the safe and sound 
operation of banking entities, and would also promote the financial 
stability of the United States.
    The CFTC requests comment on the proposed rule's approach to 
implementing the exemption for permitted investments in and 
relationships with SBICs and certain related funds. In particular, the 
CFTC requests comment on the following questions:
    Question 276. Is the proposed rule's approach to implementing the 
SBIC, public welfare and qualified rehabilitation investment exemption 
for acquiring or retaining an ownership interest in a covered fund 
effective? If not, what alternative approach would be more effective?
    Question 277. Should the approach include other elements? If so, 
what elements and why? Should any of the proposed elements be revised 
or eliminated? If so, why and how?
    Question 278. Should the proposed rule permit a banking entity to 
sponsor an SBIC and other identified public interest investments? Why 
or why not? Does the CFTC's determination under section 13(d)(1)(J) of 
the BHC Act regarding sponsoring of an SBIC, public welfare or 
qualified rehabilitation investment effectively promote and protect the 
safety and soundness of banking entities and the financial stability of 
the United States? If not, why not?
    Question 279. What would the effect of the proposed rule be on a 
banking entity's ability to sponsor and syndicate funds supported by 
public welfare investments or low income housing tax credits which are 
utilized to assist banks and other insured depository institutions with 
meeting their Community Reinvestment Act (``CRA'') obligations?
    Question 280. Does the proposed rule unduly constrain a banking 
entity's ability to meet the convenience and needs of the community 
through CRA or other public welfare investments or services? If so, why 
and how could the proposed rule be revised to address this concern?
b. Permitted Risk-Mitigating Hedging Activities
    Section ----.13(b) of the proposed rule permits a banking entity to 
acquire and retain an ownership interest in a covered fund if the 
transaction is made in connection with, and related to, certain 
individual or aggregated positions, contracts, or other holdings of the 
banking entity and is designed to reduce the specific risks to the 
banking entity in connection with and related to such positions, 
contracts, or other holdings. This section of the proposed rule 
implements, in relevant part, section 13(d)(1)(C) of the BHC Act, which 
provides an exemption from the prohibition on acquiring or retaining an 
ownership interest in a covered fund for certain risk-mitigating 
hedging activities.\303\
---------------------------------------------------------------------------

    \303\ See 12 U.S.C. 1851(d)(1)(C).
---------------------------------------------------------------------------

    Interests by a banking entity in a covered fund may not typically 
be used as hedges for specific positions, contracts, or other holdings 
of a banking entity. However, two situations where a banking entity may 
potentially acquire or retain an ownership interest in a covered fund 
as a hedge are (i) when acting as intermediary on behalf of a customer 
that is not itself a banking entity to facilitate the exposure by the 
customer to the profits and losses of the covered fund (similar to 
acting as a ``riskless principal''),\304\ and (ii) to cover a 
compensation arrangement with an employee of the banking entity that 
directly provides investment advisory or other services to that fund. 
Section ----.13(b) of the proposed rule provides an exemption for 
banking entity to acquire or retain an ownership interest in a covered 
fund in these limited situations.\305\
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    \304\ In order to prevent evasion of the general limitation that 
a banking entity may not acquire or retain more than 3 percent of 
the ownership interests in any single covered fund that such banking 
entity organizes and offers, the proposed rule limits a banking 
entity's ability to acquire or retain an ownership interest in a 
covered fund as a permitted risk-mitigating hedge to those 
situations where the customer of the banking entity is not itself a 
banking entity. See proposed rule Sec.  ----.13(b)(1)(i)(A).
    \305\ See proposed rule Sec.  ----.13(b).
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i. Approach for Hedges Using an Ownership Interest in a Covered Fund
    As noted above in the discussion of Sec.  ----.5 of the proposed 
rule, risk-mitigating hedging activities present certain implementation 
challenges because of the potential that prohibited activities or 
investments could be conducted in the context of, or mischaracterized 
as, hedging transactions. In light of these complexities, the Agencies 
have proposed a multi-faceted approach to implementation, which is 
discussed in detail above in reference to Sec.  ----.5 of the proposed 
rule.\306\ As with the hedging exemption provided under Sec.  ----.5, 
this multi-faceted approach is intended to clearly articulate the 
CFTC's expectation regarding the scope of permitted hedging activities 
under Sec.  ----.13(b) in a manner that limits potential abuse of the 
hedging exemption while not unduly constraining the important risk 
management function that is served by a banking entity's hedging 
activities. However, because of the possibility that using an ownership 
interest in a covered fund as a hedging instrument may mask an intent 
to evade the limitations on the amount and value of ownership interests 
in a covered fund or funds under Sec.  ----.12, the proposed rule 
contains several additional requirements related to a banking entity's 
ability to use an ownership interest in a covered fund as a hedging 
instrument.
---------------------------------------------------------------------------

    \306\ See SUPPLEMENTARY INFORMATION, Part III.B.3.
---------------------------------------------------------------------------

ii. Required Criteria for Permitted Risk-Mitigating Hedging Activities 
Involving a Covered Fund
    Section ----.13(b) of the proposed rule describes the criteria that 
a banking entity must meet in order to rely on the hedging exemption 
with respect to ownership interests of a covered fund. The majority of 
these requirements are substantially similar to those discussed in 
detail above in connection with the risk-mitigating hedging exemption 
contained in Sec.  ----.5 of the proposed rule, and include the 
requirements that:

[[Page 8395]]

(i) The hedge is made in connection with and related to individual or 
aggregated obligations or liabilities of the banking entity that are: 
(A) taken by the banking entity when acting as intermediary on behalf 
of a customer that is not itself a banking entity to facilitate the 
exposure by the customer to the profits and losses of the covered fund, 
or (B) directly connected to a compensation arrangement with an 
employee that directly provides investment advisory or other services 
to the covered fund; (ii) the banking entity has established the 
internal compliance program required by subpart D designed to ensure 
the banking entity's compliance with the requirements of this 
paragraph, including reasonably designed written policies and 
procedures regarding the instruments, techniques and strategies that 
may be used for hedging, internal controls and monitoring procedures, 
and independent testing; (iii) the transaction is designed to reduce 
the specific risks to the banking entity in connection with and related 
to such obligations or liabilities; (iv) the acquisition or retention 
of an ownership interest in a covered fund: (A) Is made in accordance 
with the written policies, procedures and internal controls established 
by the banking entity pursuant to subpart D; (B) hedges or otherwise 
mitigates an exposure to a covered fund through a substantially similar 
offsetting exposure to the same covered fund and in the same amount of 
ownership interest in that covered fund that arises out of a 
transaction conducted solely to accommodate a specific customer request 
with respect to, or directly connected to its compensation arrangement 
with an employee that directly provides investment advisory or other 
services to, that covered fund; (C) does not give rise, at the 
inception of the hedge, to significant exposures that were not already 
present in individual or aggregated positions, contracts, or other 
holdings of a banking entity and are not hedged contemporaneously; and 
(D) is subject to continuing review, monitoring and management by the 
banking entity that: (1) Is consistent with its written hedging 
policies and procedures; (2) maintains a substantially similar 
offsetting exposure to the same amount and type of ownership interest, 
based upon the facts and circumstances of the underlying and hedging 
positions and the risks and liquidity of those positions, to the risk 
or risks the purchase or sale is intended to hedge or otherwise 
mitigate; and (3) mitigates any significant exposure arising out of the 
hedge after inception; and (v) the compensation arrangements of persons 
performing the risk-mitigating hedging activities are designed not to 
reward proprietary risk-taking.\307\
---------------------------------------------------------------------------

    \307\ See proposed rule Sec.  ----.13(b).
---------------------------------------------------------------------------

    These requirements, while substantially similar to those contained 
in Sec.  ----.5 above, are different in several material aspects. 
First, Sec.  ----.13(b)(1)(i) of the proposed rule provides that any 
banking entity relying on this exemption may only hedge or otherwise 
mitigate one or more specific risks arising in connection with and 
related to the two situations enumerated in that section. These are 
risks taken by the banking entity when acting as intermediary on behalf 
of a customer that is not itself a banking entity to facilitate the 
exposure by the customer to the profits and losses of the covered fund, 
or directly connected to its compensation arrangement with an employee 
that directly provides investment advisory or other services to the 
covered fund.\308\ Second, Sec.  ----.13(b)(2)(ii)(B) of the proposed 
rule requires that the acquisition or retention of an ownership 
interest in a covered fund hedge or otherwise mitigate a substantially 
similar offsetting exposure to the same covered fund and in the same 
amount of ownership interest in that covered fund, which requires 
greater equivalency between the reference asset and hedging instrument 
than the correlation required under Sec.  ----.5. Third, Sec.  --
--.13(b)(3) of the proposed rule imposes a documentation requirement on 
all types of hedging transactions where the banking entity uses 
ownership interests in a covered fund as the hedging instrument. This 
requirement is broader than that contained in Sec.  ----.5 and is 
reflective of the limited scope of positions or exposures for which a 
banking entity may acquire or retain an ownership interest in a covered 
fund as a hedge. Specifically, for any transaction that a banking 
entity acquires or retains an ownership interest in a covered fund in 
reliance of the hedging exemption, the banking entity must document the 
risk-mitigating purposes of the transaction and identify the risks of 
the individual or aggregated positions, contracts, or other holding of 
the banking entity that the transaction is designed to reduce. Such 
documentation must be established at the time the hedging transaction 
is effected, not after the fact. This documentation requirement 
establishes a contemporaneous record that will assist the CFTC in 
assessing the actual reasons for which the position was established.
---------------------------------------------------------------------------

    \308\ See proposed rule Sec.  ----.13(b)(1)(i).
---------------------------------------------------------------------------

iii. Request for Comment
    In addition to those questions raised in connection with the 
proposed implementation of the risk-mitigating hedging exemption under 
Sec.  ----.5 of the proposed rule, the CFTC requests comment on the 
proposed implementation of that same exemption with respect to covered 
fund activities. In particular, the CFTC requests comment on the 
following questions:
    Question 281. Is the proposed rule's approach to implementing the 
hedging exemption for acquiring or retaining an ownership interest in a 
covered fund effective? If not, what alternative approach would be more 
effective?
    Question 282. Should the approach include other elements? If so, 
what elements and why? Should any of the proposed elements be revised 
or eliminated? If so, why and how?
    Question 283. What burden will the proposed approach to 
implementing the hedging exemption have on banking entities? How can 
any burden be minimized or eliminated in a manner consistent with the 
language and purpose of the statute?
    Question 284. Are the criteria included in Sec.  ----.13(b)'s 
hedging exemption effective? Is the application of each criterion to 
potential transactions sufficiently clear? Should any of the criteria 
be changed or eliminated? Should other requirements be added?
    Question 285. Is the requirement that an ownership interest in a 
covered fund may only be used as a hedge (i) by the banking entity when 
acting as intermediary on behalf of a customer that is not itself a 
banking entity to facilitate the exposure by the customer to the 
profits and losses of the covered fund, or (ii) to cover compensation 
arrangements with an employee of the banking entity that directly 
provides investment advisory or other services to that fund effective? 
If not, what other requirements would be more effective?
    Question 286. Does the proposed rule sufficiently articulate the 
types of risks and positions that a banking entity typically would 
utilize an ownership interest in a covered fund to hedge? If not, how 
should the proposal be changed?
    Question 287. Is the requirement that the hedging transaction 
involve a substantially similar offsetting exposure to the same covered 
fund and in the same amount of ownership interest to the risk or risks 
the transaction is intended to hedge or otherwise mitigate effective? 
If not, how should the

[[Page 8396]]

requirement be changed? Should some other level of correlation be 
required? Should the proposal specify in greater detail how correlation 
should be measured? If not, how could it better do so?
    Question 288. Is the requirement that the transaction not give 
rise, at the inception of the hedge, to material risks that are not 
themselves hedged in a contemporaneous transaction effective? Is the 
proposed materiality qualifier appropriate and sufficiently clear? If 
not, what alternative would be effective and/or clearer?
    Question 289. Is the requirement that any transaction conducted in 
reliance on the hedging exemption be subject to continuing review, 
monitoring and management after the transaction is established 
effective? If not, what alternative would be more effective?
    Question 290. Is the proposed documentation requirement effective? 
If not, what alternative would be more effective? What burden would the 
proposed documentation requirement place on covered banking entities? 
How might such burden be reduced or eliminated in a manner consistent 
with the language and purpose of the statute?
c. Permitted Covered Fund Activities and Investments Outside of the 
United States
    Section ----.13(c) of the proposed rule, which implements section 
13(d)(1)(I) of the BHC Act,\309\ permits certain foreign banking 
entities to acquire or retain an ownership interest in, or to act as 
sponsor to, a covered fund so long as such activity occurs solely 
outside of the United States and the entity meets the requirements of 
sections 4(c)(9) or 4(c)(13) of the BHC Act. The purpose of this 
statutory exemption appears to be to limit the extraterritorial 
application of the statutory restrictions on covered fund activities to 
foreign firms that, in the course of operating outside of the United 
States, engage outside the United States in activities permitted under 
relevant foreign law, while preserving national treatment and 
competitive equality among U.S. and foreign firms within the United 
States.\310\ Consistent with this purpose, the proposed rule defines 
both the type of foreign banking entities that are eligible for the 
exemption and the circumstances in which covered fund activities or 
investments by such an entity will be considered to have occurred 
solely outside of the United States (including clarifying when an 
ownership interest will be deemed to have been offered for sale or sold 
to a resident of the United States).
---------------------------------------------------------------------------

    \309\ Section 13(d)(1)(I) of the BHC Act permits a banking 
entity to acquire or retain an ownership interest in, or have 
certain relationships with, a covered fund notwithstanding the 
prohibition on proprietary trading and restrictions on investments 
in, and relationships with, a covered fund, if: (i) such activity or 
investment is conducted by a banking entity pursuant to paragraph 
(9) or (13) of section 4(c) of the BHC Act; (ii) the activity occurs 
solely outside of the United States; (iii) no ownership interest in 
such fund is offered for sale or sold to a resident of the United 
States; and (iv) the banking entity is not directly or indirectly 
controlled by a banking entity that is organized under the laws of 
the United States or of one or more States. See 12 U.S.C. 
1851(d)(1)(I).
    \310\ See 156 Cong. Rec. S5897 (daily ed. July 15, 2010) 
(statement of Sen. Merkley).
---------------------------------------------------------------------------

i. Foreign Banking Entities Eligible for the Exemption
    Section ----.13(c)(1)(i) of the proposed rule incorporates the 
statutory requirement that the banking entity not be, directly or 
indirectly, controlled by a banking entity that is organized under the 
laws of the United States or of one or more States. Consistent with the 
statutory language, banking entities organized under the laws of the 
United States or of one or more States, or the subsidiaries or branches 
thereof (wherever organized or licensed), may not rely on the 
exemption. Similarly, the U.S. subsidiaries or U.S. branches of foreign 
banking entities would not qualify for the exemption.
    Section ----.13(c)(2) clarifies when a banking entity would be 
considered to have met the statutory requirement that the banking 
entity conduct the activity pursuant to paragraphs 4(c)(9) or 4(c)(13) 
of the BHC Act \311\ Section 4(c)(9) of the BHC Act generally provides 
that the restrictions on nonbanking activities contained in section 
4(a) of that statute do not apply to the ownership of shares held or 
activities conducted by any company organized under the laws of a 
foreign country the greater part of whose business is conducted outside 
the United States, if the Board by regulation or order determines that, 
under the circumstances and subject to the conditions set forth in the 
regulation or order, the exemption would not be substantially at 
variance with the purposes of this Act and would be in the public 
interest.\312\ The CFTC notes that the Board has, in part, implemented 
section 4(c)(9) through subpart B of the Board's Regulation K, which 
specifies a number of conditions and requirements that a foreign 
banking organization must meet in order to use such authority. Such 
conditions and requirements include, for example, a qualifying foreign 
banking organization test that requires the foreign banking 
organization to demonstrate that more than half of its worldwide 
business is banking and that more than half of its banking business is 
outside the United States.
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    \311\ Section ----.13(c)(2) of the proposed rule only addresses 
when a transaction or activity will be considered to have been 
conducted pursuant to section 4(c)(9) of the BHC Act; although the 
statute also references section 4(c)(13) of the BHC Act, the CFTC 
notes that the Board has applied the authority contained in that 
section only to include certain foreign activities of U.S. banking 
organizations. The express language of section 13(d)(1)(I) of the 
BHC Act limits its availability to foreign banking entities that are 
not controlled by a banking entity organized under the laws of the 
United States or of one or more States. A foreign banking entity may 
not rely on the exemptive authority of section 4(c)(13) and, so, 
that section is not addressed in the proposed rule.
    \312\ See 12 U.S.C. 1843(c)(9).
---------------------------------------------------------------------------

    The proposed rule makes clear that a banking entity will qualify 
for the foreign fund exemption if the entity is a foreign banking 
organization subject to subpart B of the Board's Regulation K and the 
transaction occurs solely outside the United States. Section 13 of the 
BHC Act also applies to foreign companies that are banking entities 
covered by Section 13 but are not currently subject either to the BHC 
Act generally or the Board's Regulation K, for example, because the 
foreign company controls a savings association or an FDIC-insured 
industrial loan company but not a bank or branch in the United States. 
Accordingly, the proposed rule clarifies when such a foreign banking 
entity would be considered to have conducted a transaction or activity 
``pursuant to section 4(c)(9)'' for purposes of the exemption at Sec.  
----.13(c) of the proposed rule.\313\ In particular, the proposed rule 
proposes that to qualify for the foreign banking entity exemption, such 
firms must meet at least two of three requirements that evaluate the 
extent to which the foreign entity's business is conducted outside the 
United States, as measured by assets, revenues, and income. This test 
largely mirrors the qualifying foreign banking organization test that 
is made applicable under section 4(c)(9) and Sec.  211.23(a) of the 
Board's Regulation K, except that the relevant test under Sec.  --
--.13(c)(2)(ii) of the proposed rule does not require such a foreign 
entity to demonstrate that more than half of its

[[Page 8397]]

business is banking conducted outside the United States.\314\
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    \313\ The CFTC notes that the Board emphasizes that this 
clarification would be applicable solely in the context of sections 
13(d)(1)(H) and (I) of the BHC Act. The application of section 
4(c)(9) to such foreign companies in other contexts is likely to 
involve different legal and policy issues and may therefore merit 
different approaches.
    \314\ See 12 U.S.C. 1843(c)(9); 12 CFR 211.23(a); proposed rule 
Sec.  ----.13(c)(2). This difference reflects the fact that foreign 
entities subject to section 13 of the BHC Act but not the BHC Act 
are, in many cases, predominantly commercial firms. A requirement 
that a firm also demonstrate that more than half of its banking 
business is outside the United States would likely make the 
exemption unavailable to many such firms and subject their global 
activities to the prohibition on acquiring or retaining an ownership 
interest in, or acting as sponsor to, a covered fund, a result that 
the statute does not appear to have intended.
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ii. Transactions and Activities Solely Outside of the United States
    Section ----.13(c) of the proposed rule also clarifies when a 
transaction or activity will be considered to have occurred solely 
outside of the United States for purposes of the exemption. In 
interpreting this aspect of the statutory language, the proposal 
focuses on the extent to which material elements of the transaction 
occur within, or are effected by personnel within, the United States. 
This aspect of the proposal reflects the apparent intent of the foreign 
funds exemption to avoid extraterritorial application of the 
restrictions on covered funds activities and investments outside the 
United States while preserving competitive parity within U.S. market. 
The proposed rule does not evaluate solely whether the risk of the 
transaction or activity, or management or decision-making with respect 
to such transaction or activity, rests outside the United States. 
Rather, the proposal also provides that foreign banking entities may 
not structure a transaction or activity so as to be ``outside of the 
United States'' for risk and booking purposes while simultaneously 
engaging in transactions within U.S. markets that are prohibited for 
U.S. banking entities.
    In particular, Sec.  ----.13(c)(3) of the proposed rule provides 
that a transaction or activity will be considered to have occurred 
solely outside of the United States only if all of the following three 
conditions are satisfied:
    <bullet> 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;
    <bullet> 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
    <bullet> No ownership interest in such covered fund is offered for 
sale or sold to a resident of the United States.

These three criteria reflect statutory constraints and are intended to 
ensure that a transaction or activity conducted in reliance on the 
exemption does not involve either investors that are residents of the 
United States or a relevant U.S. employee of the banking entity, as 
such involvement would appear to constitute a sufficient locus of 
activity in the U.S. marketplace so as to preclude the availability of 
the exemption.
    A resident of the United States is defined in Sec.  ----.2(t) of 
the proposed rule, and is described in detail in Part III.B.4.d of this 
SUPPLEMENTARY INFORMATION. The proposed rule applies this definition in 
the context of the foreign covered funds exemption because it would 
appear to appropriately capture the scope of counterparties (including 
investors that are residents of the United States) or relevant U.S. 
personnel of the banking entity, that, if involved in the transaction 
or activity, would preclude such transaction or activity from being 
considered to have occurred solely outside the United States. Under the 
proposed rule, an employee or entity engaged in the offer or sale of an 
ownership interest (or booking such transaction) must be outside of the 
United States; however, an employee or entity with no customer 
relationship and involved solely in providing administrative services 
or so-called ``back office'' functions to the fund as incident to the 
activity permitted under Sec.  ----.13(c) of the proposed rule (such as 
clearing and settlement or maintaining and preserving records of the 
fund with respect to a transaction where no ownership interest is 
offered for sale or sold to a resident of the United States) would not 
be subject to this requirement.
iii. Request for Comment
    The CFTC requests comment on the proposed rule's approach to 
implementing the foreign covered funds activity and investment 
exemption. In particular, the CFTC request comment on the following 
questions:
    Question 291. Is the proposed rule's implementation of the 
``foreign funds'' exemption effective? If not, what alternative would 
be more effective and/or clearer?
    Question 292. Are the proposed rule's provisions regarding when an 
activity will be considered to be conducted pursuant to section 4(c)(9) 
of the BHC Act effective and sufficiently clear? If not, what 
alternative would be more effective and/or clearer? Does it effectively 
address application of the foreign funds exemption to foreign banking 
entities not subject to the BHC Act generally? If not, how could it 
better address application of the exemption?
    Question 293. Are the proposed rule's provisions regarding when a 
transaction or activity will be considered to have occurred solely 
outside the United States effective and sufficiently clear? If not, 
what alternative would be more effective and/or clearer? Should 
additional requirements be added? If so, what requirements and why? 
Should additional requirements be modified or removed? If so, what 
requirements and why or how?
    Question 294. Is the proposed exemption consistent with the purpose 
of the statute? Is the proposed exemption consistent with respect to 
national treatment for foreign banking organizations? Is the proposed 
exemption consistent with the concept of competitive equity?
    Question 295. Does the proposed rule effectively define a resident 
of the United States for these purposes? If not, how should the 
definition be altered? What definitions of resident of the United 
States are currently used by banking entities? Would using any one of 
these definitions reduce the burden of complying with section 13 of the 
BHC Act? Why or why not?
d. Sale and Securitization of Loans
    Section ----.13(d) of the proposed rule permits a banking entity to 
acquire and retain an ownership interest in a covered fund that is an 
issuer of asset-backed securities, the assets or holdings of which are 
solely comprised of: (i) Loans; (ii) contractual rights or assets 
directly arising from those loans supporting the asset-backed 
securities; and (iii) interest rate or foreign exchange derivatives 
that (A) materially relate to the terms of such loans or contractual 
rights or assets and (B) are used for hedging purposes with respect to 
the securitization structure.\315\ The authority contained in this 
section of the proposed rule would therefore allow a banking entity to 
engage in the sale and securitization of loans by acquiring and 
retaining an ownership interest in certain securitization vehicles 
(which could qualify as a covered fund for purposes of section 13(h)(2) 
of the BHC Act and the proposed rule) that the banking entity organizes 
and offers, or acts as sponsor to, in excess of and

[[Page 8398]]

without being subject to the limitations contained in Sec.  ----.12 of 
the proposed rule. Proposed Sec.  ----.13(d) is designed to assist in 
implementing section 13(g)(2) of the BHC Act, which provides that 
nothing in section 13 of the BHC Act shall be construed to limit or 
restrict the ability of a banking entity or nonbank financial company 
supervised by the Board to sell or securitize loans in a manner 
otherwise permitted by law.\316\
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    \315\ See proposed rule Sec.  ----.13(d). The types of 
derivatives permitted under Sec.  ----.13(d)(3) of the proposed rule 
are not meant to include a synthetic securitization or a 
securitization of derivatives, but rather to include those 
derivatives that are used to hedge foreign exchange or interest rate 
risk resulting from loans held by the issuer of asset-backed 
securities.
    \316\ See 12 U.S.C. 1851(g)(2).
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    The CFTC notes that the phrase ``materially relate to terms of such 
loans'' is intended to quantitatively limit the derivatives permitted 
in a ``securitization of loans'' under Sec.  ----.13(d) of the proposed 
rule to include only those derivatives where the notional amount of the 
derivative is tied to the outstanding principal balance of the loans 
supporting the asset-backed securities of such issuer, either 
individually or in the aggregate. Additionally, such derivatives must 
be used solely to hedge risks that result from a mismatch between the 
loans and the related asset-backed securities (e.g., fixed rate loans 
with floating rate asset-backed securities, loans tied to the Prime 
Rate with LIBOR asset-backed securities, or Euro-denominated loans with 
Dollar-denominated asset-backed securities). Therefore, Sec.  --
--.13(d)(3) of the proposed rule would not allow the use of a credit 
default swap by an issuer of asset-backed securities.
    The CFTC requests comment on the proposed rule's approach to 
implementing the rule of construction related to the sale and 
securitization of loans. In particular, the CFTC requests comment on 
the following questions:
    Question 296. Is the proposed rule's implementation of the 
statute's ``sale and securitization of loans'' rule of construction 
effective? If not, what alternative would be more effective and/or 
clearer?
    Question 296.1. Should the proposed CFTC Rule include the 
securitization exemption in Sec.  ----.13(d)? Please explain the 
rationale for including or excluding the securitization exemption in 
the proposed CFTC Rule.
    Question 297. Are there other entities or activities that should be 
included in the proposed rule's implementation of the rule of 
construction related to the sale and securitization of loans? If so, 
what entity or activity and why?
    Question 298. Is the proposed rule's application of the rule of 
construction contained in section 13(g)(2) of the BHC Act appropriate?
    Question 299. Are the proposed rule and this SUPPLEMENTARY 
INFORMATION sufficiently clear regarding which derivatives would be 
allowed in a ``securitization of loans'' under Sec.  ----.13(d)(3) of 
the proposed rule? Is additional guidance necessary with respect to the 
types of derivatives that would be included in or excluded from a 
securitization of loans for purposes of interpreting the rule of 
construction contained in section 13(g)(2) of the BHC Act? If so, what 
topics should the additional guidance discuss and why?
    Question 300. Should derivatives other than interest rate or 
foreign exchange derivatives be allowed in a ``securitization of 
loans'' for purposes of interpreting the rule of construction contained 
in section 13(g)(2) of the BHC Act? Why or why not? What would be the 
legal and economic impact of not allowing the use of derivatives other 
than interest rate or foreign exchange derivatives in a 
``securitization of loans'' under Sec.  ----.13(d)(3) of the proposed 
rule for existing issuers of asset-backed securities and for future 
issuers of asset-backed securities?
    Question 301. Should the CFTC consider providing additional 
guidance for when a transaction with intermediate steps constitutes one 
or more securitization transactions that each would be subject to the 
rule? For example, both auto lease securitizations and asset-backed 
commercial paper conduits typically involve intermediate 
securitizations. The asset-backed securities issued to investors in 
such covered funds are technically supported by the intermediate asset-
backed securities. Should these kinds of securitizations be viewed as a 
single transaction and included within a securitization of loans for 
purposes of the proposed rule? Should each step be viewed as a separate 
securitization?
5. Section ----.14: Covered Fund Activities and Investments Determined 
To Be Permissible
    Section ----.14 of the proposed rule, which implements section 
13(d)(1)(J) of the BHC Act,\317\ permits a banking entity to engage in 
any covered funds activity that the CFTC determines promotes and 
protects the safety and soundness of a banking entity and the financial 
stability of the United States.\318\ Any activity authorized under 
Sec.  ----.14 of the proposed rule must still comply with the 
prohibition and limitations governing relationships with covered funds 
contained in section 13(f) of the BHC Act, as implemented by Sec.  --
--.16 of this proposal.\319\ Additionally, like other activities 
permissible under section 13(d)(1) of the BHC Act and as implemented by 
subpart C of the proposed rule, activities found permissible under 
Sec.  ----.14 of the proposed rule and section 13(d)(1)(J) remain 
subject to other provisions of section 13 of the BHC Act, including the 
sections limiting conflicts of interest and high-risk assets or trading 
strategies, as well as the section designed to prevent evasion of 
section 13 of the BHC Act.\320\
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    \317\ Section 13(d)(1)(J) of the BHC Act provides the CFTC 
discretion to determine that other activities not specifically 
identified by sections 13(d)(1)(A)-(I) of the BHC Act are exempted 
from the general prohibitions contained in section 13(a) of that 
Act, and are thus permitted activities. In order to make such a 
determination, the CFTC must find that such activity or activities 
promote and protect the safety and soundness of a banking entity, as 
well as promote and protect the financial stability of the United 
States. See 12 U.S.C. 1851(d)(1)(J).
    \318\ See 12 U.S.C. 1851(d)(1)(J).
    \319\ Section 13(d)(1)(J) of the BHC Act only provides the CFTC 
with the ability to provide additional exemptions from the 
prohibitions contained in section 13(a)(1) of the BHC Act. Section 
13(f) of the BHC Act, which deals with relationships and 
transactions with a fund that is, directly or indirectly, organized 
and offered or sponsored by a banking entity, operates as an 
independent prohibition and set of limitations on the activities of 
banking entities. As such, Sec.  ----.14 of the proposed rule cannot 
and does not provide any exemptions from the prohibition on 
relationships or transaction with a covered fund contained in 
section 13(f) of the BHC Act or Sec.  ----.16 of the proposed rule.
    \320\ See 12 U.S.C. 1851(d)(2), (e)(1).
---------------------------------------------------------------------------

    The CFTC has proposed to permit three activities at this time under 
this authority. These activities involve acquiring or retaining an 
ownership interest in and sponsoring of (i) certain BOLI separate 
accounts; (ii) certain entities that, although within the definition of 
covered fund are, in fact, common corporate organizational vehicles; 
and (iii) a covered fund in the ordinary course of collecting a debt 
previously contracted in good faith or pursuant to and in compliance 
with the conformance or extended transition period provided for under 
the Board's rules issued under section 13(c)(6) of the BHC Act.
a. Investments in Certain Bank Owned Life Insurance Separate Accounts
    Banking entities have for many years invested in life insurance 
policies that cover key employees, in accordance with supervisory 
policies established by the Federal banking agencies.\321\ These BOLI 
investments are typically structured as investments in separate 
accounts that are excluded from the definition of ``investment 
company'' under the Investment Company Act by virtue of section 3(c)(1) 
or 3(c)(7) of that

[[Page 8399]]

Act. By virtue of reliance on these exclusions, these BOLI accounts 
would be covered by the definition of ``hedge fund'' or ``private 
equity fund'' in section 13 of the BHC Act.\322\
---------------------------------------------------------------------------

    \321\ See, e.g., Bank Owned Life Insurance, Interagency 
Statement on the Purchase and Risk Management of Life Insurance 
(``Interagency BOLI Guidance'') (Dec. 7, 2004).
    \322\ See 12 U.S.C. 1851(h)(2).
---------------------------------------------------------------------------

    However, when made in the normal course, these investments do not 
involve the speculative risks intended to be addressed by section 13 of 
the BHC Act. Moreover, applying the prohibitions in section 13 to these 
investments would eliminate an investment that helps banking entities 
to reduce their costs of providing employee benefits as well as other 
costs.
    Section ----.14(a)(1) of the proposed rule permits a banking entity 
to acquire and retain these BOLI investments, as well as act as sponsor 
to a BOLI separate account.\323\ The proposal includes a number of 
conditions designed to ensure that BOLI investments are not conducted 
in a manner that raises the concerns that section 13 of the BHC Act is 
intended to address. In particular, in order for a banking entity to 
invest in or sponsor a BOLI separate account, the banking entity that 
purchases the insurance policy: (i) May not control the investment 
decisions regarding the underlying assets or holdings of the separate 
account; and (ii) must hold its ownership interests in the separate 
account in compliance with applicable supervisory guidance provided by 
the appropriate Federal regulatory agency regarding BOLI.\324\
---------------------------------------------------------------------------

    \323\ The proposed rule defines ``separate account'' as ``an 
account established and maintained by an insurance company subject 
to regulation by a State insurance regulatory or a foreign insurance 
regulator under which income, gains, and losses, whether or not 
realized, from assets allocated to such account, are, in accordance 
with the applicable contract, credited to or charged against such 
account without regard to other income, gains, or losses of the 
insurance company.'' See proposed rule Sec.  ----.2(z).
    \324\ See proposed rule Sec.  ----.14(a)(1)(i)-(ii). While other 
guidance or requirements may be imposed by the CFTC or other 
Agencies for a specific banking entity for which it serves as the 
primary financial regulator, the CFTC notes that, at a minimum, 
investments under authority of this section must comply with the 
Interagency BOLI Guidance. This guidance requires, among other 
things, that a banking entity generally: (i) Not control the 
investment decisions regarding the underlying assets or holdings of 
the separate account; (ii) demonstrate to the satisfaction of the 
CFTC that the potential returns from the investments in such 
separate account are appropriately matched to the banking entity's 
employee compensation or benefit plan obligations; and (iii) not use 
such separate account to take speculative positions or to support 
the general operations of the banking entity.
---------------------------------------------------------------------------

    The CFTC has structured this exemption in the proposed rule so as 
to allow a banking entity to continue to manage and structure its risks 
and obligations related to its employee compensation or benefit plan 
obligations in a manner that promotes and protects the safety and 
soundness of banking entities, which on an industry-wide level has the 
concomitant effect of promoting and protecting the financial stability 
of the United States.
b. Investments in Certain Other Covered Funds
    As noted above, the definition of ``covered fund'' as contained in 
Sec.  ----.10(b)(1) of the proposed rule potentially includes within 
its scope many entities and corporate structures that would not usually 
be thought of as a ``hedge fund'' or ``private equity fund.'' 
Additionally, the Dodd-Frank Act contains other provisions that permit 
or require a banking entity to acquire or retain an ownership interest 
in or act as sponsor to a covered fund in a manner not specifically 
described under section 13 of the BHC Act.
    Section ----.14(a)(2) of the proposed rule permits a banking entity 
to own certain specified entities that are often part of corporate 
structures and that, by themselves and without other extenuating 
circumstances or factors, do not raise the type of concerns which 
section 13 of the BHC Act was intended to address but which 
nevertheless may be captured by the definition of ``hedge fund'' or 
``private equity fund'' in section 13(h)(2) of the BHC Act. 
Specifically, Sec.  ----.14(a)(2) of the proposed rule permits a 
banking entity to acquire or retain an ownership interest in or act as 
sponsor to (i) a joint venture between the banking entity and any other 
person, provided that the joint venture is an operating company and 
does not engage in any activity or any investment not permitted under 
the proposed rule; (ii) an acquisition vehicle, provided that the sole 
purpose and effect of such entity is to effectuate a transaction 
involving the acquisition or merger of one entity with or into the 
banking entity or one of its affiliates; and (iii) a wholly-owned 
subsidiary of the banking entity that is (A) engaged principally in 
providing bona fide liquidity management services described under Sec.  
----.3(b)(2)(iii)(C) of the proposed rule, and (B) carried on the 
balance sheet of the banking entity.\325\
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    \325\ See proposed rule Sec.  ----.14(a)(2).
---------------------------------------------------------------------------

    The CFTC notes that these types of entities may meet the definition 
of covered fund contained in Sec.  ----.10(b)(1) of the proposed rule 
(and as contained in section 13(h)(2) of the BHC Act), to the extent 
these entities rely solely on section 3(c)(1) or 3(c)(7) of the 
Investment Company Act. However, these types of entities do not engage 
in the type and scope of activities to which Congress intended section 
13 of the BHC Act to apply.\326\ Additionally, without this exemption, 
many entities would be forced to alter their corporate structure 
without achieving any reduction in risk. Permitting such investments in 
these entities would thus appear to promote and protect the safety and 
soundness of banking entities and promote and protect the financial 
stability of the United States.
---------------------------------------------------------------------------

    \326\ See 156 Cong. Rec. H5226 (daily ed. June 30, 2010) 
(statement of Reps. Hymes and Frank).
---------------------------------------------------------------------------

    Section ----.14(a)(2) of the proposed rule also permits a banking 
entity to comply with section 15G of the Exchange Act (15 U.S.C. 78o-
11), added by section 941 of the Dodd-Frank Act, which requires a 
banking entity to maintain a certain minimum interest in certain 
sponsored or originated asset-backed securities.\327\ In order to give 
effect to this separate requirement under the Dodd-Frank Act, Sec.  --
--.14(a)(2)(iii) of the proposed rule permits a banking entity to 
acquire or retain an ownership interest in or act as sponsor to an 
issuer of asset-backed securities, but only with respect to that amount 
or value of economic interest in a portion of the credit risk for an 
asset-backed security that is retained by a banking entity that is a 
``securitizer'' or ``originator'' in compliance with the minimum 
requirements of section 15G of the Exchange Act (15 U.S.C. 78o-11) and 
any implementing regulations issued thereunder.\328\ The Agencies have 
structured this exemption to recognize that Congress imposed other 
requirements on firms that are banking entities under section 13 of the 
BHC Act. Additionally, permitting a banking entity to retain the 
minimum level of economic interest will incent banking entities to 
engage in more careful and prudent underwriting and evaluation of the 
risks and obligations that may accompany asset-backed securitizations, 
which would promote and protect the safety and soundness of banking 
entities and the financial stability of the United States.
---------------------------------------------------------------------------

    \327\ The SEC and certain banking agencies issued a proposed 
rule to implement the requirements of section 15G of the Exchange 
Act, as required under section 941 of the Dodd-Frank Act. See Credit 
Risk Retention, 76 FR 24090 (Apr. 29, 2011).
    \328\ See proposed rule Sec.  ----.14(a)(2)(iii).
---------------------------------------------------------------------------

    Section 14(a)(2) of the proposed rule permits a banking entity to 
acquire and retain an ownership interest in a covered fund that is an 
issuer of asset-backed securities described in Sec.  13(d) of the 
proposed rule, the assets or holdings of which are solely comprised of: 
(i) Loans; (ii) contractual rights or assets directly arising from 
those loans

[[Page 8400]]

supporting the asset-backed securities; and (iii) interest rate or 
foreign exchange derivatives that (A) materially relate to the terms of 
such loans or contractual rights or assets and (B) are used for hedging 
purposes with respect to the securitization structure. This exemption 
augments the authority regarding the sale and securitization of loans 
available under Sec.  ----.13(d) of the proposed rule (which partially 
implements the rule of construction under section 13(g)(2) of the BHC 
Act) and permits a banking entity to engage in the purchase, and not 
only the sale and securitization, of loans through authorizing the 
acquisition or retention of an ownership interest in such 
securitization vehicles that the banking entity does not organize and 
offer, or for which it does not act as sponsor, provided that the 
assets or holdings of such vehicles are solely comprised of the 
instruments or obligations referenced above.\329\
---------------------------------------------------------------------------

    \329\ See id. at Sec.  ----.14(a)(2)(v).
---------------------------------------------------------------------------

    Permitting banking entities to acquire or retain an ownership 
interest in these loan securitizations will provide a deeper and richer 
pool of potential participants and a more liquid market for the sale of 
such securitizations, which in turn should result in increased 
availability of funds to individuals and small businesses, as well as 
provide greater efficiency and diversification of risk. The CFTC 
believes this exemption would promote and protect the safety and 
soundness of a banking entity, and would also promote and protect the 
financial stability of the United States.\330\
---------------------------------------------------------------------------

    \330\ The CFTC notes that proposed exemption applies only to the 
covered fund-related provisions of the proposed rule, and not to its 
prohibition on proprietary trading.
---------------------------------------------------------------------------

c. Acquiring or Retaining an Ownership Interest in or Acting a Sponsor 
to a Covered Fund Under Certain Specified Authorities
    Section ----.14(b) of the proposed rule permits a banking entity to 
acquire or retain an ownership interest in or act as sponsor to a 
covered fund in those instances where the ownership interest is 
acquired or retained by a banking entity (i) in the ordinary course of 
collecting a debt previously contracted in good faith, if the banking 
entity divests the ownership interest within applicable time periods 
provided for by the CFTC, or (ii) pursuant to and in compliance with 
the Conformance or Extended Transition Period authorities provided for 
under the proposed rule.\331\
---------------------------------------------------------------------------

    \331\ See proposed rule Sec.  ----.14(b). The Conformance or 
Extended Transition period authorities are substantially similar to 
those proposed by the Board in its February 2011 final rule 
governing such conformance periods under section 13 of the BHC Act.
---------------------------------------------------------------------------

    Allowing banking entities to rely on these authorities for 
acquiring or retaining an ownership interest in or acting as sponsor to 
a covered fund will enable banking entities to manage their risks and 
structure their business in a manner consistent with their chosen 
corporate form and in a manner that otherwise complies with applicable 
laws. Thus, permitting such activities would promote and protect the 
safety and soundness of a banking entity, and would also promote and 
protect the financial stability of the United States.
d. Request for Comment
    The CFTC requests comment on the proposed rule's approach to 
implementing the exemption related to activities specifically 
determined to be permissible under section 13(d)(1)(J) of the BHC Act. 
In particular, the CFTC requests comment on the following questions:
    Question 302. Is the proposed rule's implementation of exemptions 
for covered fund activities and investments pursuant to section 
13(d)(1)(J) of the BHC Act effective? If not, what alternative would be 
more effective and/or clearer?
    Question 302.1. Should the proposed CFTC Rule include the 
additional exemptions listed in section 13(d)(1)(J) of the BHC Act in 
Section ----.14 (e.g., BOLI, certain acquisition vehicles)? Please 
explain the rationale for including or excluding the exemptions in the 
proposed CFTC Rule.
    Question 303. Is the proposed rule's approach to utilizing section 
13(d)(1)(J) of the BHC Act to permit a banking entity to acquire or 
retain an ownership interest in, or act as sponsor to, certain entities 
that would fall into the definition of covered fund effective? Why or 
why not? If not, what alternative would be more effective and why? What 
legal authority under the statute would permit such an alternative?
    Question 304. Are the proposed rule's provisions regarding when a 
covered fund activity will be deemed to be permitted under authority of 
section 13(d)(1)(J) of the BHC Act effective and sufficiently clear? If 
not, what alternative would be more effective and/or clearer?
    Question 305. Do the exemptions provided for in Sec.  ----.14 of 
the proposed rule effectively promote and protect the safety and 
soundness of banking entities and the financial stability of the United 
States? If not, why not?
    Question 306. Are the proposed rule's provisions regarding what 
qualifications must be satisfied in order to qualify for an exemption 
under Sec.  ----.14 of the proposed rule effective and sufficiently 
clear? If not, what alternative would be more effective and/or clearer? 
Should additional requirements be added? If so, what requirements and 
why? Should additional requirements be modified or removed? If so, what 
requirements and why or how?
    Question 307. Does the proposed rule effectively cover the scope of 
covered funds activities which the Agencies should specifically 
determine to be permissible under section 13(d)(1)(J) of the BHC Act? 
If not, what activity or activities should be permitted? For additional 
activities that should be permitted, on what grounds would these 
activities promote and protect the safety and soundness of banking 
entities and the financial stability of the United States?
    Question 308. Does the proposed rule effectively address the 
interplay between the restrictions on covered fund activities and 
investments in section 13 of the BHC Act and the requirements imposed 
on certain banking entities under section 15G of the Exchange Act? Why 
or why not?
    Question 309. Rather than permitting the acquisition or retentions 
of an ownership interest in, or acting as sponsor to, specific covered 
funds under section 13(d)(1)(J) of the BHC Act, should the CFTC use the 
authority provided under section 13(d)(1)(J) to permit investments in a 
covered fund that display certain characteristics? If so, what 
characteristics should the Agencies consider? How would investments 
with such characteristics promote and protect the safety and soundness 
of the banking entity and promote the financial stability of the United 
States?
    Question 310. Should venture capital funds be excluded from the 
definition of ``covered fund''? Why or why not? If so, should the 
definition contained in rule 203(l)-1 under the Advisers Act be used? 
Should any modification to that definition of venture capital fund be 
made? How would permitting a banking entity to invest in such a fund 
meet the standards contained in section 13(d)(1)(J) of the BHC Act?
    Question 311. Should non-U.S. funds or entities be included in the 
definition of ``covered fund''? Should any non-U.S. funds or entities 
be excluded from this definition? Why or why not? How would permitting 
a banking entity to invest in such a fund meet the standards contained 
in section 13(d)(1)(J) of the BHC Act?

[[Page 8401]]

    Question 312. Should so-called ``loan funds'' that invest 
principally in loans and not equity be excluded from the definition of 
``covered fund''? Why or why not? What characteristics would be most 
effective in determining whether a fund invests principally in loans 
and not equity? How would permitting a banking entity to invest in such 
a fund meet the standards contained in section 13(d)(1)(J) of the BHC 
Act?
    Question 313. Are the proposed rule's proposed determinations that 
the specified covered funds activities or investments promote and 
protect the safety and soundness of banking entities and the financial 
stability of the United States appropriate? If not, how should the 
determinations be amended or altered?
6. Section ----.15: Internal Controls, Reporting and Recordkeeping 
Requirements Applicable to Covered Fund Activities and Investments
    Section ----.15 of the proposed rule, which implements section 
13(e)(1) of the BHC Act,\332\ requires a banking entity engaged in 
covered fund activities and investments to comply with (i) the internal 
controls, reporting, and recordkeeping requirements required under 
Sec.  ----.20 and Appendix C of the proposed rule, as applicable and 
(ii) such other reporting and recordkeeping requirements as the CFTC 
may deem necessary to appropriately evaluate the banking entity's 
compliance with this subpart C.\333\ These requirements are discussed 
in detail in Part III.D of this SUPPLEMENTARY INFORMATION.
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    \332\ Section 13(e)(1) of the BHC Act requires the Agencies to 
issue regulations regarding internal controls and recordkeeping to 
ensure compliance with section 13. See 12 U.S.C. 1851(e)(1).
    \333\ See proposed rule Sec.  ----.15.
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7. Section ----.16: Limitations on Relationships With a Covered Fund
    Section 13(f) of the BHC Act generally prohibits a banking entity 
from entering into certain transactions with a covered fund that would 
be a covered transaction as defined in section 23A of the FR Act.\334\ 
Section ----.16 of the proposed rule implements this provision. Section 
----.16(a)(2) of the proposed rule clarifies that, for reasons 
explained in detail below, certain transactions between a banking 
entity and a covered fund remain permissible. Section ----.16(b) of the 
proposed rule implements the statute's requirement that any transaction 
permitted under section 13(f) of the BHC Act (including a prime 
brokerage transaction) between the banking entity and covered fund is 
subject to section 23B of the FR Act,\335\ which, in general, requires 
that the transaction be on market terms or on terms at least as 
favorable to the banking entity as a comparable transaction by the 
banking entity with an unaffiliated third party.
---------------------------------------------------------------------------

    \334\ 12 U.S.C. 371c.
    \335\ 12 U.S.C. 371c-1.
---------------------------------------------------------------------------

a. General Prohibition on Certain Transactions and Relationships
    Section 13(f)(1) of the BHC Act generally prohibits a banking 
entity that, directly or indirectly, serves as investment manager, 
investment adviser, commodity trading adviser, or sponsor to a covered 
fund (or that organizes and offers a covered fund pursuant to section 
13(d)(1)(G) of the BHC Act) from engaging in any transaction with the 
covered fund, or with any covered fund that is controlled by such fund, 
if the transaction would be a ``covered transaction'' as defined in 
section 23A of the FR Act, as if the banking entity and any affiliate 
thereof were a member bank and the covered fund were an affiliate 
thereof.\336\ Section ----.16(a)(1) of the proposed rule includes this 
prohibition.
---------------------------------------------------------------------------

    \336\ As noted above, the proposed rule implements the 
definition of ``banking entity'' in a manner that does not include 
covered funds for which a banking entity acts as sponsor or 
organizes and offers pursuant to section 13(d)(1)(G) of the BHC Act, 
or any covered fund in which such related covered fund invests. 
Accordingly, these covered funds (and any covered fund in which such 
covered fund acquired or retains a controlling investment) are not 
generally subject to the prohibitions contained in Sec.  ----.16 of 
the proposed rule.
---------------------------------------------------------------------------

    Consistent with the requirements of section 13(f)(1) of the BHC 
Act, Sec.  ----.16(a)(1) of the proposed rule is more restrictive than 
section 23A of the FR Act because Sec.  ----.16(a)(1) generally 
prohibits a banking entity and any of its affiliates from entering into 
any such transaction, while section 23A permits covered transactions 
with affiliates so long as the transactions meet specified quantitative 
and qualitative requirements.\337\
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    \337\ Section 23A of the FR Act limits the aggregate amount of 
covered transactions by a member bank to no more than (i) 10 per 
centum of the capital stock and surplus of the member bank in the 
case of any affiliate, and (ii) 20 per centum of the capital stock 
and surplus of the member bank in the case of all affiliates. See 12 
U.S.C. 371c(a). Conversely, section 13(f) of the BHC Act operates as 
a general prohibition on such transactions without providing any 
similar amount of permitted transactions.
---------------------------------------------------------------------------

b. Transactions That Would Be a ``Covered Transaction''
    Section 13(f) of the BHC Act applies to covered transactions as 
defined in section 23A of the FR Act without incorporating any of the 
provisions in section 23A that provide exemptions from the prohibitions 
in that section for certain types of covered transactions.\338\ Section 
----.16 of the proposed rule adopts the same language as the statute. 
The definition of ``covered transaction'' contained in section 23A of 
the FR Act itself includes an explicit exemption from the definition of 
``covered transaction'' for ``such purchase of real and personal 
property as may be specifically exempted by the Board by order or 
regulation.'' \339\ Since these transactions are, by definition, 
excluded from the definition of ``covered transaction,'' any 
transaction that is specifically exempted by the Board pursuant to this 
specific authority would not be deemed to be a covered transaction as 
defined in section 23A of the FR Act.
---------------------------------------------------------------------------

    \338\ The term ``covered transaction'' is defined in section 23A 
of the FR Act to mean, with respect to an affiliate of a member 
bank: (i) a loan or extension of credit to the affiliate, including 
a purchase of assets subject to an agreement to repurchase; (ii) a 
purchase of or an investment in securities issued by the affiliate; 
(iii) a purchase of assets from the affiliate, except such purchase 
of real and personal property as may be specifically exempted by the 
Board by order or regulation; (iv) the acceptance of securities or 
other debt obligations issued by the affiliate as collateral 
security for a loan or extension of credit to any person or company; 
(v) the issuance of a guarantee, acceptance, or letter of credit, 
including an endorsement or standby letter of credit, on behalf of 
an affiliate; (vi) a transaction with an affiliate that involves the 
borrowing or lending of securities, to the extent that the 
transaction causes a member bank or subsidiary to have credit 
exposure to the affiliate; or (vii) a derivative transaction, as 
defined in paragraph (3) of section 5200(b) of the Revised Statutes 
of the United States (12 U.S.C. 84(b)), with an affiliate, to the 
extent that the transaction causes a member bank or a subsidiary to 
have credit exposure to the affiliate. See 12 U.S.C. 371c(b)(7), as 
amended by section 608 of the Dodd-Frank Act.
    \339\ Id. at 371c(b)(7)(C).
---------------------------------------------------------------------------

c. Certain Transactions and Relationships Permitted
    While section 13(f)(1) of the BHC Act operates as a general 
prohibition on a banking entity's ability to enter into a transaction 
with a related covered fund that would be a covered transaction as 
defined under section 23A of the FR Act, other specific portions of the 
statute expressly provide for, or make reference to, a banking entity's 
ability to engage in certain transactions or relationships with such 
funds.\340\ Section ----.16(a)(2) of the proposed rule implements and 
clarifies these authorities.
---------------------------------------------------------------------------

    \340\ See, e.g.,12 U.S.C. 1851(d)(1)(G), (d)(4), and (f)(3).
---------------------------------------------------------------------------

i. Permitted Investments and Ownerships Interests
    Section----.16(a)(2) of the proposed rule clarifies that a banking 
entity may acquire or retain an ownership interest in a covered fund in 
accordance with the requirements of subpart C of the

[[Page 8402]]

proposed rule.\341\ This clarification is proposed in order to remove 
any ambiguity regarding whether the section prohibits a banking entity 
from acquiring or retaining an interest in securities issued by a 
related covered fund in accordance with the other provisions of the 
rule, since the purchase of securities of a related covered fund would 
be a covered transaction as defined by section 23A of the FR Act. There 
is no evidence that Congress intended section 13(f)(1) of the BHC Act 
to override the other provisions of section 13 with regard to the 
acquisition or retention of ownership interests specifically permitted 
by the section. Moreover, a contrary reading would make these more 
specific sections that permit covered transactions between a banking 
entity and a covered fund mere surplusage.
---------------------------------------------------------------------------

    \341\ See proposed rule Sec.  ----.16(a)(2)(i).
---------------------------------------------------------------------------

ii. Prime Brokerage Transactions Also Permitted
    Section ----.16(a)(2)(ii) of the proposed rule implements section 
13(f)(3)(A) of the BHC Act, which provides that a banking entity may 
enter into any prime brokerage transaction with a covered fund in which 
a covered fund managed, sponsored, or advised by such banking entity 
has taken an ownership interest, so long as certain enumerated 
conditions are satisfied.\342\ The proposed rule defines ``prime 
brokerage transaction'' to mean one or more products or services 
provided by the banking entity to a covered fund, such as custody, 
clearance, securities borrowing or lending services, trade execution, 
or financing, and data, operational, and portfolio management 
support.\343\ To engage in a prime brokerage transaction with a covered 
fund pursuant to Sec.  ----.16(a)(2)(ii) of the proposed rule, a 
banking entity must be in compliance with the limitations set forth in 
Sec.  ----.11 of the proposed rule with respect to a covered fund 
organized and offered by such banking entity. In addition, as required 
by statute, the chief executive officer (or equivalent officer) of the 
banking entity must certify in writing annually that the banking entity 
does not, directly or indirectly, guarantee, assume, or otherwise 
insure the obligations or performance of the covered fund or of any 
covered fund in which such covered fund invests. Finally, the Board 
must not have determined that such transaction is inconsistent with the 
safe and sound operation and condition of the banking entity.
---------------------------------------------------------------------------

    \342\ See proposed rule Sec.  ----.16(a)(2)(ii).
    \343\ See proposed rule Sec.  ----.10(b)(4).
---------------------------------------------------------------------------

d. Restrictions on Transactions With Any Permitted Covered Fund
    Section ----.16(b) of the proposed rule implements sections 
13(f)(2) and 13(f)(3)(B) of the BHC Act and applies section 23B of the 
FR Act \344\ to certain transactions and investments between a banking 
entity and a covered fund as if such banking entity were a member bank 
and such covered fund were an affiliate thereof.\345\ Section 23B 
provides that transactions between a member bank and an affiliate must 
be on terms and under circumstances, including credit standards, that 
are substantially the same or at least as favorable to such banking 
entity as those prevailing at the time for comparable transactions with 
or involving other unaffiliated companies or, in the absence of 
comparable transactions, on terms and under circumstances, including 
credit standards, that in good faith would be offered to, or would 
apply to, nonaffiliated companies.\346\
---------------------------------------------------------------------------

    \344\ 12 U.S.C. 371c-1.
    \345\ See proposed rule Sec.  ----.16(b).
    \346\ 12 U.S.C. 371c-1(a); 12 CFR 223.51.
---------------------------------------------------------------------------

    Section ----.16(b) applies this requirement to transactions between 
a banking entity that serves as investment manager, investment adviser, 
commodity trading adviser, or sponsor to a covered fund and that fund 
and any other fund controlled by that fund. It also applies this 
condition to a permissible prime brokerage transaction in which a 
banking entity may engage pursuant to Sec.  ----.16(a)(2)(ii) of the 
proposed rule.\347\
---------------------------------------------------------------------------

    \347\ See 12 U.S.C. 1851(f)(2), (f)(3)(B); proposed rule Sec.  
----.16(b).
---------------------------------------------------------------------------

e. Request for Comment
    The CFTC requests comment on the proposed rule's approach to 
implementing the limitations on certain relationships with covered 
funds and, in particular, the manner in which the CFTC has proposed to 
apply a banking entity's ability to make explicitly permitted 
investments for these purposes, as described above. In particular, the 
CFTC requests comment on the following questions:
    Question 314. Is the proposed rule's approach to implementing the 
limitations on certain transactions with a covered fund effective? If 
not, what alternative approach would be more effective and why?
    Question 315. Should the approach include other elements? If so, 
what elements and why? Should any of the proposed elements be revised 
or eliminated? If so, why and how?
    Question 316. What types of transactions or relationships that 
currently exist between banking entities and a covered fund (or another 
covered fund in which such covered fund makes a controlling investment) 
would be prohibited under the proposed rule? What would be the effect 
of the proposed rule on banking entities' ability to continue to meet 
the needs and demands of their clients? Are there other transactions 
between a banking entity and such covered funds that are not already 
covered but that should be prohibited or limited under the proposed 
rule?
    Question 317. Should the CFTC provide a different definition of 
``prime brokerage transaction'' under the proposed rule? If so, what 
definition would be appropriate? Are there any transactions that should 
be included in the definition of ``prime brokerage transaction''? Are 
there transactions or practices provided by banking entities that 
should be excluded in order to mitigate the burdens of complying with 
section 13 of the BHC Act?
    Question 318. With respect to the CEO (or equivalent officer) 
certification required under section 13(f)(3)(A) (ii) of the BHC Act 
and Sec.  ----.16(a)(2)(ii)(B) of the proposed rule, what would be the 
most useful, efficient method of certification (e.g., a new stand-alone 
certification, a certification incorporated into an existing form or 
filing, Web site certification, or certification filed directly with 
the CFTC)?
8. Section ----.17: Other Limitations on Permitted Covered Funds 
Activities
    Section ----.17 of the proposed rule implements section 13(d)(2) of 
the BHC Act, which places certain limitations on the permitted covered 
fund activities and investments in which a banking entity may engage. 
Consistent with the statute and Sec.  ----.8 of the proposed rule, 
Sec.  ----.17 provides that no transaction, class of transactions, or 
activity is permissible under Sec. Sec.  ----.11 through ----.16 of the 
proposed rule if the transaction, class of transactions, or activity 
would:
    <bullet> Involve or result in a material conflict of interest 
between the banking entity and its clients, customers, or 
counterparties;
    <bullet> Result, directly or indirectly, in a material exposure by 
the banking entity to a high-risk asset or a high-risk trading 
strategy; or
    <bullet> Pose a threat to the safety and soundness of the banking 
entity or the financial stability of the United States.
    Section ----.17 of the proposed rule further defines ``material 
conflict of interest,'' ``high-risk assets,'' and ``high-

[[Page 8403]]

risk trading strategies for these purposes, which are identical to the 
definitions of the same terms for purposes of Sec.  ----.8 of the 
proposed rule related to proprietary trading, and are described in 
detail in Part III.B.6 of this SUPPLEMENTARY INFORMATION.\348\
---------------------------------------------------------------------------

    \348\ As noted in the discussion of the definition of ``material 
conflict of interest in Part III.B.6 of this Supplementary 
Information, the proposed disclosure provisions of that definition 
are provided solely for purposes of the proposed rule's definition 
of material conflict of interest, and do not affect a banking 
entity's obligation to comply with additional or different 
disclosure or other requirements with respect to a conflict under 
applicable securities, banking, or other laws (e.g., section 27B of 
the Securities Act, which governs conflicts of interest relating to 
certain securitizations; section 206 of the Investment Advisers Act 
of 1940, which applies to conflicts of interest between investment 
advisers and their clients; or 12 CFR 9.12, which applies to 
conflicts of interest in the context of a national bank's fiduciary 
activities).
---------------------------------------------------------------------------

    The CFTC requests comment on the proposed limitations on permitted 
covered fund activities and investments, including with respect to the 
questions in Part III.B.6 of the Supplemental Information as they 
pertain to covered fund activities and investments in particular.

D. Subpart D (Compliance Program Requirement) and Appendix C (Minimum 
Standards for Programmatic Compliance)

    Subpart D of the proposed rule, which implements section 13(e)(1) 
of the BHC Act,\349\ requires certain banking entities to develop and 
provide for the continued administration of a program reasonably 
designed to ensure and monitor compliance with the prohibitions and 
restrictions on covered trading activities and covered fund activities 
and investments set forth in section 13 of the BHC Act and the proposed 
rule.\350\ This compliance program requirement forms a key part of the 
proposal's multi-faceted approach to implementing section 13 of the BHC 
Act, and is intended to ensure that banking entities establish, 
maintain and enforce compliance procedures and controls to prevent 
violation or evasion of the prohibitions and restrictions on covered 
trading activities and covered fund activities and investments.
---------------------------------------------------------------------------

    \349\ See 12 U.S.C. 1851(e)(1).
    \350\ See proposed rule Sec.  ----.20.
---------------------------------------------------------------------------

1. Section ----.20: Compliance Program Mandate
    The proposed rule adopts a tiered approach to implementing the 
compliance program mandate, requiring a banking entity engaged in 
covered trading activities or covered fund activities and investments 
to establish a compliance program that contains specific elements and, 
if the banking entity's activities are significant, meet a number of 
minimum standards. If a banking entity does not engage in covered 
trading activities and covered fund activities and investments, it must 
ensure that its existing compliance policies and procedures include 
measures that are designed to prevent the banking entity from becoming 
engaged in such activities and making such investments and must develop 
and provide for the required compliance program under proposed Sec.  --
--.20(a) of the proposed rule prior to engaging in such activities or 
making such investments, but is not otherwise required to meet the 
requirements of subpart D of the proposed rule.\351\
---------------------------------------------------------------------------

    \351\ See proposed rule Sec.  ----.20(d).
---------------------------------------------------------------------------

    Section ----.20(a) of the proposed rule contains the core 
requirement that each banking entity engaged in covered trading 
activities or covered fund activities and investments must establish, 
maintain and enforce a program reasonably designed to ensure and 
monitor compliance with the prohibitions and restrictions on 
proprietary trading activities and covered fund activities and 
investments set forth in section 13 of the BHC Act and the proposed 
rule and that such program must be suitable for the size, scope, and 
complexity of activities and business structure of the banking entity. 
Section ----.20(b) of the proposed rule specifies the following six 
elements that each compliance program established under subpart D must 
provide for, at a minimum:
    <bullet> Internal written policies and procedures reasonably 
designed to document, describe, and monitor the covered trading 
activities and covered fund activities and investments of the banking 
entity to ensure that such activities and investments comply with 
section 13 of the BHC Act and the proposed rule;
    <bullet> A system of internal controls reasonably designed to 
monitor and identify potential areas of noncompliance with section 13 
of the BHC Act and the proposed rule in the banking entity's covered 
trading activities and covered fund activities and investments and to 
prevent the occurrence of activities that are prohibited by section 13 
of the BHC Act and the proposed rule;
    <bullet> A management framework that clearly delineates 
responsibility and accountability for compliance with section 13 of the 
BHC Act and the proposed rule;
    <bullet> Independent testing for the effectiveness of the 
compliance program, conducted by qualified banking entity personnel or 
a qualified outside party;
    <bullet> Training for trading personnel and managers, as well as 
other appropriate personnel, to effectively implement and enforce the 
compliance program; and
    <bullet> Making and keeping records sufficient to demonstrate 
compliance with section 13 of the BHC Act and the proposed rule, which 
a banking entity must promptly provide to the CFTC upon request and 
retain for a period of no less than 5 years.
    In addition, for a banking entity with significant covered trading 
activities or covered fund activities and investments, Sec.  ----.20(c) 
requires the compliance program established under subpart D to meet a 
number of minimum standards, which are specified in Appendix C of the 
proposed rule. In particular, a banking entity must comply with the 
minimum standards specified in Appendix C of the proposed rule if:
    <bullet> With respect to its covered trading activities, it engages 
in any covered trading activities and has, together with its affiliates 
and subsidiaries, trading assets and liabilities the average gross sum 
of which (on a worldwide consolidated basis), as measured as of the 
last day of each of the four prior calendar quarters, (i) is equal to 
or greater than $1 billion or (ii) equals 10 percent or more of its 
total assets; and
    <bullet> With respect to its covered fund activities and 
investments, it engages in any covered fund activities and investments 
and either (i) has, together with its affiliates and subsidiaries, 
aggregate investments in one or more covered funds the average value of 
which is, as measured as of the last day of each of the four prior 
calendar quarters, equal to or greater than $1 billion or (ii) sponsors 
or advises, together with its affiliates and subsidiaries, one or more 
covered funds the average total assets of which are, as measured as of 
the last day of each of the four prior calendar quarters, equal to or 
greater than $1 billion.
    The application of detailed minimum standards to these types of 
banking entities is intended to reflect the heightened compliance risks 
of large covered trading and large covered fund activities and 
investments and provide guidance to such banking entities regarding the 
minimum compliance measures that would be required under the proposed 
rule.
    If a banking entity does not meet the thresholds specified in Sec.  
----.20(c)(2), it need not comply with each of the minimum standards 
specified in Appendix C. However, the proposed rule would require such 
a banking

[[Page 8404]]

entity to establish a compliance program that effectively implements 
the six elements specified in Sec.  ----.20(b). Banking entities 
engaged in a relatively small amount of covered fund activities are 
encouraged to look to the minimum standards of Appendix C for guidance. 
Generally, the CFTC would expect that the closer a banking entity is to 
the thresholds specified in Sec.  ----.20(c)(2), the more its 
compliance program should generally include the specific requirements 
described in Appendix C. Within the bounds of subpart D and Appendix C, 
a banking entity has discretion to structure and manage its program for 
compliance with section 13 of the BHC Act and the proposed rule in a 
manner that best reflects the unique organization and operation of the 
banking entity and its affiliates and subsidiaries, and is suitable 
taking account of the size, scope, and complexity of activities in 
which the banking entity and its affiliates and subsidiaries engage.
    As described above, Sec.  ----.20(d) of the proposed rule clarifies 
that, if a banking entity does not engage in covered trading activities 
and/or covered fund activities or investments, it will have satisfied 
the requirements of this section if its existing compliance policies 
and procedures include measures that are designed to prevent the 
banking entity from becoming engaged in such activities or making such 
investments and which require the banking entity to develop and provide 
for the compliance program required under paragraph (a) of this section 
prior to engaging in such activities or making such investments.
2. Appendix C--Minimum Standards for Programmatic Compliance
    Appendix C of the proposed rule specifies a variety of minimum 
standards applicable to the compliance program of a banking entity with 
significant covered trading activities or covered fund activities and 
investments.\352\ Section I.A of proposed Appendix C sets forth the 
purpose of the required compliance program, which is to ensure that 
each banking entity establishes, maintains, and enforces an effective 
compliance program, consisting of written policies and procedures, 
internal controls, a management framework, independent testing, 
training, and recordkeeping, that:
---------------------------------------------------------------------------

    \352\ The CFTC has proposed to include these minimum standards 
as part of the regulation itself, rather than as accompanying 
guidance, reflecting the compliance program's importance within the 
general implementation framework.
---------------------------------------------------------------------------

    <bullet> Is designed to clearly document, describe, and monitor the 
covered trading activities and covered fund activities or investments 
and the risks of the banking entity related to such activities or 
investments, identify potential areas of noncompliance, and prevent 
activities or investments prohibited by, or that do not comply with, 
section 13 of the BHC Act and the proposed rule;
    <bullet> Specifically addresses the varying nature of activities or 
investments conducted by different units of the banking entity's 
organization, including the size, scope, complexity, and risks of the 
individual activity or investment;
    <bullet> Subjects the effectiveness of the compliance program to 
independent review and testing;
    <bullet> Makes senior management and intermediate managers 
accountable for the effective implementation of the compliance program, 
and ensures that the board of directors or chief executive office 
(``CEO'') review the effectiveness of the compliance program; and
    <bullet> Facilitate supervision of the banking entity's covered 
trading activities and covered fund activities or investments by the 
CFTC.
    A banking entity's compliance program should not be developed 
through a generic, one-size-fits-all approach, but rather should 
carefully take into account and reflect the unique manner in which a 
banking entity operates, as well as the particular compliance risks and 
challenges that its businesses present. In light of the complexities 
presented in differentiating prohibited proprietary trading from 
permitted market making-related activities in particular, the CFTC 
expects that such a dynamic, carefully-tailored approach to internal 
compliance will play an important role in ensuring that banking 
entities comply with section 13's prohibitions and restrictions. In 
addition, although this statement of purpose appears within the text of 
proposed Appendix C, the CFTC notes the statement equally describes the 
general purpose of any compliance program required under subpart D of 
the proposed rule, regardless of whether proposed Appendix C 
specifically applies.
    Section I.B of proposed Appendix C provides for several definitions 
used throughout the appendix, including the definition of ``trading 
unit'' and ``asset management unit'' to which the minimum standards 
apply. The term ``trading unit'' is defined in the same way as in 
Appendix A, as described in Part II.B.5 of the Supplementary 
Information, and is intended to identify multiple layers of a banking 
entity's organizational structure because any effective compliance 
program will need to manage, limit and monitor covered trading activity 
at each such level of organization in order to effectively support 
compliance with the prohibition on proprietary trading. The term 
``asset management unit'' is defined as any unit of organization of a 
banking entity that makes an investment in, acts as sponsor to, or has 
relationships with, a covered fund that the banking entity sponsors, 
organizes and offers, or in which a covered fund sponsored or advised 
by a banking entity invests.
    Section I.C of proposed Appendix C incorporates by reference the 
six elements that must be included in the compliance program under 
Sec.  ----.20 of the proposed rule, and section I.D describes the 
structure of a compliance program meeting the minimum standards. In 
particular, section I.D permits a banking entity to establish a 
compliance program on an enterprise-wide basis to satisfy the 
requirements of Sec.  ----.20 of the proposed rule and the appendix, 
which program could cover the banking entity and all of its affiliates 
and subsidiaries collectively. In order to do so, the program must (i) 
be clearly applicable, both by its terms and in operation, to all such 
affiliates and subsidiaries, (ii) specifically address the requirements 
set forth in proposed Appendix C, (iii) take into account and address 
the consolidated organization's business structure, size, and 
complexity, as well as the particular activities, risks, and applicable 
legal requirements of each subsidiary and affiliate, and (iv) be 
determined through periodic independent testing to be effective for the 
banking entity and its affiliates and subsidiaries. In addition, the 
enterprise-wide program would be subject to supervisory review and 
examination by any Agency vested with rulewriting authority under 
section 13 of the BHC Act with respect to the compliance program and 
the activities of any banking entity for which the Agency has such 
authority. Further, such Agency would have access to all records 
related to the enterprise-wide compliance program pertaining to any 
banking entity that is supervised by the Agency vested with such 
rulewriting authority.
a. Internal Policies and Procedures
    Section II of proposed Appendix C articulates minimum standards for 
the first element of the compliance program, internal policies and 
procedures, for both covered trading activities and covered fund 
activities and investments. With respect to covered trading activities, 
the proposal would require

[[Page 8405]]

that internal policies and procedures: (i) Specify how the banking 
entity identifies its trading accounts; (ii) identify the trading 
activity in which the banking entity is engaged and how that activity 
is organized; (iii) thoroughly articulate the mission, strategy, risks, 
and compliance controls for each trading unit; (iv) include for each 
trader a mandate that describes the scope of his or her trading 
activity; (v) clearly articulate and document a comprehensive 
description of the risks associated with the trading unit's activities; 
(vi) document a comprehensive explanation of how the mission and 
strategy of the trading unit, and its related risk levels, comply with 
the proposed rule; and (vii) require the banking entity to promptly 
address and remedy any violation of section 13 of the BHC Act and the 
proposed rule. These internal policies and procedures would require 
banking entities to have the data and standards to prevent prohibited 
proprietary trading and to identify abnormalities and discrepancies 
that may be indicative of prohibited proprietary trading. The internal 
policies and procedures should also provide the Agencies with a clear, 
comprehensive picture of a banking entity's covered trading activities 
that can be effectively reviewed. With respect to covered fund 
activities and investments, the proposal would require that internal 
policies and procedures describe all covered fund activities in which 
the banking entity engages and the procedures used by the banking 
entity to ensure that it complies with the restrictions of section 13 
of the BHC Act and the proposed rule.
    The CFTC expects that these internal policies and procedures will 
be regularly reviewed and updated to reflect changes in business 
practices, strategies, or laws and regulations, though frequent, 
unexplained changes to policies and procedures or other aspects of the 
compliance program--particularly changes to reduce their stringency--
would warrant additional scrutiny from banking entity management, 
independent testing personnel, and CFTC examiners.
b. Internal Controls
    Section III of proposed Appendix C articulates minimum standards 
for the second element of the compliance program, internal controls. 
With respect to covered trading activities, the proposal would require 
internal controls that: (i) Are reasonably designed to ensure that the 
covered trading activity is conducted in conformance with a trading 
unit's authorized risks, instruments and products, as documented in the 
banking entity's written policies and procedures; (ii) establish and 
enforce risk limits for each trading unit; and (iii) perform robust 
analysis and quantitative measurement of covered trading activity for 
conformance with section 13 of the BHC Act and the proposed rule. In 
particular, the banking entity must perform analysis and quantitative 
measurement that is reasonably designed to: (i) Ensure that the 
activity of each trading unit is appropriate to the mission, strategy, 
and risk of each trading unit, as documented in the banking entity's 
internal written policies and procedures; (ii) monitor and assist in 
the identification of potential and actual prohibited trading activity; 
and (iii) prevent the occurrence of prohibited proprietary trading. 
This analysis and measurement should incorporate the quantitative 
measurements calculated and reported under Appendix A of the proposed 
rule, but should also include other analysis and measurements developed 
by the banking entity that are specifically tailored to the business, 
risks, practices, and strategies of its trading units. The Agencies 
expect that the thoughtful use of these types of quantitative tools to 
monitor the extent to which the activities of a trading unit are 
consistent with its stated mission, strategy, and risk profile may help 
identify, for banking entities and the CFTC, abnormalities or 
discrepancies in permitted trading activity that may be indicative of 
prohibited proprietary trading. In addition, these internal controls 
must provide for regular monitoring of the effectiveness of the banking 
entity's compliance program and require the banking entity to take 
prompt action to address and remedy any deficiencies identified and to 
provide timely notification to the CFTC of any investigation and 
remedial action taken.
    With respect to covered fund activities and investments, the 
internal controls required under section III of proposed Appendix C 
generally focus on ensuring that a banking entity has effective 
controls in place to monitor its investments in, and relationships 
with, covered funds to ensure its compliance with the covered fund 
activity and investments restrictions, including controls that relate 
to implementing remedies in the event of a violation of the 
requirements of section 13 of the BHC Act and the proposed rule.
c. Responsibility and Accountability
    Section IV of proposed Appendix C articulates minimum standards for 
the third element of the compliance program, responsibility and 
accountability. These standards focus on four key constituencies--the 
board of directors, the CEO, senior management, and managers at each 
trading unit and asset management unit level. Section IV makes clear 
that the board of directors, or similar corporate body, and the CEO are 
responsible for creating an appropriate ``tone at the top'' by setting 
an appropriate culture of compliance and establishing clear policies 
regarding the management of covered trading activities and covered fund 
activities and investments. Senior management must be made responsible 
for communicating and reinforcing the culture of compliance established 
by the board of directors and the CEO, for the actual implementation 
and enforcement of the approved compliance program, and for taking 
effective corrective action, where appropriate. Managers with 
responsibility for one or more trading units or asset management units 
of the banking entity that are engaged in covered trading activity or 
covered fund activity and investments are accountable for effective 
implementation and enforcement of the compliance program for the 
applicable trading unit or asset management unit.
d. Independent Testing
    Section V of proposed Appendix C articulates minimum standards for 
the fourth element of the compliance program, independent testing. A 
banking entity subject to the appendix must ensure that its independent 
testing is conducted by a qualified independent party, such as the 
banking entity's internal audit department, outside auditors, 
consultants or other qualified independent parties. The independent 
testing must examine both the banking entity's compliance program and 
its actual compliance with the proposed rule. Such testing must include 
not only the general adequacy and effectiveness of the compliance 
program and compliance efforts, but also the effectiveness of each 
element of the compliance program and the banking entity's compliance 
with each provision of the proposed rule. This requirement is intended 
to ensure that a banking entity continually reviews and assesses, in an 
objective manner, the strength of its compliance efforts and promptly 
identifies and remedies any weaknesses or matters requiring attention 
within the compliance framework.
e. Training
    Section VI of proposed Appendix C articulates minimum standards for 
the fifth element of the compliance program, training. It proposes to 
require that a banking entity provide adequate

[[Page 8406]]

training to its trading personnel and managers, as well as other 
appropriate personnel, in order to effectively implement and enforce 
the compliance program. In particular, personnel engaged in covered 
trading activities or covered fund activities and investments should be 
educated with respect to applicable prohibitions and restrictions, 
exemptions, and compliance program elements to an extent sufficient to 
permit them to make informed, day-to-day decisions that support the 
banking entity's compliance with the proposed rule and section 13 of 
the BHC Act. In particular, any personnel with discretionary authority 
to trade, in any amount, should be appropriately trained regarding the 
differentiation of prohibited proprietary trading and permitted trading 
activities and given detailed guidance regarding what types of trading 
activities are prohibited. Similarly, personnel providing investment 
management or advisory services, or acting as general partner, managing 
member, or trustee of a covered fund, should be appropriately trained 
regarding what covered fund activities and investments are permitted 
and prohibited.
f. Recordkeeping
    Section VII of proposed Appendix C articulates minimum standards 
for the sixth element of the compliance program, recordkeeping. 
Generally, a banking entity must create records sufficient to 
demonstrate compliance and support the operation and effectiveness of 
its compliance program (i.e., records demonstrating the banking 
entity's compliance with the requirements of section 13 of the BHC Act 
and the proposed rule, any scrutiny or investigation by compliance 
personnel or risk managers, and any remedies taken in the event of a 
violation or non-compliance), and retain these records for no less than 
five years in a form that allows the banking entity to promptly produce 
these records to the CFTC upon request. Records created and retained 
under the compliance program shall include trading records of the 
trading units, including trades and positions of each such unit.
g. Request for Comment
    The CFTC requests comment on the compliance program requirement 
contained in Sec.  ----.20 of the proposed rule and the minimum 
standards specified in proposed Appendix C. In particular, the CFTC 
requests comment on the following questions:
    Question 319. Is the proposed rule's inclusion of a compliance 
program requirement effective in light of the purpose and language of 
the statute? If not, what alternative would be more effective?
    Question 320. Is the proposed application of Sec.  ----.20's 
compliance program requirement to all banking entities engaged in 
covered trading activity or covered trading investments and activities 
and the minimum standards of proposed Appendix C to only banking 
entities with significant covered trading or covered fund activities, 
effective? If not, what alternative would be more effective? Should 
proposed Appendix C apply to all banking entities? If so, why? Are the 
thresholds proposed for determining whether a banking entity must 
comply with proposed Appendix C appropriate? If not, what alternative 
would be more effective?
    Question 321. What implementation, operational, or other burdens or 
expenses might be associated with the compliance program requirement? 
How could those burdens or expenses be reduced or eliminated in a 
manner consistent with the purpose and language of the statute?
    Question 322. Do the proposed compliance program requirement and 
minimum standards provide sufficient guidance and clarity regarding how 
compliance programs should be structured? If not, what additional 
guidance or clarity is needed? Do the proposed compliance program 
requirement and minimum standards provide sufficient discretion to 
banking entities to structure a compliance program that appropriately 
reflects the unique nature of their businesses? If not, how could 
additional discretion be provided in a manner consistent with the 
purpose and language of the statute?
    Question 323. Are the six proposed elements of a required 
compliance program effective? If not, what alternative would be more 
effective? Should elements be added or removed? If so, which ones and 
why?
    Question 324. For each of the six proposed elements of a required 
compliance program for which minimum standards are provided in proposed 
Appendix C, are the proposed minimum standards effective? If not, what 
alternative would be more effective? Should minimum standards be added 
or removed? If so, which ones and why?
    Question 325. Does the requirement that a banking entity provide 
timely notification to the relevant Agency provide sufficient guidance 
as to what activities must be reported and how and when such reporting 
should be made? Should more specific standards be provided (e.g., 
regarding the timing of reporting and the types of activities that must 
be reported)? If so, what additional criteria should be implemented? 
Should the notification requirement be applied explicitly to banking 
entities that are not required to comply with the minimum standards 
specified in Appendix C because they are below the thresholds specified 
in Sec.  ----.20(c)(2)? Why or why not?
    Question 326. Are there specific records that banking entities 
should be required to make and keep to document compliance with section 
13 of the BHC Act and the proposed rule? Please explain.
    Question 327. What process should the Agencies use in determining 
whether to require a banking entity that, based on its size, would not 
be subject to Appendix C to comply with all or portions of the appendix 
under section I.E of the proposed appendix? What considerations should 
the CFTC take into account in making such a determination? Should this 
requirement be implemented by a CFTC order, by authority delegated to 
the CFTC staff, or a different method? Please explain.
    Question 328. Should the proposed rule permit banking entities to 
comply with Appendix C of the proposed rule on an enterprise-wide 
basis? If so, why? What are the advantages and disadvantages of an 
enterprise-wide compliance program? Should the proposed appendix 
provide additional clarity or discretion regarding how such an 
enterprise-wide program should be structured? If so, how? Please 
include a discussion relating to the infrastructure of an enterprise-
wide compliance program and its management. If enterprise-wide 
compliance or similar programs are used in other contexts, please 
describe your experience with such programs and how those experiences 
influence your judgment concerning whether or not you would choose an 
enterprise-wide compliance program in this context.
    Question 329. Should the proposed rule permit banking entities to 
comply with Sec.  ----.20(b) of the proposed rule on an enterprise-wide 
basis? If so, why? What are the advantages and disadvantages of an 
enterprise-wide compliance program for smaller banking entities that 
are not subject to Appendix C? Please include a discussion relating to 
the infrastructure of an enterprise-wide compliance program and its 
management in the context of smaller banking entities. If enterprise-
wide compliance or similar programs are used in other contexts, please 
describe your experience with such programs and how those experiences 
influence your judgment concerning whether or

[[Page 8407]]

not you would choose an enterprise-wide compliance program in this 
context. Are there particular reasons why a enterprise-wide compliance 
program should be permitted for larger banking entities subject to the 
requirements of Appendix C, but not those that are subject to Sec.  --
--.20(b) of the proposed rule?
    Question 330. What are the particular challenges that should be 
considered in connection with establishing a compliance program on an 
enterprise-wide basis? How will such challenges be addressed? Can an 
enterprise-wide compliance program be appropriately tailored to each of 
the subsidiaries and affiliates of a banking entity?
    Question 331. Are there efficiencies that can be gained through an 
enterprise-wide compliance program? If so, how and what efficiencies?
    Question 332. Would the complexities of various types of covered 
trading activity be adequately reflected in an enterprise-wide 
compliance program?
    Question 333. Should only outside parties be permitted to conduct 
independent testing for the effectiveness of the proposed compliance 
program to satisfy certain minimum standards? If so, why? Under the 
proposal, the independent testing requirement may be satisfied by 
testing conducted by an internal audit department or a third party. 
Should the rule specify the minimum standards for ``independence'' as 
applied to internal and/or external parties testing the effectiveness 
of the compliance program? For example, would an internal audit be 
deemed to be independent if none of the persons involved in the testing 
are involved with, or report to persons that are involved with, 
activities implicated by section 13 of the BHC Act? Why or why not?
    Question 334. Do you anticipate that banking entities that do not 
meet the thresholds specified in Sec.  ----.20(c) would voluntarily 
comply with the proposed minimum standards in Appendix C in order to 
effectively implement the six elements specified in Sec.  ----.20(b)? 
Are there specific minimum standards that would not be practical or 
would be unattainable for a banking entity that does not meet the Sec.  
------.20(c) thresholds? Please identify the minimum standard(s) and 
explain.
    Question 335. In light of the size, scope, complexity, and risk of 
covered trading activities, do commenters anticipate the need to hire 
new staff with particular expertise in order to establish, maintain, 
and enforce the proposed compliance program requirement concerning 
covered trading activities or any subset of covered trading activities?
    Question 336. With respect to the proposed requirement that 
training should occur with a frequency appropriate to the size and risk 
profile of the banking entity's covered trading activities and covered 
fund activities, should there be a minimum requirement that such 
training shall be conducted no less than once every twelve (12) months? 
If so, why?
    Question 337. Should proposed rule's Appendix C be revised to 
require a banking entity's CEO to annually certify that the banking 
entity has in place processes to establish, maintain, enforce, review, 
test and modify the compliance program established pursuant to Appendix 
C in a manner that is reasonably designed to achieve compliance with 
section 13 of the BHC Act and this proposal? If so, why? If so, what 
would be the most useful, efficient method of certification (e.g., a 
new stand-alone certification, a certification incorporated into an 
existing form or filing, Web site certification, or certification filed 
directly with the CFTC)? Would a central data repository with a CEO 
attestation to the CFTC be a preferable approach?
    Question 338. Do the proposed rule requirements relating to 
establishment and implementation of a compliance program pose unique 
concerns or challenges to issuers of asset-backed securities that are 
banking entities, and if so, why? Are certain asset classes 
particularly impacted by the proposed rule requirements, and if so, 
how?
    Question 339. How would existing issuers of asset-backed securities 
that are banking entities pay for establishing and implementing a 
compliance program? Should existing issuers of asset-backed securities 
that cannot comply with the compliance program requirements be excluded 
from the proposed definition of ``banking entity''? Should such 
exclusion be limited, and if so, based on what factors? Are the 
proposed thresholds specified in Sec.  ----.20(c) of the proposed rule 
and/or the allowance of an enterprise-wide compliance program as set 
forth in Appendix C of the proposed rule sufficient to minimize these 
concerns for issuers of asset-backed securities?
    Question 340. With respect to future securitizations, what would be 
the impact of the establishment and implementation of the compliance 
program related to the provisions of the proposed rule as required by 
Sec.  ----.20 of the proposed rule (including Appendix C, where 
applicable)? Are the proposed thresholds specified in Sec.  ----.20(c) 
of the proposed rule and/or the allowance of an enterprise-wide 
compliance program as set forth in Appendix C of the proposed rule 
sufficient to minimize these concerns for issuers of asset-backed 
securities?
    Question 341. Would existing issuers of asset-backed securities 
that are banking entities be able to establish and implement a 
compliance program related to the provisions of the proposed rule as 
required by Sec.  ----.20 of the proposed rule (including Appendix C, 
where applicable)? If amendments to transactional documents are 
necessary, are there any obstacles that would make such amendments 
difficult to execute? If existing issuers of asset-backed securities 
cannot establish and implement a compliance program, what would be the 
impact on such existing issuers of asset-backed securities and the 
holders of securities issued by a non-compliant issuer of asset-backed 
securities? Is the allowance of an enterprise-wide compliance program 
as set forth in Appendix C of the proposed rule sufficient to minimize 
these concerns for issuers of asset-backed securities?
    Question 342. To rely on the exemptions for permitted underwriting, 
market making-related, and risk-mitigating hedging activities, the 
proposed rule requires banking entities to establish the internal 
compliance program under Sec.  ----.20 and, where applicable, Appendix 
C, designed to ensure compliance with the requirements of the 
applicable exemption (e.g., policies and procedures, internal controls 
and monitoring procedures, etc.). Do these requirements in the proposed 
rule impose undue cumulative burdens, such that the marginal benefit of 
a given requirement is not justified by the cost that the requirement 
imposes? If so, why does the proposed rule impose cumulative burdens 
and what are the costs of those burdens? Please explain the 
circumstances under which these burdens may arise. Is there a way to 
reduce or eliminate such burdens or requirements in a manner consistent 
with the language and purpose of the statute? For any requirements that 
impose undue burdens, are there other requirements that could be 
substituted that would more efficiently ensure compliance with the 
statute? Are there any requirements that the proposed rule imposes that 
are particularly effective, and if so, how can the Agencies make better 
use of these requirements?
    Question 343. Are the six elements of the proposed compliance 
program requirement mutually reinforcing and

[[Page 8408]]

cost effective, or are there redundancies in the six elements? Please 
explain any redundant requirements in the policies and procedures, 
internal controls, management framework, independent testing, training, 
and recordkeeping requirements in Sec.  ----.20(b) of the proposed rule 
or proposed Appendix C. Why are such requirements redundant, and how 
should the redundancy be addressed and remedied in the rule?
    Question 344. A banking entity that meets the $1 billion or greater 
trading assets and liabilities threshold would be required under the 
proposed rule to comply with both the reporting and recordkeeping 
requirements in Appendix A with respect to quantitative measurements 
and the compliance program requirement in Appendix C. Are the 
requirements in these appendices mutually reinforcing and cost 
effective, or do the appendices impose redundant requirements on 
banking entities that meet the $1 billion threshold? Please explain any 
redundant requirements in the appendices and how such redundancy should 
be addressed and remedied in the rule.
    Question 345. Proposed Appendix C incorporates the quantitative 
measurements provided in proposed Appendix A in the internal controls 
requirement for banking entities that are engaged in covered trading 
activity and meet the $1 billion or greater trading assets and 
liabilities threshold. Do the requirements in proposed Appendix A and 
Appendix C impose undue cumulative burdens with respect to any elements 
(e.g., quantitative measurements), such that the marginal benefit of a 
given requirement is not justified by the cost that the requirement 
imposes? Please explain why the proposed appendices impose cumulative 
burdens, the costs of those burdens, and the circumstances under which 
these burdens may arise. Is there a way to reduce or eliminate such 
burdens or requirements in a manner consistent with the language and 
purpose of the statute? For any requirements in the appendices that 
impose undue burdens, are there other requirements that could be 
substituted that would more efficiently ensure compliance with the 
statute? Are there any requirements that the proposed appendices impose 
that are particularly effective, and if so, how can the CFTC make 
better use of these requirements?
    Question 346. Should the CFTC prescribe any specific method by 
which the board of directors or similar corporate body reviews and 
approves the compliance program? For example, should the CFTC require 
that: (i) A chief compliance officer or similar officer present an 
annual compliance report including, as appropriate, recommended actions 
to be taken by the banking entity to improve compliance or correct any 
compliance deficiencies; (ii) the board review any such recommendations 
and determine whether to approve them; and (iii) the banking entity 
notify the CFTC if the board declines to approve such recommendations, 
or approves different actions than those recommended in the compliance 
report? What are the advantages and disadvantages of such an approach?
3. Section ----.21: Termination of Activities or Investments; Penalties 
for Violations
    Section ----.21 of the proposed rule implements section 13(e)(2) of 
the BHC Act, which requires the termination of activities or 
investments that violate or function as an evasion of section 13 of the 
Act.\353\ In particular, Sec.  ----.21(a) of the proposed rule requires 
any banking entity that engages in an activity or makes an investment 
in violation of section 13 of the BHC Act or the proposed rule or in a 
manner that functions as an evasion of the requirements of section 13 
of the BHC Act or the proposed rule, including through an abuse of any 
activity or investment permitted under subparts B or C, or otherwise 
violates the restrictions and requirements of section 13 of the BHC Act 
or the proposed rule, to terminate the activity and, as relevant, 
dispose of the investment.\354\ Section ----.21(b) of the proposed rule 
provides that if a relevant Agency finds reasonable cause to believe 
any banking entity has engaged in an activity or made an investment 
described in paragraph (a), the CFTC may, after due notice and an 
opportunity for hearing, by order, direct the banking entity to 
restrict, limit, or terminate the activity and, as relevant, dispose of 
the investment.\355\
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    \353\ See 12 U.S.C. 1851(e)(2).
    \354\ See proposed rule Sec.  ----,21(a). The CFTC has proposed 
to include Sec.  ----.21(a), in addition to the provisions of Sec.  
----.21(b) of the proposed rule, to make clear that the requirement 
to terminate an activity or, as relevant, dispose of an investment 
would be triggered where a banking entity discovers a violation or 
evasion, regardless of whether an Agency order has been issued.
    \355\ See proposed rule Sec.  ----,21(b).
---------------------------------------------------------------------------

IV. Request for Comments

    The CFTC is interested in receiving comments on all aspects of the 
proposed rule.

V. The Economic Impact of the Proposed Rule Under Section 13 of the BHC 
Act--Request for Comment

    Section 13 of the BHC Act imposes on all banking entities 
prohibitions and restrictions on proprietary trading and certain 
interests in, and relationships with, a covered fund,\356\ which apply 
to banking entities whether or not the CFTC adopts implementing rules. 
In formulating the proposed rule to implement these provisions, which 
is required by statute, the CFTC has chosen a multi-faceted approach to 
establish a regulatory framework that provides for clear, robust, and 
effective implementation of the statute's provisions in a consistent 
manner, while also not unduly constraining the ability of banking 
entities to engage in permitted activities and investments.\357\ The 
CFTC has proposed this approach after considering the Council's 
findings and recommendations regarding how to implement section 13 of 
the BHC Act and a variety of alternatives described throughout this 
Supplemental Information.\358\ The CFTC seeks comment, in particular, 
on the potential costs and benefits of those aspects of the proposed 
rule that involve choices made, or the exercise of discretion, by the 
CFTC in implementing section 13 of the BHC Act.\359\
---------------------------------------------------------------------------

    \356\ As noted above in connection with the conformance and 
extended transition periods, the proposed rule would not require an 
immediate application of these restrictions for any activity or 
investment entered into prior to the effective date of section 13 of 
the BHC Act (July 21, 2012). However, any activity or investment 
entered into after the effective date would be required to comply 
with section 13 of the BHC Act and the proposed rule, if adopted. 
See Supplemental Information Part III.E.
    \357\ See Supplemental Information Part II.A.
    \358\ See 12 U.S.C. 1851(b)(2)(A); see also Financial Stability 
Oversight Council, Study & Recommendations on Prohibitions on 
Proprietary Trading & Certain Relationships with Hedge Funds & 
Private Equity Funds (Jan. 2011), available at http://www.treasury.gov/initiatives/Documents/Volcker%20sec%20%20619%20study%20final%201%2018%2011%20rg.pdf.
    \359\ This CFTC Rule is being promulgated exclusively under 
section 13 of the BHC. Therefore, the Commission will not be 
conducting a cost-benefit consideration under Section 15(a) of the 
Commodity Exchange Act. However, the Commission will consider the 
responses to the questions posed in this section when finalizing 
this rulemaking.
---------------------------------------------------------------------------

    The CFTC recognizes that there are economic impacts that may arise 
from the proposed rule and its implementation of section 13 of the BHC 
Act and invite comment on the manner in which the proposed rule 
implements section 13 of the BHC Act, including commenters' views on 
the potential economic impacts discussed in this Part of the 
Supplemental

[[Page 8409]]

Information. In addition, the CFTC seeks comment on whether the 
proposed rule represents a balanced and effective approach to 
implementing section 13 of the BHC Act or whether alternative 
approaches to implementing section 13 of the BHC Act exist that would 
provide greater benefits or involve fewer costs, consistent with the 
statutory purpose. We also request comment on the potential competitive 
effects of the manner in which the proposed rule implements the 
statute.\360\
---------------------------------------------------------------------------

    \360\ For example, implementation of section 13(d)(1)(H) of the 
BHC Act may result in a competitive advantage for foreign-controlled 
banking entities over U.S.-controlled banking entities with respect 
to activities that occur solely outside of the United States.
---------------------------------------------------------------------------

    In addition to the questions posed throughout Part II of the 
Supplemental Information with respect to the potential costs and 
benefits of particular aspects of the statute and proposed rule, in 
order to assist in the analysis of the economic impacts associated with 
the final rule and any alternatives the CFTC may evaluate, the CFTC 
encourages commenters to provide quantitative information about the 
rule's impact on banking entities, their clients, customers, and 
counterparties, specific markets or asset classes, and any other 
entities potentially affected by the proposed rule with respect to:
    1. The direct and indirect costs and benefits of compliance with 
section 13 of the BHC Act, as proposed to be implemented;
    2. The effect of section 13 of the BHC Act, as proposed to be 
implemented, on competition; and
    3. Any other economic impacts of the proposal.
    In addition, to assist with potential estimates of the proposed 
rule's quantitative impacts, we request specific comment on: (i) The 
extent to which banking entities currently engage in proprietary 
trading activity or covered funds activities or investments that are 
prohibited or restricted by the statute, or have otherwise divested or 
conformed such activities; and (ii) the potential costs and benefits or 
other quantitative impacts of various aspects of the proposed rule, 
such as the compliance program requirement, the required reporting of 
quantitative measurements, and the conditions and requirements for 
relying on the proposed exemptions.
    To further facilitate public comment on the economic effects of the 
manner in which the proposed rule implements the statute, the CFTC has 
identified below a number of significant aspects of the proposed rule 
and potential economic impacts that may result from section 13 of the 
BHC Act's requirements, as proposed to be implemented. We seek 
commenters' views on the likelihood of the potential economic impacts 
identified in this Part and whether there are additional costs, 
benefits, or other impacts that may arise from the proposed rule. To 
the extent that such costs, benefits, or other impacts are 
quantifiable, commenters are encouraged to identify, discuss, analyze, 
and supply relevant data, information, or statistics related to such 
costs, benefits, and other impacts and the quantification of such 
costs, benefits, and other impacts. In addition, commenters are asked 
to identify or estimate start-up, or non-recurring, costs separately 
from costs or effects they believe would be ongoing.

A. Proprietary Trading Provisions

1. Definition of Trading Account
    Section ----.3 of the proposed rule, which implements the statutory 
definition of ``trading account,'' provides a multi-pronged definition 
of that term that is intended to ensure that banking entities do not 
engage in ``hidden'' proprietary trading by characterizing trading 
activity as being conducted outside a trading account. In addition to 
positions taken principally for the purpose of short-term resale, 
benefitting from short-term price movements, realizing short-term 
arbitrage profits, or hedging another trading account position, the 
proposed definition also includes: (i) With respect to a banking entity 
subject to the Federal banking agencies' Market Risk Capital Rules, all 
positions in financial instruments subject to the prohibition on 
proprietary trading that are treated as ``covered positions'' under 
those capital rules, other than certain foreign exchange and 
commodities positions; and (ii) all positions acquired or taken by 
certain registered securities and derivatives dealers (or, in the case 
of financial institutions that are government securities dealers, that 
have filed notice with an appropriate regulatory agency) in connection 
with their activities that require such registration or notice. 
Although these prongs of the definition are proposed to prevent evasion 
of the statutory requirements, we seek comment on the extent to which 
either of these two prongs may create a competitive disadvantage for 
certain banking entities vis-[agrave]-vis competitors that are either 
not subject to section 13 of the BHC Act and/or competitors subject to 
different prongs of the proposed definition.
2. Exemption for Underwriting Activities
    Section 13(d)(1)(B) of the BHC Act provides an exemption from the 
prohibition on proprietary trading for purchases and sales in 
connection with underwriting activities, to the extent that such 
activities are designed not to exceed the reasonably expected near term 
demands of clients, customers, or counterparties. In implementing this 
exemption in Sec.  ----.4(a) of the proposed rule, the CFTC has 
endeavored to establish a regime that clearly sets forth the 
requirements for relying on the underwriting exemption established in 
the statute to facilitate banking entities' compliance with the 
statutory requirements. In considering potential requirements for the 
underwriting exemption, and assessing the potential economic impacts of 
each such requirement, the CFTC strived to propose an appropriate 
balance between considerations related to: (i) The potential for 
evasion of the statutory prohibition on proprietary trading through 
misuse of the underwriting exemption; and (ii) the potential costs that 
may arise from constraints on legitimate underwriting activities.
    The CFTC has proposed to use, wherever practicable, common terms 
from existing laws and regulations in the context of underwriting to 
facilitate market participants' understanding and use of the exemption 
and to promote consistency across laws and regulations. Specifically, 
the proposed definitions of ``distribution'' and ``underwriter'' 
established in the proposed rule largely mirror the definitions 
provided for these terms in the SEC's Regulation M. Because the 
proposed rule uses a modified version of the Regulation M definition of 
``underwriter'' to include selling group members, the proposed 
definition would permit the current market practice of members of the 
underwriting syndicate entering into an agreement with other selling 
group members to collectively distribute the securities, rather than 
requiring all members of a distribution to join the underwriting 
syndicate.
    In addition, the definition of ``distribution'' from Regulation M 
that the CFTC has proposed in Sec.  ----.4(a) of the proposed rule is 
intended to ensure that the underwriting exemption does not unduly 
constrain banking entities from providing underwriting services, while 
at the same time preventing banking entities from relying on the 
underwriting exemption to evade the proposed rule and the statutory 
prohibition on proprietary trading. The CFTC anticipates that the 
proposed

[[Page 8410]]

approach to implementing the underwriting exemption should permit 
legitimate forms of underwriting in which market participants currently 
engage and, thus, should not unduly burden capital formation. In 
addition, the proposed rule would permit underwriters to continue to 
employ existing practices to stabilize a distribution of securities, 
which stabilization promotes confidence among issuers, selling security 
holders, and investors and further supports capital formation.
    Under the proposed rule, the underwriting activities of a banking 
entity must be designed to generate revenues primarily from fees, 
commissions, underwriting spreads or other income, not from 
appreciation in value of covered financial positions that the banking 
entity holds related to such activities or the hedging of such covered 
financial positions. This proposed requirement should promote investor 
confidence by ensuring that the activities conducted in reliance on the 
underwriting exemption are designed to benefit the interests of clients 
seeking to bring their securities to market, not the interests of the 
underwriters themselves. The proposed requirement should also help 
prevent evasion of the statutory prohibition on proprietary trading, as 
trading activity designed to generate revenues from appreciation in the 
value of positions held by the banking entity would be indicative of 
prohibited proprietary trading, not underwriting activity. We seek 
comment on whether this approach of identifying underwriting activity 
by reference to revenue source could also make underwriting less 
profitable to the extent that it precludes or discourages certain types 
of profitability for bona fide underwriting services.
    In addition to commenters' views on the potential economic impacts 
identified above, we request comment on whether the proposed rule may 
cause some banking entities to choose to decrease the supply of 
underwriting services in response to potential costs of the proposed 
rule and whether this result would adversely affect competition among 
underwriters or have a harmful impact on capital formation. In 
addition, if banking entities were to pass the increased costs of 
complying with the proposed exemption on to issuers, selling security 
holders, or their customers, we seek comment on whether the effect 
would be to increase the cost of raising capital and whether this would 
harm capital formation to the extent that such cost increases were 
sufficient to preclude issuers from accessing the capital markets. As 
described above, the CFTC has designed the proposal to balance such 
potential costs with provisions intended to permit banking entities' 
legitimate underwriting activities to continue as provided by the 
statute, while also establishing sufficient requirements to prevent 
evasion of the statutory goals through misuse of the underwriting 
exemption.
3. Exemption for Market Making-Related Activities
    Section 13(d)(1)(B) of the BHC Act provides an exemption from the 
prohibition on proprietary trading for purchases and sales in 
connection with market making-related activities, to the extent that 
such activities are designed not to exceed the reasonably expected near 
term demands of clients, customers, or counterparties. In setting forth 
the requirements for eligibility for this exemption in Sec.  ----.4(b) 
of the proposed rule, the CFTC has endeavored to establish a regime 
that clearly sets forth the requirements for relying on the exemption 
for market making-related activity established in the statute to 
facilitate banking entities' compliance with the statutory 
requirements. In considering potential requirements for the market-
making exemption, and assessing the potential economic impacts of each 
such requirement, the CFTC tried to strike an appropriate balance 
between considerations related to: (i) The potential for evasion of the 
statutory prohibition on proprietary trading through misuse of the 
exemption for market making-related activity; (ii) the potential 
difficulties related to distinguishing market making-related activity 
from prohibited proprietary trading; and (iii) potential costs that may 
arise from constraints on legitimate market making-related activities.
    The CFTC has proposed to use, where practicable, terms and concepts 
used in current laws and regulations in the context of market making to 
promote clarity and consistency. Recognizing that there are differences 
in market making activities between different types of asset classes 
(e.g., liquid and illiquid instruments) and market structures (e.g., 
organized trading facilities and the over-the-counter markets), the 
CFTC has proposed to implement the market-making exemption in a manner 
that accounts for these distinctions and permits market making 
activities in different asset classes and market structures. Permitting 
legitimate market making in its different forms should promote market 
liquidity and efficiency by allowing banking entities to continue to 
provide customer intermediation and liquidity services in both liquid 
and illiquid instruments. The CFTC also recognizes, however, that 
market making-related activities in the over-the-counter markets or 
activities involving less liquid instruments are sometimes less 
transparent than similar activities on organized trading facilities or 
in liquid markets. We seek comment on whether, in order to comply with 
the statutory prohibition on proprietary trading, some banking entities 
may be inclined to abstain from some market-making activities in an 
effort to reduce the risk of noncompliance. We also request comment on 
whether, if banking entities did so, this could result in reduced 
liquidity for certain types of trades or for certain less liquid 
instruments.
    In addition, the proposed exemption permits anticipatory market 
making, block positioning, and hedging of market making positions under 
certain circumstances, which should further facilitate customer 
intermediation and market liquidity and efficiency. However, certain 
conditions are placed on such market making-related activities in the 
proposal in an effort to ensure that such activities are, in fact, 
market making-related activities, and are not hidden proprietary 
trading activities subject to the statutory prohibition.
    The proposal requires that the market making-related activities be 
designed to generate revenues primarily from fees, commissions, bid/ask 
spreads or other income not attributable to appreciation in the value 
of covered financial positions a banking entity holds in trading 
accounts or the hedging of such positions. This proposed requirement 
should promote investor confidence by helping to ensure that market 
making serves customer needs. The proposed requirement should also help 
prevent evasion of the statutory prohibition on proprietary trading, as 
trading activity designed to generate revenues from appreciation in the 
value of positions held by the banking entity would be indicative of 
prohibited proprietary trading, not market making-related activity. The 
CFTC requests comment on whether this approach of identifying market 
making activity by reference to a market making trading unit's revenue 
source would also make market making activity less profitable and 
whether it would preclude or discourage certain types of profitability 
for bona fide market making services. Commenters should also address 
whether this requirement would reduce the willingness of some banking 
entities to continue to provide market making-related services and 
whether this could

[[Page 8411]]

reduce liquidity, harm capital formation, or make market making-related 
services more expensive. The CFTC notes that, in order to balance the 
potential for such effects with the statutory purpose, the proposed 
rule does not expressly prohibit all types of non-client income, and 
recognizes that the precise type and source of revenues generated by 
bona fide market making services can and will vary depending on the 
relevant market, asset, and facts and circumstances.
4. Exemption for Risk-Mitigating Hedging Activities
    Section 13(d)(1)(C) provides an exemption from the prohibition on 
proprietary trading for risk-mitigating hedging activities in 
connection with and related to individual or aggregated positions, 
contracts, or other holdings of a banking entity that are designed to 
reduce the specific risks to the banking entity in connection with and 
related to such positions, contracts, or other holdings. The proposed 
exemption requires that the hedging transaction be reasonably 
correlated to these risks that the transaction is intended to hedge or 
otherwise mitigate. This proposed requirement is intended to address 
the potential for misuse of the exemption where a transaction is not 
closely tied to risk mitigation, while also providing some flexibility 
in the degree of correlation that is required in order to promote 
consistency with the statutory goals and requirements.
    In addition, the proposed exemption requires that the hedging 
transaction: (i) Not give rise, at the inception of the hedge, to 
significant exposures that are not themselves hedged in a 
contemporaneous transaction; and (ii) be subject to continuing review, 
monitoring, and management. Together, these proposed requirements are 
designed to ensure that a banking entity does not use the hedging 
exemption to conduct prohibited proprietary trading in the guise of 
hedging activity and to prevent evasion of the proprietary trading 
prohibition contained in section 13 of the BHC Act and the proposed 
rule. These proposed requirements are intended to ensure that an exempt 
hedging transaction will mitigate, not amplify, risk. Moreover, such 
requirements should further the goals of compliance with the statutory 
requirements and reducing banking entities' risks.
    We seek comment on whether the proposed requirements for relying on 
the hedging exemption are more restrictive than necessary to implement 
the statutory language and purpose, and to prevent evasion of the 
statutory provisions, and whether a banking entity's hedging activities 
could be unduly constrained by the proposed rule. Further, commenters 
should address the extent to which a banking entity may be unable or 
unwilling to execute certain hedges and whether, as a result, a banking 
entity could be limited in its means to reduce its risk. In addition, 
would banking entities be dissuaded from engaging in other permitted 
activities or activities outside the scope of the statute (e.g., long-
term investments) if the requirements of the proposed hedging exemption 
unduly limits or prevents them from mitigating the risks associated 
with such activities? We request comment on whether a reduction in 
efficiency could result from a reduced ability of covered banking 
entities to transfer risks to those more willing to bear them. 
Commenters should also address whether the proposed rule would reduce a 
banking entity's willingness to engage in permitted risk-mitigating 
hedging activities in order to avoid costs related to ensuring 
compliance with the exemption's requirements and whether this would 
increase the banking entity's risk exposure. In order to balance the 
potential for such effects with the statutory purpose, the proposed 
rule attempts to implement the risk-mitigating hedging exemption in a 
manner that recognizes that the precise nature and execution of risk 
mitigation through hedging transactions can and will vary depending on 
the relevant market, asset, and facts and circumstances, while also 
establishing requirements designed to ensure that transactions relying 
on the hedging exemption are, in fact, hedges and not hidden 
proprietary trading prohibited by the statute.
    The proposed exemption would require documentation with respect to 
hedges established at a different level of organization than that 
responsible for the underlying positions or risks that are being 
hedged. This proposed documentation requirement is intended to 
facilitate review by banking entities and Agency supervisors and 
examiners in assessing whether the hedge position was established to 
hedge or otherwise mitigate another unit's risks. Without such 
documentation, there could be an increased risk of evasion of the 
statute's prohibition on proprietary trading, as it would be difficult 
to assess whether a purported hedging transaction was established to 
mitigate another level of organization's risk or solely to profit from 
price appreciation of the position established by the purported hedge. 
We seek comment on the costs of the proposed documentation requirement 
for certain hedging transactions, such as the costs related to systems 
changes and maintenance, employee resources and time, and 
recordkeeping.\361\ The CFTC also requests comment on the extent to 
which the proposed documentation requirement would reduce the speed in 
which a banking entity could execute a hedge at a different level 
within the entity and whether this could reduce efficiency or result in 
a banking entity being exposed to a greater amount of risk. Further, we 
seek commenters' views on whether potentially slower execution times 
could also reduce profitability associated with the position as it 
remains unhedged (or, alternatively, increase profitability, depending 
on whether the value of the unhedged position is increasing or 
decreasing in the market). To balance the potential for such 
consequences with the statutory purpose, the CFTC has proposed to apply 
the documentation requirement to only a subset of hedging transactions 
that pose the greatest compliance risk (i.e., hedges that are 
established at a different level of organization than that establishing 
or responsible for the underlying positions or risks that are being 
hedged). In addition, the CFTC expects that the preparation of required 
documentation would become less burdensome and more efficient over time 
as systems are developed and personnel become more accustomed to the 
proposed requirement.
---------------------------------------------------------------------------

    \361\ The Agencies note that, for some costs of the proposed 
rule, hour burden estimates are provided in Part [internal cite to 
PRA] of this SUPPLEMENTARY INFORMATION for purposes of the Agencies' 
compliance with the Paperwork Reduction Act.
---------------------------------------------------------------------------

5. Compensation Related to Permitted Activities
    The proposed rule would require that the compensation arrangements 
of persons performing underwriting, market making-related, and risk-
mitigating hedging activities be designed not to reward proprietary 
risk-taking. These proposed requirements are intended to reduce 
incentives for personnel of the banking entity to violate the statutory 
prohibition on proprietary trading and expose the banking entity to 
risks arising from prohibited proprietary trading. We request comment 
on whether the proposed rule's requirements regarding compensation 
arrangements would reduce the banking entity's ability to attract 
talented and experienced trading personnel or would harm the banking 
entity's ability to compete with entities that are not subject to 
section 13 of the BHC Act and the proposed rule. In order

[[Page 8412]]

to balance the potential for such effects with the statutory goals, the 
proposed rule does not expressly prescribe how a banking entity must 
compensate its personnel or prohibit all types of compensation 
incentives related to non-client income, but instead proposes an 
approach that leaves banking entities with a degree of flexibility to 
compensate their personnel as they deem appropriate.
6. Exemption for Trading on Behalf of Customers
    Section ----.6(b) of the proposed rule implements section 
13(d)(1)(D) of the BHC Act, which permits a banking entity, 
notwithstanding the prohibition on proprietary trading, to purchase or 
sell a covered financial position on behalf of customers. Because the 
statute does not define when a transaction would be conducted on behalf 
of customers, the proposed rule identifies three categories of 
transactions that would qualify under this exemption. By providing that 
only transactions meeting the terms of the three categories would be 
considered to be on behalf of customers for purposes of the exemption, 
the proposed rule addresses the potential for evasion of the statutory 
prohibition. At the same time, the proposed rule also would not permit 
banking entities to rely on the exemption with respect to other, 
unanticipated transactions that banking entities may undertake on 
behalf of customers. The CFTC seeks comment on whether banking entities 
currently engage in principal transactions on behalf of customers that 
are not covered by the proposed exemption or other permitted activities 
and whether the lack of an exemption in the proposed rule for such 
activities would impact beneficial customer facilitation, market 
liquidity, efficiency, or capital formation.
7. Exemption for Trading Outside of the United States
    Section ----.6(d) of the proposed rule implements section 
13(d)(1)(H) of the BHC Act, which permits certain foreign banking 
entities to engage in proprietary trading that occurs ``solely outside 
of the United States.'' The proposed exemption provides a number of 
specific criteria for determining when trading will be considered to 
have occurred solely outside of the United States to help prevent 
evasion of the statutory restriction. The proposed exemption also 
provides a definition of ``resident of the United States'' that is 
similar to the SEC's definition of ``U.S. person'' in Regulation S, 
which should promote consistency and understanding among market 
participants that have experience with the concept from the SEC's 
Regulation S. In addition, the proposed exemption clarifies when a 
foreign banking entity will be considered to engage in such trading 
pursuant to sections 4(c)(9) and 4(c)(13) of the BHC Act, as required 
by the statute, including with respect to a foreign banking entity that 
is not a ``foreign banking organization'' under the Board's Regulation 
K. This implementation of section 13(d)(1)(H) of the BHC Act would 
permit certain foreign banking entities that are not ``qualifying 
foreign banking organizations'' under the Board's Regulation K to also 
rely on the exemption, notwithstanding the fact such foreign banking 
entities are not currently subject to the BHC Act generally or the 
Board's Regulation K. As a result, such foreign banking entities should 
encounter fewer costs related to complying with the proprietary trading 
prohibitions than if they were unable to rely on the exemption in 
section 13(d)(1)(H) of the BHC Act.
    Despite the reference to section 4(c)(13) of the BHC Act, the 
statute provides that the exemption for trading outside of the United 
States is only available to banking entities that are not directly or 
indirectly controlled by U.S. banking entities (i.e., not any U.S. 
banking entities or their foreign subsidiaries and affiliates). Under 
the statute, the prohibition on proprietary trading applies to the 
consolidated, worldwide operations of U.S. firms. As required by 
statute, the proposal prohibits U.S. banking entities from engaging in 
proprietary trading unless the requirements of one or more relevant 
exemptions (other than the exemption for trading by foreign banking 
entities) are satisfied. As a result, the statute creates a competitive 
difference between the foreign activities of U.S. banking entities, 
which must monitor and limit their foreign activities in accordance 
with the requirements of section 13 of the BHC Act, relative to the 
foreign activities of foreign-based banking entities, which may not be 
subject to restrictions similar to those in section 13 of BHC Act. The 
CFTC seeks commenters' views on whether the proposed rule's 
implementation of section 13(d)(1)(H) of the BHC Act imposes additional 
competitive differences, beyond those recognized above, and the 
potential economic impact of such competitive differences.
8. Quantitative Measurements
    Section ----.7 of the proposed rule, which implements in part 
section 13(e)(1) of the BHC Act,\362\ requires certain banking entities 
to comply with the reporting and recordkeeping requirements specified 
in Appendix A of the proposed rule. Proposed Appendix A requires a 
banking entity with significant trading activities to furnish periodic 
reports to the relevant Agency regarding various quantitative 
measurements of its trading activities and create and retain records 
documenting the preparation and content of these reports. The proposed 
measurements would vary depending on the scope, type, and size of 
trading activities. In addition, proposed Appendix B contains a 
detailed commentary regarding the characteristics of permitted market 
making-related activities and how such activities may be distinguished 
from trading activities that, even if conducted in the context of 
banking entity's market making operations, would constitute prohibited 
proprietary trading. These proposed requirements are intended, in 
particular, to address some of the difficulties associated with (i) 
identifying permitted market making-related activities and 
distinguishing such activities from prohibited proprietary trading and 
(ii) identifying certain trading activities resulting in material 
exposure to high-risk assets or high-risk strategies. In combination, 
Sec.  ----.7 and Appendix A of the proposed rule provide a quantitative 
overlay designed to help banking entities and the CFTC identify trading 
activities that warrant further analysis or review in a variety of 
levels and contexts.
---------------------------------------------------------------------------

    \362\ Section 13(e)(1) of the BHC Act requires the CFTC to issue 
regulations regarding internal controls and recordkeeping to ensure 
compliance with section 13. See 12 U.S.C. 1851(e)(1). Section --
--.20 and Appendix C of the proposed rule also implement section 
13(e)(1) of the BHC Act.
---------------------------------------------------------------------------

    The various quantitative measurements that would be required to be 
reported focus on assessing banking entities' risk management, sources 
of revenue, revenues in relation to risk, customer servicing, and fee 
generation. Aberrant patterns among the measurements with respect to 
these areas would warrant further review to determine whether trading 
activities have occurred that are proprietary in nature and whether 
such activities may be exposing banking entities to disproportionate 
risk. For example, quantitative measurements should provide banking 
entities with a useful starting point for assessing whether their 
trading activities are consistent with the proposed rule and whether 
traders are exposing the entity to disproportionate risks. In addition,

[[Page 8413]]

proposed Appendix A applies a standardized description and general 
method of calculating each quantitative measurement that, while taking 
into account the potential variation among trading practices and asset 
classes, is intended to facilitate reporting of sufficiently uniform 
information across different banking entities so as to permit 
horizontal reviews and comparisons of the quantitative profile of 
trading units across firms. This proposed approach, which recognizes 
that quantitative measurements must be applied with respect to 
differences within a banking entity's structure, business lines, and 
trading desks, should facilitate efficient application within firms and 
efficient examination across firms. The proposed use of a suite of 
quantitative measurements for these purposes may also limit erroneous 
indications of potential violations or erroneous indications of 
compliance (i.e., false positives and false negatives), thus allowing 
banking entities and examiners and supervisors to focus upon the 
measurements that may be most relevant in identifying prohibited 
conduct. The uniformity of the proposed measurements across different 
types of banking entities is also intended to ensure that banking 
entities are calculating comparable measurements consistently and that 
comparable measurements are being evaluated consistently by the CFTC. 
The CFTC expects that as the implementation of quantitative 
measurements and the internal compliance and external oversight 
processes become more efficient over time, banking entities will find 
compliance efforts less burdensome.
    The CFTC seeks comment on the extent to which banking entities will 
incur costs associated with implementing, monitoring, and attributing 
financial and personnel resources for purposes of complying with the 
requirements of proposed Appendix A. Specifically, please discuss the 
extent to which banking entities are unlikely to currently calculate 
certain quantitative measurements in the manner required under the 
proposal (e.g., Spread Profit and Loss or Customer-facing Trade Ratio) 
and whether this may result in significant start-up costs associated 
with developing these measurements. Under the proposal, banking 
entities would also need to dedicate personnel and supervisory staff to 
review for potential aberrant patterns of activity that warrant further 
review, as well as maintain appropriate records of that review. In 
order to limit these calculation and surveillance costs to the greatest 
extent practicable, the CFTC has proposed measurements that, in many 
cases, are already calculated by many banking entities to measure and 
manage trading risks and activities. The costs to banking entities 
associated with calculating the proposed quantitative metrics should 
also be mitigated by the tiered application of Appendix A, which would 
require banking entities with the most extensive trading activities to 
report the largest number of quantitative measurements, while imposing 
fewer or no reporting requirements on banking entities with smaller 
trading activities. By limiting the application of aspects of Appendix 
A to firms with greater than $1 billion in trading assets and 
liabilities, and all aspects of the appendix only to entities with 
greater than $5 billion in trading assets and liabilities, the costs 
imposed should be proportional to the market reach and complexity of a 
banking entity's trading activities.

B. Covered Fund Activities

    Subpart C implements the statutory provisions of section 
13(a)(1)(B) of the BHC Act, which prohibit banking entities from 
acquiring or retaining any equity, partnership, or other ownership 
interest in, or sponsoring, a covered fund, and other provisions of 
section 13 of the BHC Act which provide exemptions from, or otherwise 
relate to, that prohibition. In implementing the covered funds 
provisions of section 13 of the BHC Act, the CFTC has proposed to 
define and interpret several terms used in implementing these 
provisions and the goals of section 13. We seek comment on whether the 
proposed rule represents a balanced and effective approach to 
implementing the covered fund provisions of the statute.
1. General Scope
    For banking entities that invest in, sponsor or have relationships 
with one or more covered funds, the economic impact of complying with 
the statute and the implementing rule will vary, depending on the size, 
scope and complexity of their respective business, operations and 
relationships with clients, customers and counterparties. Moreover, the 
types of covered funds advised or sponsored by an adviser, the types of 
business and other relationships that an adviser may conduct with such 
funds and the adviser's other business activities, including 
relationships with other third party advised covered funds, will affect 
whether a covered fund activity would be subject to the statutory 
prohibition, eligible for a particular exemption or subject to 
particular internal control requirements as specified by the proposed 
rule.
    For example, with respect to a banking entity that does not 
``sponsor,'' invest in, or otherwise provide ``prime brokerage 
transactions'' to, a ``covered fund,'' the statute, as implemented by 
the proposed rule, would not substantively restrict the banking 
entity's activity; instead, the proposed rule would only require the 
minimum internal controls reasonably designed to prevent the entity 
from engaging in the prohibited activities. As a result, we do not 
expect that the proposed rule would have a significant effect on most 
banking entities, such as investment advisers, that are primarily 
engaged in providing bona fide trust, fiduciary, or advisory services 
to unrelated parties. Although such advisers may incur some incremental 
costs to develop and implement a compliance program reasonably designed 
to ensure that they do not engage in otherwise prohibited activities, 
there should be no significant costs associated with modifying existing 
business practices and procedures. We request comment on the extent to 
which such banking entities would be required to modify their existing 
business practices and procedures to comply with the proposed rule. For 
instance, would a registered investment adviser that only advises 
registered investment companies and that does not trade for its own 
account incur costs, benefits or other impacts in addition to costs to 
implement the minimum internal controls reasonably designed to prevent 
it from engaging in prohibited activities? Would an adviser that trades 
on behalf of itself incur, with respect to such trading activities, 
additional costs, benefits or other impacts described above relating to 
the proposed restrictions on proprietary trading?
    In contrast, a banking entity that seeks to invest in a covered 
fund could only do so in reliance on an exemption specified in the 
statute or the proposed rule, such as the exemption for organizing and 
offering certain covered funds provided in section 13(d)(1)(G), as 
implemented in Sec.  ----.11 of the proposed rule. Similarly, a banking 
entity that seeks to enter into ``prime brokerage transactions'' with a 
covered fund could only do so by meeting certain requirements under the 
proposed rule. Accordingly, the economic impact of the proposed rule 
will depend on whether an adviser's activities fall within the scope of 
the terms as proposed such that the banking entity would be subject to 
the limitations on covered fund activities. To the extent that these 
terms or

[[Page 8414]]

exemptions would result in more, or fewer, activities being captured by 
the proposed rule, what are the attendant costs and benefits that a 
covered banking may incur? We request commenters provide empirical 
data, or studies, where possible.
    Definition of Covered Fund. The proposed rule's definition of 
``covered fund'' includes hedge funds and private equity funds as 
defined by statute, but also identifies two types of similar funds--
commodity pools and certain non-U.S. funds--that are subject to the 
covered fund restrictions and prohibitions of section 13 of the BHC 
Act, as implemented by the proposed rule. The CFTC has proposed to 
include these funds since they are generally managed and structured 
similar to a covered fund, but are not generally subject to the Federal 
securities laws due to the instruments in which they invest or the fact 
that they are not organized in the United States or one or more States. 
We request comment on whether applying the definition of covered fund 
in this way as proposed would increase the number of investment 
vehicles or similar entities that would be subject to the limitations 
under the proposed rule. Would this approach increase compliance costs 
for banking entities that sponsor, invest in, or have certain 
relationships with these types of funds?
    The proposed rule also excludes certain types of investments in 
covered funds, pursuant to section 13(d)(1)(J) of the BHC Act, which 
authorizes the CFTC to exclude from the general covered fund activity 
prohibition those activities that would promote the safety and 
soundness of a banking entity. Section ----.14 of the proposed rule 
would exclude from the prohibition, among other things, a banking 
entity's investments in covered funds related to bank owned life 
insurance, certain joint ventures and interests in securitization 
vehicles retained in compliance with the minimum credit risk retention 
requirements of section 15G of the Exchange Act. We request comment on 
the potential economic impact of the proposal to exclude these types of 
investments from the general prohibition. For banking entities whose 
only covered fund activities are those described in Sec.  ----.14, what 
economic impact would be attributed to complying with this provision of 
the proposed rule? Would these costs and benefits differ from those of 
banking entities that conduct covered fund activities as well as engage 
in activities described in Sec.  ----.14? As described in the 
Supplementary Information, a banking entity that generally does not 
engage in any prohibited activities is only required to adopt and 
implement a compliance program reasonably designed to ensure that the 
entity does not engage in prohibited activities. To what extent will 
the proposed provisions in Sec.  ----.14 increase or mitigate any 
costs, benefits or other impacts associated with the foregoing minimum 
internal controls requirement?
    Definition of Sponsor. Under the proposed rule, the term 
``sponsor'' is defined by incorporating the definition set forth in 
section 13(h)(5) of the BHC Act, but the CFTC has proposed to clarify 
that the term trustee, as used in the definition of sponsor, does not 
include a trustee that does not provide discretionary investment 
services to a covered fund. This exception distinguishes a trustee 
providing non-discretionary advisory services from trustees providing 
services similar to those associated with entities serving as general 
partner, managing member, commodity pool operator or investment adviser 
of a covered fund. We request comment on the economic impact associated 
with the proposed definition of ``sponsor.'' Will the economic impact 
differ depending on the scope of a banking entity's covered fund 
activities? For example, a banking entity whose only relationship with 
a covered fund involves the provision of non-discretionary investment 
services would not be a sponsor under the proposed rule. We request 
comment on whether such a banking entity would benefit from this 
exception. We also request comment on whether a covered fund's 
investors and counterparties would bear any costs associated with a 
banking entity's modification of its business practices or its 
relationship to the covered fund.
    Other Definitions. The covered fund provisions also define, among 
other things, ``director'' and ``prime brokerage transaction.'' What 
are the costs, benefits or other impacts associated with the way the 
proposed rule defines these terms? For example, would the proposed 
definition of ``prime brokerage transaction'' enable a banking entity 
to provide services to a covered fund that would not ordinarily be 
understood to be prime brokerage as long as it met certain conditions? 
What costs, or benefits, for banking entities, clients, customers or 
counterparties may be associated with this approach to defining prime 
brokerage transaction?
2. Exemptions
    In implementing the covered funds provisions of section 13 of the 
BHC Act, the CFTC also has interpreted or defined terms contained in 
the three principal exemptions related to covered fund activities by a 
banking entity: (i) The exemption for organizing and offering covered 
funds; (ii) the exemption for investment in a covered fund in the case 
of risk-mitigating hedging; and (iii) the exemption for covered fund 
activities outside of the United States. We request comment generally 
on the potential impact of these statutory exemptions, as implemented 
by the proposed rule. The CFTC notes that there are multiple factors 
that could affect the impact of the statute and the proposed rule on a 
banking entity's covered fund activities, including other conditions 
set forth in the statute or the proposed rule that could mitigate costs 
or enhance benefits associated with a particular element or condition 
of an exemption.
    Organize and Offer Exemption. Section ----.11 of the proposed rule 
implements the exemption set forth in section 13(d)(1)(G) of the BHC 
Act and generally incorporates all of the conditions specified in the 
statute. As required by the statute, the exemption for organizing and 
offering covered funds is available only to banking entities that 
provide bona fide trust, fiduciary, commodity trading or investment 
advisory services, which must meet certain requirements. As a result, 
the exemption should not preclude banking entities, such as registered 
advisers, registered operators, or other advisers, from providing trust 
or advisory services to their clients. We request comment on whether 
the proposed requirements of the exemption would result in a banking 
entity modifying its business practices or bearing higher costs to 
comply with the limitations and requirements applicable to this 
statutory exemption, as implemented by the proposed rule. These costs 
may include, for example, developing a credible plan that documents how 
advisory services would be provided to banking entity customers through 
organizing and offering covered funds and making the specified 
disclosures required by the exemption. We also request comment on 
whether the banking entity will pass these costs on to covered fund 
investors and counterparties.
    In implementing this statutory exemption, the CFTC has defined or 
clarified several key terms or requirements, including (i) the 
definition of ownership interest and (ii) the method for calculating 
the 3% ownership interest limit. The proposed definition of ownership 
interest is designed to describe the typical types of relationships 
through which an investor has exposure to the profits and losses of

[[Page 8415]]

a covered fund. Consistent with this approach, carried interest is not 
included within the proposed definition of ownership interest. As 
discussed in the Supplementary Information above, carried interest 
generally entitles service providers, such as banking entities that 
provide advisory services, to receive compensation for such services 
determined as a share of a covered fund's profits. As a result, the 
proposed rule does not treat carried interest as an ownership interest, 
which could have costs and benefits. To help discern these costs and 
benefits, we request comment on whether this is consistent with how 
providers of advisory services view the receipt of such ``carried 
interest'' (i.e., as compensation for services rather than as an 
``ownership interest'' equivalent to an investor's interest that shares 
in a fund's profits and losses). The proposed definition of carried 
interest has limitations designed to prevent a banking entity from 
circumscribing the proposed rule's limitations on ownership. For 
instance, among other things, the proposed definition requires that the 
``sole purpose and effect of the interest is to allow banking entity * 
* * to share in the profits of the covered fund. \363\ For banking 
entities receiving compensation that would satisfy all of the elements 
of the proposed definition, there should be no burden associated with 
modifying existing business practices. For other banking entities, 
however, the conditions specified in the proposed definition could 
result in more banking entities being deemed to hold ``ownership 
interests'' and hence subject to the limitations under the statute and 
the proposed rule, including the limitations on material conflicts of 
interest, high-risk trading activities and exposure to high-risk 
assets. We request comment on whether these banking entities would need 
to modify their existing practices and develop alternatives, and, if 
so, whether these modifications will impose costs and benefits. For 
example, costs associated with modifying business practices could 
include developing and implementing a compliance program in accordance 
with the proposed rule; benefits that may arise as a result of 
modifying business practices could include limiting the extent to which 
material conflicts of interest may arise between clients, customer and 
counterparties of banking entities. We also request comment on whether 
such costs, if any, are likely to be passed on to fund investors, 
clients and counterparties.
---------------------------------------------------------------------------

    \363\ Proposed rule Sec.  ----.10(b)(3)(i).
---------------------------------------------------------------------------

    As required by statute, a banking entity that seeks to invest in a 
covered fund under the exemption for organizing and offering covered 
funds could not, after the expiration of an initial one-year period 
(plus any applicable extensions), hold more than 3% of the total 
outstanding ownership interests of such fund. The proposed rule would 
require that a banking entity calculate the per-fund limit whenever the 
covered fund calculates its value or permits investor investments or 
redemptions, but in no case less frequently than quarterly. We request 
comment on whether this approach will limit any additional burden 
associated with calculating the per-fund limit for banking entities 
that invest in covered funds that determine their value on at least a 
quarterly basis. We also request comment on whether such banking 
entities will incur any additional significant costs in determining 
their compliance with the 3% ownership limitation.
    Risk-mitigating Hedging Exemption. The proposed rule specifies an 
exemption from the general prohibition on covered fund activities in 
the case of risk-mitigating hedging. Similar to the hedging exemption 
in the case of proprietary trading (discussed above), the hedging 
exemption for covered fund activities specifies a number of conditions 
that are identical except for two conditions. In the case of the 
hedging exemption for covered fund activities, the hedging must 
generally ``offset'' the exposure of the banking entity to the 
liabilities associated with (i) the facilitation of customer 
transactions or (ii) compensation arrangements for certain employees. 
Consistent with the statute, the proposed exemption would enable a 
banking entity to invest in a covered fund without limit if the 
investment is for risk-mitigating hedging purposes.
    We request comment on whether the proposed requirements will have 
benefits of furthering the goals of compliance with the statute and 
reducing banking entities' risks. We also request comment on whether 
the proposed requirements are more restrictive than necessary to 
implement the statute and whether they could unnecessarily limit a 
banking entity's hedging activities and ability to reduce risk. 
Commenters should also address whether the proposed requirements will 
dissuade banking entities from engaging in other permitted activities 
(e.g., organizing and offering covered funds) or those activities 
outside the scope of the statute to the extent that the exemption 
prevents them from mitigating the risks associated with such 
activities. We request comment on whether a reduction in efficiency 
could result from a reduced ability of covered banking entities to 
transfer risks to those more willing to bear them. Commentators should 
also address whether the proposed rule could reduce a banking entity's 
willingness to engage in permitted risk-mitigating hedging activities 
in order to avoid costs related to ensuring compliance with the 
exemption's requirements, and whether this would increase the banking 
entity's risk exposure.
    Exemption for Covered Fund Activities Outside of the United States. 
Section ----.13(c) of the proposed rule implements section 13(d)(1)(I) 
of the BHC Act, which permits certain foreign banking entities to 
sponsor or invest in covered funds ``solely outside of the United 
States,'' so long as the covered fund is not offered or sold to a 
resident of the United States. The proposed exemption provides a number 
of specific criteria for determining when a banking entity will be 
considered to have invested or sponsored a covered fund solely outside 
of the United States. The proposed exemption provides a definition of 
``resident of the United States'' that is similar, but not identical, 
to the SEC's definition of ``U.S. person'' in Regulation S, which 
should promote consistency and understanding among market participants 
that have experience with the concept from the SEC's Regulation S. In 
addition, the proposed exemption clarifies when a foreign banking 
entity will be considered to engage in such trading pursuant to 
sections 4(c)(9) and 4(c)(13) of the BHC Act, as required by the 
statute, including with respect to a foreign banking entity that is not 
a ``foreign banking organization'' under the Board's Regulation K. This 
implementation of section 13(d)(1)(I) of the BHC Act would permit 
certain foreign banking entities that are not ``qualifying foreign 
banking organizations'' under the Board's Regulation K to also rely on 
the exemption, notwithstanding the fact such foreign banking entities 
are not currently subject to the BHC Act generally or the Board's 
Regulation K. As a result, such foreign banking entities should 
encounter fewer costs related to complying with the covered fund 
activity prohibitions than if they were unable to rely on the exemption 
in section 13(d)(1)(I) of the BHC Act.
    Despite the reference to section 4(c)(13) of the BHC Act, the 
statute provides that the exemption for covered fund activities outside 
of the United States is only available to banking entities that are not 
directly or indirectly controlled by U.S. banking entities (i.e., not 
any U.S. banking

[[Page 8416]]

entities or their foreign subsidiaries and affiliates). Under the 
statute, the prohibition and restrictions on covered fund activities 
apply to the consolidated, worldwide operations of U.S. firms. As 
required by statute, the proposal prohibits U.S. banking entities from 
investing in or sponsoring covered funds unless the requirements of one 
or more relevant exemptions (other than the exemption for trading by 
foreign banking entities) are satisfied. As a result, the statute 
creates a competitive difference between the foreign activities of U.S. 
banking entities, which must monitor and limit their foreign activities 
in accordance with the requirements of section 13 of the BHC Act, 
relative to the foreign activities of foreign-based banking entities, 
which may not be subject to restrictions similar to those in section 13 
of the BHC Act. The CFTC seeks commenters' views on whether the 
proposed rule's implementation of section 13(d)(1)(I) of the BHC Act 
imposes additional competitive differences, beyond those discussed 
above, and the potential economic impact of such competitive 
differences.
3. Securitizations
    The CFTC recognizes that by defining ``covered fund'' and ``banking 
entity'' broadly, securitization vehicles may be affected by the 
restrictions and requirements of the proposed rule, and this may give 
rise to various economic effects. The CFTC preliminarily believes that 
the proposed rule should mitigate the impact of securitization market 
participants and investors in some non-loan asset classes (including, 
for example, banking entities that are participants in a securitization 
that may acquire or retain ownership interests in a securitization 
vehicle that falls within the definition of covered fund) by excluding 
loan securitizations from the restrictions on sponsoring or acquiring 
and retaining ownership interests in covered funds.
    Costs may be incurred to establish internal compliance programs to 
track compliance for any securitization vehicle that falls within the 
definition of banking entity. These costs may be minimized for future 
securitization vehicles, however, because such securitizations may be 
able both to incorporate any internal compliance program requirements 
into their documentation prior to execution and to minimize (or 
eliminate) any activities that may trigger greater compliance costs. 
The proposed rule should further minimize the costs of the internal 
compliance programs by (i) allowing for enterprise-wide compliance 
programs and minimal requirements for banking entities that do not 
engage in covered trading activities and/or covered fund activities or 
investments (each as described below), and (ii) allowing for reduced 
compliance program requirements by establishing financial thresholds 
for ``significant'' covered trading activities or covered fund 
activities or investments (as described below).
    There could be initial costs both for banking entities that have an 
ownership interest in a securitization vehicle and for other 
securitization participants to determine if a particular vehicle falls 
within the definition of covered fund. Additional costs could be 
incurred to the extent that banking entities divest their ownership 
interests in any securitization vehicle that is a covered fund and is 
not otherwise eligible for one of the exceptions allowed under the 
proposed rule. This divestment could result in selling pressure that 
may have a negative impact on the market prices for the vehicles that 
fall within the definition of covered fund, which in turn could impact 
all investors in those securitization vehicles. Additionally, under the 
proposed rule, banking entities would no longer be allowed to acquire 
and retain such ownership interests, which may result in fewer 
potential investors and reduced liquidity in the market for ownership 
interests in these covered funds.
    For example, the proposed rule could lead to significant potential 
market impacts if, with respect to an issuance of asset-backed 
securities secured by assets which are not loans, the market requires 
credit risk retention in excess of the minimum requirements to be 
adopted pursuant to Section 941 of the Dodd-Frank Act (i.e., the market 
believes that 5% credit risk retention is insufficient to address 
potential misalignment of incentives in a particular transaction). In 
such circumstances, the proposed rule could reduce potential investors' 
demand for such securitizations and could make such securitizations 
more expensive.

C. Limitations on Permitted Activities for Material Conflicts of 
Interest and High-Risk Assets and High-Risk Trading Strategies

    Section 13(d)(2)(A)(i) of the BHC Act provides that an otherwise-
permitted activity would not qualify for a statutory exemption if it 
would involve or result in a material conflict of interest. The 
proposed rule's definition of material conflict of interest, as 
discussed in more detail in Part II of the Supplemental Information, 
would provide flexibility to banking entities and their clients, 
customers, and counterparties with respect to how transactions are 
structured, while also establishing a structure to prevent banking 
entities from engaging in transactions and activities in reliance on a 
statutory exemption when the transaction or activity would have a 
materially adverse effect on the clients, customers, or counterparties 
of the banking entity. Specifically, the proposed definition would 
permit the use of timely and effective disclosure and/or information 
barriers in certain circumstances to address and mitigate conflicts of 
interest, while prohibiting transactions or activities where such a 
conflict of interest cannot be addressed or mitigated in the specified 
manner. The CFTC has endeavored to establish a workable definition that 
sets forth when a banking entity may not rely on an exemption because 
it would involve or result in a material conflict of interest, 
consistent with the statutory goals, to facilitate banking entities' 
compliance with the statutory requirements. We seek comment on whether 
the statutory prohibition, as implemented by the proposal, may impose 
costs on banking entities or their clients, customers, or 
counterparties. For instance, by permitting a client, customer or 
counterparty the option of negating or mitigating the conflict after 
the banking entity has disclosed the conflict, would the banking entity 
incur certain costs related to terminating the transaction, providing 
compensation or other means of mitigating the conflict, or 
administrative costs associated with negotiating the extent of any such 
compensation or other means of mitigating the conflict, depending on 
the actions of the client, customer, or counterparty in response to the 
disclosure?
    In addition, section 13(d)(2)(A)(ii) of the BHC Act provides that 
an otherwise-permitted activity would not qualify for a statutory 
exemption if it would result, directly or indirectly, in a material 
exposure by the banking entity to high-risk assets or high-risk trading 
strategies. This statutory limitation, as implemented in the proposed 
rule, would prevent a banking entity from engaging in certain high-risk 
activity. The CFTC requests comment on whether the proposed definitions 
of high-risk asset and high-risk trading strategy would potentially 
reduce liquidity or create a reduction in efficiency for assets or 
markets related to that high-risk activity.

D. Compliance Program

    Under Sec.  ----.20 of the proposed rule, all covered banking 
entities that are engaged in covered trading activities or

[[Page 8417]]

covered fund activities or investments would be required to have a 
compliance program that provides for the following six elements, at a 
minimum: (i) Internal written policies and procedures; (ii) internal 
controls; (iii) a management framework; (iv) independent testing; (v) 
training; and (vi) recordkeeping. For those banking entities with 
significant covered trading activities or covered fund activities or 
investments under Sec.  ----.20(c) of the proposed rule, additional 
standards in proposed Appendix C must be met with respect to these six 
elements.\364\ Collectively, the six proposed requirements would 
facilitate a banking entity's review and assessment of its compliance 
with section 13 of the BHC Act and the proposed rule, including 
identifying potential areas of deficiency in a banking entity's 
compliance program and providing the banking entity the opportunity to 
take appropriate corrective or disciplinary action, where warranted. 
The proposed compliance program would also facilitate Agency 
examination and supervision for compliance with the requirements of the 
statute and the proposed rule. By requiring that a banking entity have 
in place specific, documented elements (e.g., written policies and 
procedures and internal controls, recordkeeping requirements), the 
proposed rule would ensure that Agency examiners and supervisors can 
effectively review a banking entity's activities and investments to 
assess compliance and, where a banking entity is not in compliance with 
the proposed rule, take appropriate action.
---------------------------------------------------------------------------

    \364\ Proposed rule Sec.  ----.20 and Appendix C implement 
section 13(e) of the BHC Act, which requires the Agencies to issue 
regulations regarding internal controls and recordkeeping to ensure 
compliance with section 13.
---------------------------------------------------------------------------

    Beyond the benefits recognized above, the individual elements of 
the proposed compliance program should also provide certain benefits. 
For example, the proposed management framework requirement is designed 
to give management a greater incentive to comply with the proposed rule 
and to ascertain that the employees they are responsible for overseeing 
are also complying with the proposed rule. Further, by establishing a 
management framework for compliance, the banking entity would be 
required to set a strong compliance tone at the top of the banking 
entity's organization and signal to its employees that management is 
serious about compliance, which should foster a strong culture of 
compliance throughout the banking entity. Similarly, the proposed 
independent testing requirement would provide a third-party assessment 
of a banking entity's compliance with the proposed rule, which should 
provide assurances to the banking entity, its clients, customers, and 
counterparties, and current or prospective investors that the banking 
entity is in compliance with the proposed rule. In addition, the 
proposed training requirement should help the various employees of a 
banking entity that have responsibilities and obligations under the 
proposed rule (e.g., complying with the requirements for permitted 
market making-related activity) understand such responsibilities and 
obligations and facilitate the banking entity's compliance with the 
proposed rule. This proposed requirement may also promote market 
confidence by assuring that trading personnel, and other appropriate 
personnel of the banking entity, are familiar with their regulatory 
responsibilities and are complying with the applicable laws and 
regulations in their interactions with clients, customers, and 
counterparties.
    Because the six elements would be required to be established by all 
banking entities, other than those that are not engaged in covered 
trading activities or covered fund activities or investments, the 
proposed compliance program requirement should promote consistency 
across banking entities. However, the proposed elements are also 
intended to give a banking entity a degree of flexibility in 
establishing and maintaining its compliance program in order to address 
the varying nature of activities or investments conducted by different 
units of the banking entity's organization, including the size, scope, 
complexity, and risks of the activity or investment.
    We seek comment on whether developing and providing for the 
continued administration of a compliance program under Sec.  ----.20 of 
the proposed rule is likely to impose material costs on banking 
entities. Costs related to the proposed compliance program requirement 
are likely to be higher for those banking entities that are engaged in 
significant covered trading or covered fund activities or investments 
and, as a result, are required to comply with the more detailed, 
specific requirements of proposed Appendix C. Potential costs related 
to implementation of a compliance program under the proposal include 
those associated with: Hiring additional personnel or other personnel 
modifications, new or additional systems (including computer hardware 
or software), developing exception reports, and consultation with 
outside experts (e.g., attorneys, accountants). The proposed compliance 
program requirement would also impose ongoing costs related to 
maintenance and enforcement of the compliance program elements, which 
may include those associated with: Ongoing system maintenance, 
surveillance (e.g., reviewing and monitoring exception reports), 
recordkeeping, independent testing, and training. For example, the 
independent testing requirement in the proposal may necessitate that 
additional resources be provided to the internal audit department of 
the covered banking entity that is a registered broker-dealer or 
security-based swap dealer, if such testing is conducted by a qualified 
internal tester. Alternatively, if an outside party is used to conduct 
the independent testing, the covered banking entity would incur costs 
associated with paying the qualified outside partys for its services. 
The CFTC does not anticipate significant costs related to the proposed 
management framework requirement, as banking entities should already 
have relevant management structures in place.
    The tiered approach with which the proposal applies the proposed 
compliance program requirement to banking entities of varying size 
should reduce the costs associated with developing and providing for 
the continued administration of a compliance program. In setting forth 
the proposed compliance program requirement in Sec.  ----.20 of the 
proposed rule and Appendix C, the CFTC has taken into consideration the 
size, scope, and complexity of a banking entity's covered trading 
activities and covered fund activities and investments in developing 
requirements targeted to the compliance risks of large and small 
banking entities. Specifically, banking entities that do not meet the 
thresholds established in Sec.  ----.20(c) of the proposed rule would 
not be required to comply with the more detailed and burdensome 
requirements set forth in Appendix C. In addition, banking entities 
that do not engage in covered trading activities and covered fund 
activities and investments would not be required to establish a 
compliance program under the proposed rule, and therefore should incur 
only minimal costs associated with adding measures to their existing 
compliance policies and procedures to prevent the banking entity from 
becoming engaged in such activities or making such investments. 
Together, these provisions have been proposed in order to permit a 
banking entity to tailor its compliance program to its activities and 
investments and,

[[Page 8418]]

where possible, leverage its existing compliance structures, all of 
which should minimize the incremental costs associated with 
establishing a compliance program under the proposed rule. However, 
banking entities that are engaged in significant covered trading and 
covered fund activities and investments and thereby present a 
heightened compliance risk due to the size and nature of their 
activities and investments would be required to comply with the 
additional standards set forth in proposed Appendix C.
    Costs associated with the requirements of proposed Appendix C 
should also be reduced by aspects of the proposed rule that would 
permit a banking entity to establish an enterprise-wide compliance 
program under certain circumstances. An enterprise-wide compliance 
program would generally permit one compliance program to be established 
for a banking entity and all of its affiliates and subsidiaries 
collectively, rather than each legal entity being required to establish 
its own separate compliance program. The CFTC expects that an 
enterprise-wide compliance program should promote efficiencies and 
economies of scale, and reduce costs, associated with establishing 
separate compliance programs.

E. Additional Request for Comment

    In addition to the requests for comment discussed above, we seek 
commenters' views on the following additional questions related to the 
potential economic impacts of the proposed framework for implementing 
section 13 of the BHC Act:
    Question 348. What are the expected costs and benefits of complying 
with the requirements of the proposed rule? We seek commenters' 
estimates of the aggregate cost or benefit that would be incurred or 
received by banking entities subject to section 13 of the BHC Act to 
comply. We also ask commenters to break out the costs or benefits of 
compliance to banking entities with each individual aspect of the 
proposed rule. Please provide an explanation of how cost or benefit 
estimates were derived. Please also identify any costs or benefits that 
would occur on a one time basis and costs that would recur. Would 
particular costs or benefits decrease or increase over time? If certain 
costs or benefits cannot be estimated, please discuss why such costs or 
benefits cannot be estimated.
    Question 348.1 The CFTC seeks comment on the proposed rule's 
effects on market-making and liquidity, the costs of borrowing by 
businesses and consumers, the prices of financial assets, and the 
competitiveness of the United States financial services sector. The 
Commission also solicits comment on the benefits that will result from 
the proposed regulations and how these benefits compare to the costs of 
complying with the proposed regulations. The Commission also solicits 
comment on the CFTC's assessments of the costs and benefits of the 
regulations proposed herein.
    Question 349. Please identify any costs or benefits that would 
occur on a one-time basis and costs or benefits that would recur (e.g., 
training and compliance monitoring). Please identify any costs or 
benefits that you believe would decrease over time. Please identify any 
costs or benefits that you believe may increase over time or remain 
static.
    Question 350. Are there circumstances in which registered dealers, 
security-based swap dealers, and/or swap dealers (i) hold accounts 
other than trading accounts or (ii) hold investment positions for 
activities for which they are required to be registered? If so, would 
including all such dealer positions within the trading account 
definition create competitive burdens as well as additional burdens on 
the operations of such dealers that may not be consistent with the 
language and purpose of the statute? Please describe how this may 
occur, and to what extent it may occur.
    Question 351. Please identify the ways, if any, that banking 
entities might alter the ways they currently conduct business as a 
result of the costs that could be incurred to comply with the 
requirements of the proposed rule. Do you anticipate that banking 
entities will terminate any services or products currently offered to 
clients, customers, or counterparties due to the proposed rule, if 
adopted? Please explain.
    Question 352. How would trading systems and practices used in 
today's marketplace be impacted by the proposed rule? What would be the 
costs and/or benefits of such changes in trading practices and systems?
    Question 353. Would the proposed rule create any additional 
implementation or operational costs or benefits associated with systems 
(including computer hardware and software), surveillance, procedural, 
recordkeeping, or personnel modifications, beyond those discussed in 
the above analysis? Would smaller banking entities be 
disproportionately impacted by any of these additional implementation 
or operational costs?
    Question 354. We seek specific comments on the costs and benefits 
associated with systems changes on banking entities with respect to the 
proposed rule, including the type of systems changes necessary and 
quantification of costs associated with changing the systems, including 
both start-up and maintenance costs. We request comments on the types 
of jobs and staff that would be affected by systems modifications and 
training with respect to the proposed rule, the number of labor hours 
that would be required to accomplish these matters, and the 
compensation rates of these staff members.
    Question 355. Please discuss any human resources costs associated 
with the proposed rule, along with any associated overhead costs.
    Question 356. What are the benefits and costs associated with the 
requirements for relying on the underwriting exemption? What impact 
will these requirements have on capital formation, efficiency, 
competition, liquidity, price efficiency, if any? Please estimate any 
resulting benefits and costs or discuss why such benefits and costs 
cannot be estimated. What alternatives, if any, may be more cost-
effective while still being consistent with the purpose and language of 
the statute?
    Question 357. What are the benefits and costs associated with the 
requirements for relying on the exemption for market-making-related 
activity, including the requirement that such activity be consistent 
with the commentary in Appendix B? What impact will these requirements 
have on liquidity, price efficiency, capital formation, efficiency, and 
competition, if any? Please estimate any resulting benefits and costs 
or discuss why such benefits and costs cannot be estimated. What 
alternatives, if any, may be more cost-effective while still being 
consistent with the purpose and language of the statute?
    Question 358. What are the benefits and costs associated with the 
requirements for relying on the exemption for risk-mitigating hedging 
activity, including the requirement that certain hedge transactions be 
documented? What impact will these requirements have on liquidity, 
price efficiency, capital formation, efficiency, and competition, if 
any? Please estimate any resulting benefits and costs or discuss why 
such benefits and costs cannot be estimated. What alternatives, if any, 
may be more cost-effective while still being consistent with the 
purpose and language of the statute?
    Question 359. Are there traditional risk management activities of 
banking entities that are not covered by the liquidity management and 
risk-

[[Page 8419]]

mitigating hedging exemptions as currently proposed? What risks do 
banking entities face that go beyond market, counterparty/credit, 
currency/foreign exchange, interest rate, and basis risk? Could the 
proposed construction of the liquidity management and risk-mitigating 
hedging exemptions increase the costs of management or impede the 
ability of banking entities to effectively manage risk?
    Question 360. To rely on the exemptions from the proposed rule for 
permitted underwriting, market-making-related activity, and risk-
mitigating hedging, banking entities must establish, maintain, and 
enforce a compliance program, including written policies and procedures 
and internal controls. Please discuss how the costs incurred, or 
benefits received, by banking entities related to initial 
implementation and ongoing maintenance of the compliance program would 
impact their customers and their businesses with respect to 
underwriting, market making, and hedging activity.
    Question 361. Please discuss benefits and costs related to the 
limitations on permitted activities for material conflicts of interest, 
high-risk assets and trading strategies, and threats to the safety and 
soundness of banking entities or to the financial stability of the U.S. 
in the proposed rule. Are there particular benefits and costs related 
to the proposed definitions of material conflict of interest, high-risk 
asset, and high-risk trading strategy in the proposed rule? Would these 
definitions have any unintended costs, such as creating undue burdens 
and limitations on permitted underwriting, market making-related, or 
hedging activity? Please explain. What alternatives, if any, may be 
more cost-effective while still being consistent with the purpose and 
language of the statute?
    Question 362. Please discuss the benefits and costs related to the 
definition of derivative in the proposed rule and the application of 
the restrictions on proprietary trading to transactions in the 
different types of derivatives covered by the definition. What 
alternatives, if any, may be more cost-effective while still being 
consistent with the purpose and language of the statute?
    Question 363. What costs and benefits would be associated with 
calculating, reviewing, and analyzing the proposed quantitative 
measurements? What costs and benefits would be associated with 
reporting the proposed quantitative measurements to an Agency? Please 
identify any of the proposed quantitative measurements that are already 
reported to an Agency and discuss whether the current reporting regime 
would mitigate costs associated with the proposed rule. With respect to 
any quantitative measurement that is not already reported to an Agency, 
what are the costs and benefits of beginning to report the measurement? 
Would banking entities have to create or purchase new systems or 
implement changes to existing systems in order to report these 
quantitative measurements? Please discuss the costs and benefits 
associated with such systems changes.
    Question 364. How much of the data necessary to calculate the 
quantitative measurements in Appendix A is currently captured, 
retained, and utilized by banking entities? If the applicable data is 
not currently used by banking entities, is it readily available? Is it 
possible to collect all of the data that is necessary for calculating 
the required measurements? Please identify any data that banking 
entities do not currently utilize that would need to be captured and 
retained for purposes of proposed Appendix A and discuss the costs and 
benefits of capturing and retaining such data.
    Question 365. Do the costs and benefits of calculating, analyzing, 
and reporting certain or all quantitative measurements differ between 
trading units and their trading activities, including trading 
strategies, asset classes, market structure, experience and market 
share, and market competitiveness? Are any quantitative measurements 
particularly costly to calculate or analyze for specific trading 
activities or, alternatively, particularly beneficial? If so, which 
quantitative measurement, what type of trading activity, and what 
factor(s) of that trading activity make the quantitative measurement 
particularly costly or beneficial? Please discuss how these costs, if 
any, could be mitigated or benefits, if any, could be enhanced.
    Question 366. The proposed definition of trading unit would require 
a tiered approach to calculating and reporting quantitative 
measurements, such that the measurements would be calculated and 
reported for different levels within the banking entity, with higher 
levels encompassing smaller units (e.g., trading desks, business lines, 
and all trading operations). What are the costs and benefits of 
calculating the quantitative measurements for each level within the 
definition of trading unit? Can the higher level calculations 
incorporate the lower level calculations such that the higher level 
calculations result in small, incremental costs? Why or why not? Are 
there particular costs or benefits associated with calculating, 
analyzing, and reporting a quantitative measurement at one of the 
levels within the definition of trading unit that would not be 
experienced at the other levels? Please explain. What are the costs, if 
any, of ``noise,'' ``false positives,'' or ``false negatives'' with 
respect to the quantitative measurements and calculations at different 
levels? Can these costs be mitigated and, if so, how? What 
alternatives, if any, may be more cost-effective while still being 
consistent with the purpose and language of the statute?
    Question 367. We seek comment on whether the requirement that 
banking entities employ a suite of quantitative measurements may lead 
to redundancies and/or inefficiencies in the application of the 
measurements for some types of trading units within some banking 
entities. Despite the flexibility of Appendix A via recognition that 
quantitative measurements will be applied with respect to differences 
within a banking entity's structure, business lines, and trading desks, 
we seek comment on whether the requirement of a mandatory suite of 
quantitative measurements may prove burdensome. For instance, is the 
application of certain quantitative measurements not efficient, 
appropriate, or calculable for certain asset classes or trading units 
or would the benefits of applying such quantitative measurements be 
negligible in relation to the costs of applying such measurements? In 
addition, would the overlay divert a banking entity from allocating 
resources toward quantitative--or other--measurements that might prove 
more useful and better tailored to its specific and unique trading 
practices?
    Question 368. What are the benefits and costs of the recordkeeping 
requirement in proposed Appendix A? Please explain and quantify, to the 
extent possible. To what extent would the proposed recordkeeping 
requirement impose new or additional costs and benefits beyond the 
current recordkeeping obligations of different types of banking 
entities (e.g., affiliated broker-dealers, affiliated investment 
advisers, insured depository institutions, etc.)? What alternatives, if 
any, may be more cost-effective while still being consistent with the 
purpose and language of the statute?
    Question 369. Please identify any cost savings that would be 
achieved through the use of an enterprise-wide compliance program. 
Alternatively, would you expect certain costs to increase when using an 
enterprise-wide compliance program? Please explain. Please identify any 
benefits that might

[[Page 8420]]

be amplified or reduced when using an enterprise-wide compliance 
program.
    Question 370. Are there tools or elements in the contents of the 
compliance program set forth in Sec.  ----.20(b) for which the costs 
may be negligible because banking entities use the same or similar 
elements for other purposes (e.g., satisfying other regulatory 
requirements, risk management, etc.) and could utilize existing 
infrastructure for purposes of the proposed rule? For example, could 
existing trader mandates or an existing training program be expanded to 
meet the requirements of the proposed rule, rather than developing an 
entirely new infrastructure? Alternatively, would the proposed rule 
require redundancies or duplications within a banking entity's 
infrastructure (e.g., the trader mandates currently used for one 
purpose do not conform to the requirements of the proposed rule, so a 
banking entity would have to utilize both in different circumstances)? 
Please identify and explain any such redundancies and how the rule 
could be modified to reduce or eliminate such redundancies, if 
possible.
    Question 371. How would the proposed rule affect compliance costs 
(e.g., personnel or system changes) or benefits for each category of 
banking entity: small, medium, and large? Please discuss any 
differences between the costs and benefits of the compliance program 
required under Sec.  ----.20(b) for smaller banking entities and the 
compliance program requirements of Appendix C for larger banking 
entities. Are the differences between these benefits and costs 
justified due to the differences in size and complexity of smaller and 
larger banking entities?
    Question 372. The definition of trading unit in proposed Appendix C 
covers different levels of a banking entity and, as a result, requires 
a tiered approach to establishing, maintaining, and enforcing the 
compliance program requirements with respect to covered trading 
activities. What are the costs and benefits of applying the compliance 
program requirements at several levels within the banking entity? To 
what extent does the ability to incorporate written policies and 
procedures of lower-level units by reference, rather than establishing 
separate written policies and procedures, mitigate the costs of the 
proposed requirements? Are there other ways that the proposed 
requirements could be made more cost-effective for the different levels 
within the banking entity?
    Question 373. How will the proposed definition of ``covered fund'' 
affect a banking entity's investment advisory activities, in particular 
activities and relationships with investment funds that would be 
treated as ``covered funds''? Please estimate any resulting costs or 
benefits or discuss why such costs or benefits cannot be estimated.
    Question 374. How have banking entities traditionally organized and 
offered covered funds? What are the benefits and costs associated with 
the proposed requirements for relying on the exception for organizing 
and offering covered funds? Please estimate any resulting costs or 
benefits or discuss why such costs or benefits cannot be estimated.
    Question 375. What are the costs and benefits associated with the 
way the proposed rule implements the ``customers of such services'' 
requirement in the exception for organizing and offering covered funds? 
What alternative, if any, may be more cost-effective while still being 
consistent with the language and purpose of the statute?
    Question 376. Is it common for a banking entity to share a name 
with the covered funds that it invests in or sponsors? If yes, what 
entity in the banking structure typically shares a name with such 
covered funds? What costs and benefits will result from the proposed 
rule's implementation of the name sharing requirement in exception for 
organizing and offering a covered fund? What alternatives, if any, may 
be more cost-effective while still being consistent with the purpose of 
the statute?
    Question 377. Under what circumstances do directors and employees 
of a banking entity invest in covered funds? What are the benefits and 
costs associated with the proposed provisions regarding director and 
employee investments in covered funds? What alternatives, if any, may 
be more cost-effective while still being consistent with the purpose of 
the statute?
    Question 378. Do banking entities currently invest in or sponsor 
SBICs and public welfare and qualified rehabilitation investments? If 
yes, to what extent? What are the benefits and costs associated with 
the proposed rule's implementation of the exception for investment in 
SBICs and public welfare and qualified rehabilitation investments?
    Question 379. Do banking entities currently invest in or sponsor 
each of the vehicles that the proposed rule permits banking entities to 
continue to invest in and sponsor under section 12(d)(1)(J) of the BHC 
Act? If yes, to what extent? What are the benefits and costs associated 
with the proposed rule's implementation of these exceptions?
    Question 380. For banking entities that are affiliated investment 
advisers, are there additional costs or benefits to complying with 
section 13 of the BHC Act and the proposed rule? For example, do 
affiliated investment advisers typically maintain records that would 
enable them to demonstrate compliance with the 3% ownership limits or 
restrictions on transactions that would be subject to sections 23A and 
23B of the FR Act?
    Question 381. Would complying with section 13 of the BHC Act and 
the proposed rule affect an affiliated investment adviser's other 
business activities (benefit or burden) that are not subject to 
restrictions on proprietary trading or other covered fund activities? 
For example, would advisers incur additional burdens to distinguish 
covered fund activities from non-covered fund activities?
    Question 382. For banking entities that are affiliated investment 
advisers, are there particular costs or benefits to complying with the 
portions of Appendix C that are applicable to each asset management 
unit of the adviser? Do these costs and benefits differ depending on 
whether the adviser complies with Appendix C individually or on an 
enterprise basis? Does the rule provide sufficient clarify for how 
Appendix C applies to unregistered affiliates of an affiliated 
investment adviser?
    Question 383. To the extent applicable, please address each of the 
questions above with respect to securitization vehicles that would be 
included in the proposed definition of covered fund.

VI. Administrative Law Matters

A. Paperwork Reduction Act Analysis; Request for Comment on Proposed 
Information Collection

    In accordance with section 3512 of the Paperwork Reduction Act of 
1995 (44 U.S.C. 3501-3521) (``PRA''), the CFTC may not conduct or 
sponsor, and a respondent is not required to respond to, an information 
collection unless it displays a currently valid Office of Management 
and Budget (``OMB'') control number. In conjunction with the Joint 
Release, the OCC, FDIC, and the Board obtained OMB control numbers. The 
information collection requirements contained in the Joint Release, to 
the extent they apply to banking entities that are not under a holding 
company, were submitted by the OCC and FDIC to OMB for review and 
approval under section 3506 of the PRA and section

[[Page 8421]]

1320.11 of OMB's implementing regulations (5 C.F.R. Sec.  1320).\365\ 
Under the Joint Release, the Board will submit to OMB once the final 
rule is published and the submission will include burden for Federal 
Reserve-supervised institutions, as well as burden for OCC-, FDIC-, 
SEC-, and CFTC-supervised institutions under a holding company.\366\ 
Under the Joint Release, the OCC or the FDIC will take burden for 
banking entities that are not under a holding company.\367\
---------------------------------------------------------------------------

    \365\ See 76 FR 68936.
    \366\ See id.
    \367\ See id.
---------------------------------------------------------------------------

    In this CFTC Rule, the CFTC is proposing a separate rulemaking 
under which the CFTC would adopt the same substantive requirements as 
proposed in the Joint Release. Accordingly, the burden for CFTC-
supervised institutions under the CFTC Rule would be the same as the 
burdens set forth and assumed by the Board and the OCC in the Joint 
Release.\368\
---------------------------------------------------------------------------

    \368\ See id.
---------------------------------------------------------------------------

    In the Joint Release, the proposed collection of information is 
titled ``Reporting, Recordkeeping, and Disclosure Requirements 
Associated with Restrictions on Proprietary Trading and Certain 
Relationships with Hedge Funds and Private Equity Funds.'' The 
collection of information request submitted to OMB by the FDIC is 
titled ``Prohibitions and Restrictions on Proprietary Trading and 
Certain Interests In, and Relationships with, Hedge Funds and Private 
Equity Funds.''
    In the Joint Release, the Board stated that it would take burden 
for all institutions under a holding company, including, among other 
things, banking entities for which the CFTC is the primary financial 
regulatory agency, as defined in section 2(12)(C) of the Dodd-Frank 
Act.\369\
---------------------------------------------------------------------------

    \369\ See id.
---------------------------------------------------------------------------

    In the Joint Release, the OCC stated that it will take the burden 
with respect to registered investment advisers and commodity trading 
advisers and commodity pool operators that are subsidiaries of national 
banks, federal savings associations, and federal savings banks not 
under a bank holding company.
    The CFTC seeks comment on whether there are any banking entities 
supervised by the FDIC or are subsidiaries or affiliates of an FDIC-
supervised banking entity (``FDIC supervised-entities) for which the 
CFTC will be the primary financial regulatory agency under section 
2(12)(C) of the Dodd-Frank Act. The Joint Release does not identify any 
such entities.
    The CFTC will request, pursuant to 44 U.S.C. 3509, that the 
director of the OMB designate the Board or the OCC as the respective 
collection agency for PRA purposes for the banking entities for which 
the CFTC is the primary financial regulatory agency under section 
2(12)(C). This does not affect the CFTC's obligation and authority to 
receive and review the relevant information (as set forth in the PRA 
section of the Joint Release for all banking entities) for those 
entities.\370\
---------------------------------------------------------------------------

    \370\ See 76 FR 68936-38.
---------------------------------------------------------------------------

B. Initial Regulatory Flexibility Act Analysis

    The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601 et seq., 
requires an agency to consider whether the rules it proposes will have 
a significant economic impact on a substantial number of small 
entities.\371\ If so, the agency must prepare an initial and final 
regulatory flexibility analysis respecting the significant economic 
impact. Pursuant to section 605(b) of the RFA, the regulatory 
flexibility analysis otherwise required under sections 603 and 604 of 
the RFA is not required if an agency certifies that the rule will not 
have a significant economic impact on a substantial number of small 
entities. The Agencies have considered the potential impact of the 
proposed rule on small entities in accordance with the RFA. The 
proposed rule would not appear to have a significant economic impact on 
small entities for several reasons.
---------------------------------------------------------------------------

    \371\ A banking organization is generally considered to be a 
small banking entity for the purposes of the RFA if it has assets 
less than or equal to $175 million. See also 13 CFR 121.1302(a)(6) 
(noting factors that the Small Business Administration considers in 
determining whether an entity qualifies as a small business, 
including receipts, employees, and other measures of its domestic 
and foreign affiliates).
---------------------------------------------------------------------------

    First, while the proposed rule will affect all banking 
organizations, including those that have been defined to be ``small 
businesses'' under the RFA, only certain limited requirements would be 
imposed on entities that engage in little or no covered trading 
activities or covered fund activities and investments. Significantly, 
the reporting and recordkeeping requirements of Sec.  ----.7 and 
Appendix A of the proposed rule apply only to banking entities with 
average trading assets and liabilities on a consolidated, worldwide 
basis equal to or greater than $1 billion for the preceding year. This 
is a threshold that a small banking entity typically would not meet.
    Second, the scope and size of the compliance program requirements 
set forth in subpart D and Appendix C of the proposed rule would vary 
based on the size and activities of each covered banking entity. Only 
banking entities with average trading assets and liabilities on a 
worldwide consolidated basis equal to or greater than $1 billion or 10 
percent or more of their total assets, or that have aggregate 
investments in, or sponsor or advise, covered funds with aggregate 
total assets of more than $1 billion must establish, maintain and 
enforce a full compliance program under the proposed rule. Banking 
entities that engage in trading activities or covered fund activities 
and investments under these thresholds must adopt, at a minimum, only 
the six core compliance requirements set forth in Sec.  ----.20 of the 
proposed rule. Banking entities that do not engage in any covered 
trading or fund activities, typical of small banking entities, must 
ensure only that their compliance programs include measures designed to 
prevent the entities from becoming engaged in covered activities unless 
they first adopt a compliance program. These compliance requirements 
would not appear to have a significant economic impact on a substantial 
number of small entities.
    For the reasons stated above, the head of the CFTC certifies, for 
the covered banking entities subject to the CFTC's jurisdiction, that 
the proposed rule would not result in a significant economic impact on 
a substantial number of small entities. The CFTC encourages written 
comments regarding this certification, and request that commenters 
describe the nature of any impact on small entities and provide 
empirical data, or studies, to illustrate and support the extent of the 
impact.

VII. CFTC: Additional Matters

A. Commodity Pool Operators and Commodity Trading Advisors

    As discussed above, under the proposed rule, a covered banking 
entity as defined in Sec.  ----.2(j) would generally be subject to the 
substantive requirements contained in the CFTC Rule. These substantive 
requirements implement the provisions on proprietary trading and 
covered fund activities under section 13 of the BHC Act. Thus for 
example, a covered banking entity that is a registered swap dealer 
would be required to comply with subparts A through D of the CFTC Rule, 
including Appendices A, B and C, where applicable. With respect to 
covered fund activities, investments, or relationships set forth in 
subpart C and

[[Page 8422]]

Sec.  ----.20 of subpart D (``covered fund restrictions''), however, 
the CFTC's proposed rule would require that a covered banking entity 
that is a covered banking entity because it is a commodity pool 
operator or commodity trading advisor for which the CFTC is the primary 
financial regulatory agency under sections 2(12)(C)(ii) and 
2(12)(C)(iii) of the Dodd-Frank Act comply with the covered fund 
restrictions issued by the appropriate Federal banking agency that 
regulates the banking entity specified in Sec.  ----.2(e)(1), (2) and 
(3) with which the commodity pool operator or commodity trading advisor 
is affiliated.\372\ Under this approach, a commodity pool operator or 
commodity trading advisor would be required to comply with the rules 
and related guidance issued by the appropriate Federal banking agency. 
The CFTC would, however, retain enforcement authority over all 
activities of commodity pool operators or commodity trading advisors 
(i.e., both proprietary trading and covered fund restrictions).
---------------------------------------------------------------------------

    \372\ A commodity pool operator or commodity trading advisor 
would, however, be required to comply with the provisions that 
implement the proprietary trading restrictions set forth in subparts 
A, B and Sec.  ----.20 of subpart D of the proposed rule as 
promulgated by the CFTC, including Appendix C, where applicable.
---------------------------------------------------------------------------

    The covered fund restrictions of section 13 of the BHC Act and the 
proposed implementing rules make reference to or incorporate a number 
of banking law and supervision concepts that traditionally appear in 
Federal banking law and are interpreted and applied by the Federal 
banking agencies. For example, as discussed in greater detail in the 
Supplementary Information, the limitations on ownership interests in a 
covered fund set forth in the statute and the proposed rule generally 
reference the tier 1 capital of the affiliated insured depository 
institution or the affiliated holding company. Similarly, capital 
deductions under the proposed rule refer to the tier 1 capital of the 
affiliated insured depository institution or the affiliated holding 
company. In addition, the covered fund restrictions of the statute and 
the proposed rule incorporate by reference sections 23A and 23B of the 
FR Act and are administered by the Federal banking agencies. These 
sections of the FR Act restrict and limit transactions between certain 
banking organizations and their affiliates, some of which are based on 
a percentage of bank capital. Further, other covered fund restrictions, 
including for example exemptions for investments involving the public 
welfare and bank-owned life insurance and the extension of time to 
divest of investments after the seeding period, reference other banking 
laws or regulations that are administered by the Federal banking 
agencies.
    In light of these considerations, the proposed CFTC Rule would 
require a commodity pool operator or commodity trading advisor to 
comply with the covered fund restrictions contained in subpart C and 
Sec.  .----20 of subpart D of rules implementing section 13 of the BHC 
that are issued by the appropriate Federal banking agency that 
regulates the banking entity with which the commodity pool operator or 
commodity trading advisor is affiliated. Under the proposed approach, a 
commodity pool operator or commodity trading advisor complying with the 
CFTC Rule would do so by complying with the rule issued by the 
appropriate Federal banking agency, including any related 
interpretations or guidance regarding such requirements. Similarly, 
under the proposed approach, the foregoing determinations regarding 
capital or other banking law requirements that may be applicable to a 
commodity pool operator or commodity trading advisor would be made by 
the appropriate Federal banking agency that regulates the banking 
entity with which the commodity pool operator or commodity trading 
advisor is affiliated. This approach would mitigate the burdens of 
complying with the covered fund restrictions for commodity pool 
operators or commodity trading advisors and would avoid creating 
incentives for covered fund activities to be moved from a commodity 
pool operator or commodity trading advisor to a bank.
    The proposed CFTC Rule specifies that a commodity operator or 
commodity trading advisor must comply with the covered fund 
restrictions contained in subpart C and Sec.  ----.20 of subpart D that 
are issued by the appropriate Federal banking agency that regulates the 
banking entity with which the commodity pool operator or commodity 
trading advisor is affiliated. Subpart C, which uses terms defined in 
subpart A, specifies the covered fund restrictions. Subpart D Sec.  --
--.20 requires the establishment of a compliance program when engaging 
in covered fund activities. A commodity pool operator or commodity 
trading advisor complying with subpart C and Sec.  ----.20 of subpart 
D, as issued by the appropriate Federal banking agency, would also rely 
on interpretative guidance issued by the appropriate Federal banking 
agency with respect to those subparts of the proposed rule. Because 
Sec.  ----.20 of subpart D relates to both the prohibitions and 
restrictions on proprietary trading activity as well as the 
prohibitions and restrictions on covered fund activities and 
investments, a commodity pool operator or commodity trading advisor 
would be required to comply with the relevant covered fund provisions 
issued by the appropriate Federal banking agency. A commodity pool 
operator or commodity trading advisor, however, would be subject to the 
provisions set forth in subpart D of the proposed CFTC Rule, including 
Sec.  ----.20, that relate to covered trading activities.
    Nothing set forth in the discussion above, or in Sec.  --
--.10(a)(2) of the proposed CFTC Rule, however, is intended, or shall 
be deemed, to limit the CFTC's authority under any other provision of 
law, including pursuant to section 13 of the BHC Act.
    The CFTC requests comment on the its proposed approach to 
implementing section 13 of the BHC Act as it applies to commodity pool 
operators or commodity trading advisors with respect to the covered 
fund restrictions. In particular, the CFTC requests comment on the 
following:
    Question CFTC-5. Should the CFTC instead require commodity pool 
operators or commodity pool advisors to comply with the covered fund 
restrictions proposed by the CFTC, instead of those issued the 
appropriate Federal banking agency? If so, could this create incentives 
to move the advisory business between the commodity pool operator or 
commodity trading advisor and its affiliated bank? Are there benefits 
to this alternate approach? If so, please explain.
    Question CFTC-6. Are there other alternative approaches to the 
proposed rule that would be more effective? If yes, what alternatives 
and why?
    Question CFTC-7. Would commodity pool operators or commodity 
trading advisors affiliated with insured depository institutions 
benefit from the proposed approach? Why or why not?
    Question CFTC-8. Would a commodity pool operator or commodity 
trading advisor that is affiliated with insured depository institutions 
that are regulated by multiple Federal banking agencies encounter 
additional burdens in implementing the proposed approach? With respect 
to these commodity pool operators or commodity trading advisors, which 
Federal banking agency's rules should be applicable to the commodity 
pool operator or commodity trading advisor? For example, should the 
commodity pool operator or commodity trading advisor be subject to the 
rules applicable to the commodity pool operator or commodity trading 
advisor's

[[Page 8423]]

immediate parent that is an insured depository institution?
    Question CFTC-9. Is the proposed requirement that commodity pool 
operators or commodity trading advisors comply with the covered fund 
restrictions in Sec.  ----.20 issued by the Federal banking agency that 
regulates the banking entity specified in Sec.  ----.2(e)(1), (2) and 
(3) of the proposed rule with which the commodity pool operator or 
commodity trading advisor is affiliated sufficiently clear? Are there 
particular compliance program requirements in Sec.  ----.20 with 
respect to the covered fund restrictions that overlap with the 
proprietary trading restrictions, such that it would be difficult to 
identify which requirements are related to the covered fund 
restrictions and which requirements are related to the proprietary 
trading restrictions? If so, which requirements and how should this 
overlap be addressed? Should commodity pool operators or commodity 
trading advisors be required to comply with Sec.  ----.20 of the CFTC 
Rule in its entirety? Why or why not?
    Question CFTC-10. Will the CFTC's proposed approach limit the 
potential for inconsistent application of the proposed rules with 
respect to affiliates of entities specified in Sec.  ----.2(e)(1), (2) 
and (3)? Why or why not?
    Question CFTC-11. Will the CFTC's proposed approach be effective in 
avoiding the creation of incentives for covered fund activities to move 
from a commodity pool operator or commodity trading advisor to a bank? 
Why or why not?

Text of the Proposed Common Rules <SUP>373</SUP> (applicable to the 
OCC, Board, FDIC, and SEC under the Joint Release)
---------------------------------------------------------------------------

    \373\ The text of the Proposed Common Rules section of the CFTC 
Rule is identical to the text of the Proposed Common Rules adopted 
in the Joint Release. See 76 FR 68944-68967.
---------------------------------------------------------------------------

    The text of the proposed common rules appears below:

PART [ ]--PROPRIETARY TRADING AND CERTAIN INTERESTS IN AND 
RELATIONSHIPS WITH COVERED FUNDS.

Subpart A--Authority and Definitions
Sec.
----.1 Authority, purpose, scope, and relationship to other 
authorities [Reserved].
----.2 Definitions.
Subpart B--Proprietary Trading
----.3 Prohibition on proprietary trading.
----.4 Permitted underwriting and market making-related activities.
----.5 Permitted risk-mitigating hedging activities.
----.6 Other permitted proprietary trading activities.
----.7 Reporting and recordkeeping requirements applicable to 
trading activities.
----.8 Limitations on permitted proprietary trading activities.
----.9 [Reserved]
Subpart C--Covered Fund Activities and Investments
----.10 Prohibition on acquiring or retaining an ownership interest 
in and having certain relationships with a covered fund.
----.11 Permitted organizing and offering of a covered fund.
----.12 Permitted investment in a covered fund.
----.13 Other permitted covered fund activities and investments.
----.14 Covered fund activities and investments determined to be 
permissible.
----.15 Internal controls, reporting and recordkeeping requirements 
applicable to covered fund activities and investments.
----.16 Limitations on relationships with a covered fund.
----.17 Other limitations on permitted covered fund activities and 
investments.
----.18 [Reserved]
----.19 [Reserved]
Subpart D--Compliance Program Requirement; Violations
----.20 Program for monitoring compliance; enforcement.
----.21 Termination of activities or investments; penalties for 
violations.
Appendix A to Part [ ]--Reporting and Recordkeeping Requirements for 
Covered Trading Activities
Appendix B to Part [ ]--Commentary Regarding Identification of 
Permitted Market Making-Related Activities
Appendix C to Part [ ]--Minimum Standards for Programmatic Compliance

Subpart A--Authority and Definitions


Sec.  ----.1  Authority, purpose, scope, and relationship to other 
authorities. [Reserved]


Sec.  ----.2  Definitions.

    Unless otherwise specified, for purposes of this part:
    (a) Affiliate has the same meaning as in section 2(k) of the BHC 
Act (12 U.S.C. 1841(k)).
    (b) Applicable accounting standards means U.S. generally accepted 
accounting principles or such other accounting standards applicable to 
a covered banking entity that the [Agency] determines are appropriate, 
that the covered banking entity uses in the ordinary course of its 
business in preparing its consolidated financial statements.
    (c) BHC Act means the Bank Holding Company Act of 1956 (12 U.S.C. 
1841 et seq.).
    (d) Bank holding company has the same meaning as in section 2 of 
the BHC Act (12 U.S.C. 1841).
    (e) Banking entity means:
    (1) Any insured depository institution;
    (2) Any company that controls an insured depository institution;
    (3) Any company that is treated as a bank holding company for 
purposes of section 8 of the International Banking Act of 1978 (12 
U.S.C. 3106); and
    (4) Any affiliate or subsidiary of any entity described in 
paragraphs (e)(1), (2), or (3) of this section, other than an affiliate 
or subsidiary that is:
    (i) A covered fund that is organized, offered and held by a banking 
entity pursuant to Sec.  ----.11 and in accordance with the provisions 
of subpart C of this part, including the provisions governing 
relationships between a covered fund and a banking entity; or
    (ii) An entity that is controlled by a covered fund described in 
paragraph (e)(4)(i) of this section.
    (f) Board means the Board of Governors of the Federal Reserve 
System.
    (g) Buy and purchase each include any contract to buy, purchase, or 
otherwise acquire. For security futures products, such terms include 
any contract, agreement, or transaction for future delivery. With 
respect to a commodity future, such terms include any contract, 
agreement, or transaction for future delivery. With respect to a 
derivative, such terms include the execution, termination (prior to its 
scheduled maturity date), assignment, exchange, or similar transfer or 
conveyance of, or extinguishing of rights or obligations under, a 
derivative, as the context may require.
    (h) CFTC means the Commodity Futures Trading Commission.
    (i) Commodity Exchange Act means the Commodity Exchange Act (7 
U.S.C. 1 et seq.).
    (j) [Reserved]
    (k) Depository institution has the same meaning as in section 3(c) 
of the Federal Deposit Insurance Act (12 U.S.C. 1813(c)).
    (l) (i) Derivative means:
    (A) Any swap, as that term is defined in section 1a(47) of the 
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as 
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C. 
78c(a)(68)), and as those terms are further jointly defined by the CFTC 
and SEC by joint regulation, interpretation, guidance, or other action, 
in consultation with the

[[Page 8424]]

Board pursuant to section 712(d) of the Dodd-Frank Wall Street Reform 
and Consumer Protection Act (15 U.S.C. 8302(d));
    (B) Any purchase or sale of a nonfinancial commodity for deferred 
shipment or delivery that is intended to be physically settled;
    (C) Any foreign exchange forward (as that term is defined in 
section 1a(24) of the Commodity Exchange Act (7 U.S.C. 1a(24)) or 
foreign exchange swap (as that term is defined in section 1a(25) of the 
Commodity Exchange Act (7 U.S.C. 1a(25));
    (D) Any agreement, contract, or transaction in foreign currency 
described in section 2(c)(2)(C)(i) of the Commodity Exchange Act (7 
U.S.C. 2(c)(2)(C)(i));
    (E) Any agreement, contract, or transactions in a commodity other 
than foreign currency described in section 2(c)(2)(D)(i) of the 
Commodity Exchange Act (7 U.S.C. 2(c)(2)(D)(i)); and
    (F) Any transaction authorized under section 19 of the Commodity 
Exchange Act (7 U.S.C. 23(a) or (b));
    (ii) A derivative does not include:
    (A) Any consumer, commercial, or other agreement, contract, or 
transaction that the CFTC and SEC have further defined by joint 
regulation, interpretation, guidance, or other action as not within the 
definition of swap, as that term is defined in section 1a(47) of the 
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as 
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C. 
78c(a)(68));
    (B) Any identified banking product, as defined in section 402(b) of 
the Legal Certainty for Bank Products Act of 2000 (7 U.S.C. 27(b)), 
that is subject to section 403(a) of that Act (7 U.S.C. 27a(a)).
    (m) Exchange Act means the Securities Exchange Act of 1934 (15 
U.S.C. 78a et seq.).
    (n) Federal banking agencies means the Board, the Office of the 
Comptroller of the Currency, and the Federal Deposit Insurance 
Corporation.
    (o) Foreign banking organization has the same meaning as in section 
211.21(o) of the Board's Regulation K (12 CFR 211.21(o)).
    (p) Insured depository institution has the same meaning as in 
section 3(c) of the Federal Deposit Insurance Act (12 U.S.C. 1813(c)), 
but does not include any insured depository institution that is 
described in section 2(c)(2)(D) of the BHC Act (12 U.S.C. 
1841(c)(2)(D)).
    (q) Loan means any loan, lease, extension of credit, or secured or 
unsecured receivable.
    (r) Nonbank financial company supervised by the Board has the 
meaning specified in section 102 of the Financial Stability Act of 2010 
(12 U.S.C. 5311).
    (s) Qualifying foreign banking organization means a foreign banking 
organization that qualifies as such under section 211.23(a) of the 
Board's Regulation K (12 CFR 211.23(a)).
    (t) Resident of the United States means:
    (1) Any natural person resident in the United States;
    (2) Any partnership, corporation or other business entity organized 
or incorporated under the laws of the United States or any State;
    (3) Any estate of which any executor or administrator is a resident 
of the United States;
    (4) Any trust of which any trustee, beneficiary or, if the trust is 
revocable, any settlor is a resident of the United States;
    (5) Any agency or branch of a foreign entity located in the United 
States;
    (6) Any discretionary or non-discretionary account or similar 
account (other than an estate or trust) held by a dealer or fiduciary 
for the benefit or account of a resident of the United States;
    (7) Any discretionary account or similar account (other than an 
estate or trust) held by a dealer or fiduciary organized or 
incorporated in the United States, or (if an individual) a resident of 
the United States; or
    (8) Any person organized or incorporated under the laws of any 
foreign jurisdiction formed by or for a resident of the United States 
principally for the purpose of engaging in one or more transactions 
described in Sec.  ----.6(d)(1) or Sec.  ----.13(c)(1).
    (u) SEC means the Securities and Exchange Commission.
    (v) Sale and sell each include any contract to sell or otherwise 
dispose of. For security futures products, such terms include any 
contract, agreement, or transaction for future delivery. With respect 
to a commodity future, such terms include any contract, agreement, or 
transaction for future delivery. With respect to a derivative, such 
terms include the execution, termination (prior to its scheduled 
maturity date), assignment, exchange, or similar transfer or conveyance 
of, or extinguishing of rights or obligations under, a derivative, as 
the context may require.
    (w) Security has the meaning specified in section 3(a)(10) of the 
Exchange Act (15 U.S.C. 78c(a)(10)).
    (x) Security future has the meaning specified in section 3(a)(55) 
of the Exchange Act (15 U.S.C. 78c(a)(55)).
    (y) Securities Act means the Securities Act of 1933 (15 U.S.C. 77a 
et seq.).
    (z) Separate account means an account established and maintained by 
an insurance company subject to regulation by a State insurance 
regulator or a foreign insurance regulator under which income, gains, 
and losses, whether or not realized, from assets allocated to such 
account, are, in accordance with the applicable contract, credited to 
or charged against such account without regard to other income, gains, 
or losses of the insurance company.
    (aa) State means any State, territory or possession of the United 
States, and the District of Columbia.
    (bb) Subsidiary has the same meaning as in section 2(d) of the BHC 
Act (12 U.S.C. 1841(d)).

Subpart B--Proprietary Trading


Sec.  ----.3  Prohibition on proprietary trading.

    (a) Prohibition. Except as otherwise provided in this subpart, a 
covered banking entity may not engage in proprietary trading.
    (b) Definition of ``proprietary trading'' and related terms. For 
purposes of this subpart:
    (1) Proprietary trading means engaging as principal for the trading 
account of the covered banking entity in any purchase or sale of one or 
more covered financial positions. Proprietary trading does not include 
acting solely as agent, broker, or custodian for an unaffiliated third 
party.
    (2) Trading account.
    (i) Trading account means any account that is used by a covered 
banking entity to:
    (A) Acquire or take one or more covered financial positions 
principally for the purpose of:
    (1) Short-term resale;
    (2) Benefitting from actual or expected short-term price movements;
    (3) Realizing short-term arbitrage profits; or
    (4) Hedging one or more positions described in paragraphs 
(b)(2)(i)(A)(1), (2), or (3) of this section;
    (B) Acquire or take one or more covered financial positions, other 
than positions that are foreign exchange derivatives, commodity 
derivatives, or contracts of sale of a commodity for future delivery, 
that are market risk capital rule covered positions, if the covered 
banking entity, or any affiliate of the covered banking entity that is 
a bank holding company, calculates risk-based capital ratios under the 
market risk capital rule; or
    (C) Acquire or take one or more covered financial position for any 
purpose, if the covered banking entity is:

[[Page 8425]]

    (1) A dealer or municipal securities dealer that is registered with 
the SEC under the Exchange Act, to the extent the position is acquired 
or taken in connection with the activities of the dealer or municipal 
securities dealer that require it to be registered under that Act;
    (2) A government securities dealer that is registered, or that has 
filed notice, with an appropriate regulatory agency (as that term is 
defined in section 3(a)(34) of the Exchange Act (15 U.S.C. 78c(a)(34)), 
to the extent the position is acquired or taken in connection with the 
activities of the government securities dealer that require it to be 
registered, or to file notice, under that Act;
    (3) A swap dealer that is registered with the CFTC under the 
Commodity Exchange Act, to the extent the position is acquired or taken 
in connection with the activities of the swap dealer that require it to 
be registered under that Act;
    (4) A security-based swap dealer that is registered with the SEC 
under the Exchange Act, to the extent the position is acquired or taken 
in connection with the activities of the security-based swap dealer 
that require it to be registered under that Act; or
    (5) Engaged in the business of a dealer, swap dealer, or security-
based swap dealer outside of the United States to the extent the 
position is acquired or taken in connection with the activities of such 
business.
    (ii) Rebuttable presumption for certain positions. An account shall 
be presumed to be a trading account if it is used to acquire or take a 
covered financial position, other than a covered financial position 
described in paragraph (b)(2)(i)(B) or (C) of this section, that the 
covered banking entity holds for a period of sixty days or less, unless 
the covered banking entity can demonstrate, based on all the facts and 
circumstances, that the covered financial position, either individually 
or as a category, was not acquired or taken principally for any of the 
purposes described in paragraph (b)(2)(i)(A) of this section.
    (iii) An account shall not be deemed a trading account for purposes 
of paragraph (b)(2)(i) of this section to the extent that such account 
is used to acquire or take a position in one or more covered financial 
positions:
    (A) That arise under a repurchase or reverse repurchase agreement 
pursuant to which the covered banking entity has simultaneously agreed, 
in writing, to both purchase and sell a stated asset, at stated prices, 
and on stated dates or on demand with the same counterparty;
    (B) That arise under a transaction in which the covered banking 
entity lends or borrows a security temporarily to or from another party 
pursuant to a written securities lending agreement under which the 
lender retains the economic interests of an owner of such security, and 
has the right to terminate the transaction and to recall the loaned 
security on terms agreed by the parties;
    (C) For the bona fide purpose of liquidity management and in 
accordance with a documented liquidity management plan of the covered 
banking entity that:
    (1) Specifically contemplates and authorizes the particular 
instrument to be used for liquidity management purposes, its profile 
with respect to market, credit and other risks, and the liquidity 
circumstances in which the particular instrument may or must be used;
    (2) Requires that any transaction contemplated and authorized by 
the plan be principally for the purpose of managing the liquidity of 
the covered banking entity, and not for the purpose of short-term 
resale, benefitting from actual or expected short-term price movements, 
realizing short-term arbitrage profits, or hedging a position taken for 
such short-term purposes;
    (3) Requires that any position taken for liquidity management 
purposes be highly liquid and limited to financial instruments the 
market, credit and other risks of which the covered banking entity does 
not expect to give rise to appreciable profits or losses as a result of 
short-term price movements;
    (4) Limits any position taken for liquidity management purposes, 
together with any other positions taken for such purposes, to an amount 
that is consistent with the banking entity's near-term funding needs, 
including deviations from normal operations, as estimated and 
documented pursuant to methods specified in the plan; and
    (5) Is consistent with [Agency]'s supervisory requirements, 
guidance and expectations regarding liquidity management; or
    (D) That are acquired or taken by a covered banking entity that is 
a derivatives clearing organization registered under section 5b of the 
Commodity Exchange Act (7 U.S.C. 7a-1) or a clearing agency registered 
with the SEC under section 17A of the Exchange Act (15 U.S.C. 78q-1) in 
connection with clearing derivatives or securities transactions.
    (3) Covered financial position.
    (i) Covered financial position means any position, including any 
long, short, synthetic or other position, in:
    (A) A security, including an option on a security;
    (B) A derivative, including an option on a derivative; or
    (C) A contract of sale of a commodity for future delivery, or 
option on a contract of sale of a commodity for future delivery.
    (ii) A covered financial position does not include any position 
that is:
    (A) A loan;
    (B) A commodity; or
    (C) Foreign exchange or currency.
    (c) Definition of other terms related to proprietary trading. For 
purposes of this subpart:
    (1) Commodity has the same meaning as in section 1a(9) of the 
Commodity Exchange Act (7 U.S.C. 1a(9)), except that a commodity does 
not include any security;
    (2) Contract of sale of a commodity for future delivery means a 
contract of sale (as that term is defined in section 1a(13) of the 
Commodity Exchange Act (7 U.S.C. 1a(13)) for future delivery (as that 
term is defined in section 1a(27) of the Commodity Exchange Act (7 
U.S.C. 1a(27)).
    (3) Exempted security has the same meaning as in section 
3(a)(12)(A) of the Exchange Act (15 U.S.C. 78c(a)(12)(A)).
    (4) Foreign insurance regulator means the insurance commission, or 
a similar official or agency, of one or more countries other than the 
United States that is engaged in the supervision of insurance companies 
under foreign insurance law.
    (5) General account means, with respect to an insurance company, 
all of the assets of the insurance company that are not legally 
segregated and allocated to separate accounts under applicable State or 
foreign law.
    (6) Government securities has the same meaning as in section 
3(a)(42) of the Exchange Act (15 U.S.C. 78c(a)(42)).
    (7) Market risk capital rule covered position means a covered 
position as that term is defined for purposes of:
    (i) In the case of a covered banking entity that is a bank holding 
company or insured depository institution, the market risk capital rule 
that is applicable to the covered banking entity; and
    (ii) In the case of a covered banking entity that is affiliated 
with a bank holding company, other than a covered banking entity to 
which a market risk capital rule is applicable, the market risk capital 
rule that is applicable to the affiliated bank holding company.
    (8) Market risk capital rule means 12 CFR 3, Appendix B, 12 CFR 
208, Appendix E, 12 CFR 225, Appendix E, and 12 CFR 325, Appendix C, as 
applicable.

[[Page 8426]]

    (9) Municipal securities has the same meaning as in section 
3(a)(29) of the Exchange Act (15 U.S.C. 78c(a)(29)).
    (10) Security-based swap has the meaning specified in section 
3(a)(68) of the Exchange Act (15 U.S.C. 78c(a)(68)).
    (11) Swap has the meaning specified in section 1a(47) of the 
Commodity Exchange Act (7 U.S.C. 1a(47)).
    (12) State insurance regulator means the insurance commission, or a 
similar official or agency, of a State that is engaged in the 
supervision of insurance companies under State insurance law.


Sec.  ----.4  Permitted underwriting and market making-related 
activities.

    (a) Underwriting activities.
    (1) Permitted underwriting activities. The prohibition on 
proprietary trading contained in Sec.  ----.3(a) does not apply to the 
purchase or sale of a covered financial position by a covered banking 
entity that is made in connection with the covered banking entity's 
underwriting activities.
    (2) Requirements. For purposes of paragraph (a)(1) of this section, 
a purchase or sale of a covered financial position shall be deemed to 
be made in connection with a covered banking entity's underwriting 
activities only if:
    (i) The covered banking entity has established the internal 
compliance program required by subpart D of this part that is designed 
to ensure the covered banking entity's compliance with the requirements 
of paragraph (a)(2) of this section, including reasonably designed 
written policies and procedures, internal controls, and independent 
testing;
    (ii) The covered financial position is a security;
    (iii) The purchase or sale is effected solely in connection with a 
distribution of securities for which the covered banking entity is 
acting as underwriter;
    (iv) The covered banking entity is:
    (A) With respect to a purchase or sale effected in connection with 
a distribution of one or more covered financial positions that are 
securities, other than exempted securities, security-based swaps, 
commercial paper, bankers' acceptances, or commercial bills:
    (1) A dealer that is registered with the SEC under section 15 of 
the Exchange Act (15 U.S.C. 78o), or a person that is exempt from 
registration or excluded from regulation as a dealer thereunder; or
    (2) Engaged in the business of a dealer outside of the United 
States and subject to substantive regulation of such business in the 
jurisdiction where the business is located;
    (B) With respect to a purchase or sale effected as part of a 
distribution of one or more covered financial positions that are 
municipal securities, a municipal securities dealer that is registered 
under section 15B of the Exchange Act (15 U.S.C. 78o-4) or exempt from 
registration thereunder; or
    (C) With respect to a purchase or sale effected as part of a 
distribution of one or more covered financial positions that are 
government securities, a government securities dealer that is 
registered, or that has filed notice, under section 15C of the Exchange 
Act (15 U.S.C. 78o-5) or exempt from registration thereunder;
    (v) The underwriting activities of the covered banking entity with 
respect to the covered financial position are designed not to exceed 
the reasonably expected near term demands of clients, customers, or 
counterparties;
    (vi) The underwriting activities of the covered banking entity are 
designed to generate revenues primarily from fees, commissions, 
underwriting spreads or other income not attributable to:
    (A) Appreciation in the value of covered financial positions 
related to such activities; or
    (B) The hedging of covered financial positions related to such 
activities; and
    (vii) The compensation arrangements of persons performing 
underwriting activities are designed not to reward proprietary risk-
taking.
    (3) Definition of distribution. For purposes of paragraph (a) of 
this section, a distribution of securities means an offering of 
securities, whether or not subject to registration under the Securities 
Act, that is distinguished from ordinary trading transactions by the 
magnitude of the offering and the presence of special selling efforts 
and selling methods.
    (4) Definition of underwriter. For purposes of paragraph (a) of 
this section, underwriter means:
    (i) A person who has agreed with an issuer of securities or selling 
security holder:
    (A) To purchase securities for distribution;
    (B) To engage in a distribution of securities for or on behalf of 
such issuer or selling security holder; or
    (C) To manage a distribution of securities for or on behalf of such 
issuer or selling security holder; and
    (ii) A person who has an agreement with another person described in 
paragraph (a)(4)(i) of this section to engage in a distribution of such 
securities for or on behalf of the issuer or selling security holder.
    (b) Market making-related activities.
    (1) Permitted market making-related activities. The prohibition on 
proprietary trading contained in Sec.  ----.3(a) does not apply to the 
purchase or sale of a covered financial position by a covered banking 
entity that is made in connection with the covered banking entity's 
market making-related activities.
    (2) Requirements. For purposes of paragraph (b)(1) of this section, 
a purchase or sale of a covered financial position shall be deemed to 
be made in connection with a covered banking entity's market making-
related activities only if:
    (i) The covered banking entity has established the internal 
compliance program required by subpart D that is designed to ensure the 
covered banking entity's compliance with the requirements of paragraph 
(b)(2) of this section, including reasonably designed written policies 
and procedures, internal controls, and independent testing;
    (ii) The trading desk or other organizational unit that conducts 
the purchase or sale holds itself out as being willing to buy and sell, 
including through entering into long and short positions in, the 
covered financial position for its own account on a regular or 
continuous basis;
    (iii) The market making-related activities of the trading desk or 
other organizational unit that conducts the purchase or sale are, with 
respect to the covered financial position, designed not to exceed the 
reasonably expected near term demands of clients, customers, or 
counterparties;
    (iv) The covered banking entity is:
    (A) With respect to a purchase or sale of one or more covered 
financial positions that are securities, other than exempted 
securities, security-based swaps, commercial paper, bankers' 
acceptances, or commercial bills:
    (1) A dealer that is registered with the SEC under section 15 of 
the Exchange Act (15 U.S.C. 78o), or a person that is exempt from 
registration or excluded from regulation as a dealer thereunder; or
    (2) Engaged in the business of a dealer outside of the United 
States and subject to substantive regulation of such business in the 
jurisdiction where the business is located;
    (B) With respect to a purchase or sale of one or more covered 
financial positions that are swaps:
    (1) A swap dealer that is registered with the CFTC under the 
Commodity Exchange Act (7 U.S.C. 1a) or a person that is exempt from 
registration thereunder; or
    (2) Engaged in the business of a swap dealer outside the United 
States and subject to substantive regulation of such business in the 
jurisdiction where the business is located;

[[Page 8427]]

    (C) With respect to a purchase or sale of one or more covered 
financial positions that are security-based swaps:
    (1) A security-based swap dealer that is registered with the SEC 
under section 15F of the Exchange Act (15 U.S.C. 78o-10) or a person 
that is exempt from registration thereunder; or
    (2) Engaged in the business of a security-based swap dealer outside 
of the United States and subject to substantive regulation of such 
business in the jurisdiction where the business is located;
    (D) With respect to a purchase or sale of one or more covered 
financial positions that are municipal securities, a municipal 
securities dealer that is registered under section 15B of the Exchange 
Act (15 U.S.C. 78o-4) or a person that is exempt from registration 
thereunder; or
    (E) With respect to a purchase or sale of one or more covered 
financial positions that are government securities, a government 
securities dealer that is registered, or that has filed notice, under 
section 15C of the Exchange Act (15 U.S.C. 78o-5) or a person that is 
exempt from registration thereunder;
    (v) The market making-related activities of the trading desk or 
other organizational unit that conducts the purchase or sale are 
designed to generate revenues primarily from fees, commissions, bid/ask 
spreads or other income not attributable to:
    (A) Appreciation in the value of covered financial positions it 
holds in trading accounts; or
    (B) The hedging of covered financial positions it holds in trading 
accounts;
    (vi) The market making-related activities of the trading desk or 
other organizational unit that conducts the purchase or sale are 
consistent with the commentary provided in appendix B to this part; and
    (vii) The compensation arrangements of persons performing the 
market making-related activities are designed not to reward proprietary 
risk-taking.
    (3) Market making-related hedging. For purposes of paragraph (b)(1) 
of this section, a purchase or sale of a covered financial position 
shall also be deemed to be made in connection with a covered banking 
entity's market making-related activities if:
    (i) The covered financial position is purchased or sold to reduce 
the specific risks to the covered banking entity in connection with and 
related to individual or aggregated positions, contracts, or other 
holdings acquired pursuant to paragraph (b) of this section; and
    (ii) The purchase or sale meets all of the requirements described 
in Sec.  ----.5(b) and, if applicable, Sec.  ----.5(c).


Sec.  ----.5  Permitted risk-mitigating hedging activities.

    (a) Permitted risk-mitigating hedging activities. The prohibition 
on proprietary trading contained in Sec.  ----.3(a) does not apply to 
the purchase or sale of a covered financial position by a covered 
banking entity that is made in connection with and related to 
individual or aggregated positions, contracts, or other holdings of a 
covered banking entity and is designed to reduce the specific risks to 
the covered banking entity in connection with and related to such 
positions, contracts, or other holdings.
    (b) Requirements. For purposes of paragraph (a) of this section, a 
purchase or sale of a covered financial position shall be deemed to be 
in connection with and related to individual or aggregated positions, 
contracts, or other holdings of a covered banking entity and designed 
to reduce the specific risks to the covered banking entity in 
connection with and related to such positions, contracts, or other 
holdings only if:
    (1) The covered banking entity has established the internal 
compliance program required by subpart D of this part designed to 
ensure the covered banking entity's compliance with the requirements of 
paragraph (b) of this section, including reasonably designed written 
policies and procedures regarding the instruments, techniques and 
strategies that may be used for hedging, internal controls and 
monitoring procedures, and independent testing;
    (2) The purchase or sale:
    (i) Is made in accordance with the written policies, procedures and 
internal controls established by the covered banking entity pursuant to 
subpart D of this part;
    (ii) Hedges or otherwise mitigates one or more specific risks, 
including market risk, counterparty or other credit risk, currency or 
foreign exchange risk, interest rate risk, basis risk, or similar 
risks, arising in connection with and related to individual or 
aggregated positions, contracts, or other holdings of a covered banking 
entity;
    (iii) Is reasonably correlated, based upon the facts and 
circumstances of the underlying and hedging positions and the risks and 
liquidity of those positions, to the risk or risks the purchase or sale 
is intended to hedge or otherwise mitigate;
    (iv) Does not give rise, at the inception of the hedge, to 
significant exposures that were not already present in the individual 
or aggregated positions, contracts, or other holdings of a covered 
banking entity and that are not hedged contemporaneously;
    (v) Is subject to continuing review, monitoring and management by 
the covered banking entity that:
    (A) Is consistent with the written hedging policies and procedures 
required under paragraph (b)(1) of this section; and
    (B) Maintains a reasonable level of correlation, based upon the 
facts and circumstances of the underlying and hedging positions and the 
risks and liquidity of those positions, to the risk or risks the 
purchase or sale is intended to hedge or otherwise mitigate; and
    (C) Mitigates any significant exposure arising out of the hedge 
after inception; and
    (vi) The compensation arrangements of persons performing the risk-
mitigating hedging activities are designed not to reward proprietary 
risk-taking.
    (c) Documentation. With respect to any purchase, sale, or series of 
purchases or sales conducted by a covered banking entity pursuant to 
this Sec.  ----.5 for risk-mitigating hedging purposes that is 
established at a level of organization that is different than the level 
of organization establishing or responsible for the positions, 
contracts, or other holdings the risks of which the purchase, sale, or 
series of purchases or sales are designed to reduce, the covered 
banking entity must, at a minimum, document, at the time the purchase, 
sale, or series of purchases or sales are conducted:
    (1) The risk-mitigating purpose of the purchase, sale, or series of 
purchases or sales;
    (2) The risks of the individual or aggregated positions, contracts, 
or other holdings of a covered banking entity that the purchase, sale, 
or series of purchases or sales are designed to reduce; and
    (3) The level of organization that is establishing the hedge.


Sec.  ----.6  Other permitted proprietary trading activities.

    (a) Permitted trading in government obligations.
    (1) The prohibition on proprietary trading contained in Sec.  --
--.3(a) does not apply to the purchase or sale by a covered banking 
entity of a covered financial position that is:
    (i) An obligation of the United States or any agency thereof;
    (ii) An obligation, participation, or other instrument of or issued 
by the Government National Mortgage

[[Page 8428]]

Association, the Federal National Mortgage Association, the Federal 
Home Loan Mortgage Corporation, a Federal Home Loan Bank, the Federal 
Agricultural Mortgage Corporation or a Farm Credit System institution 
chartered under and subject to the provisions of the Farm Credit Act of 
1971 (12 U.S.C. 2001 et seq.); or
    (iii) An obligation of any State or any political subdivision 
thereof.
    (2) An obligation or other instrument described in paragraphs 
(a)(1)(i), (ii) or (iii) of this section shall include both general 
obligations and limited obligations, such as revenue bonds.
    (b) Permitted trading on behalf of customers. (1) The prohibition 
on proprietary trading contained in Sec.  ----.3(a) does not apply to 
the purchase or sale of a covered financial position by a covered 
banking entity on behalf of customers.
    (2) For purposes of paragraph (b)(1) of this section, a purchase or 
sale of a covered financial position by a covered banking entity shall 
be considered to be on behalf of customers if:
    (i) The purchase or sale:
    (A) Is conducted by a covered banking entity acting as investment 
adviser, commodity trading advisor, trustee, or in a similar fiduciary 
capacity for a customer;
    (B) Is conducted for the account of the customer; and
    (C) Involves solely covered financial positions of which the 
customer, and not the covered banking entity or any subsidiary or 
affiliate of the covered banking entity, is beneficial owner (including 
as a result of having long or short exposure under the relevant covered 
financial position);
    (ii) The covered banking entity is acting as riskless principal in 
a transaction in which the covered banking entity, after receiving an 
order to purchase (or sell) a covered financial position from a 
customer, purchases (or sells) the covered financial position for its 
own account to offset a contemporaneous sale to (or purchase from) the 
customer; or
    (iii) The covered banking entity is an insurance company that 
purchases or sells a covered financial position for a separate account, 
if:
    (A) The insurance company is directly engaged in the business of 
insurance and subject to regulation by a State insurance regulator or 
foreign insurance regulator;
    (B) The insurance company purchases or sells the covered financial 
position solely for a separate account established by the insurance 
company in connection with one or more insurance policies issued by 
that insurance company;
    (C) All profits and losses arising from the purchase or sale of a 
covered financial position are allocated to the separate account and 
inure to the benefit or detriment of the owners of the insurance 
policies supported by the separate account, and not the insurance 
company; and
    (D) The purchase or sale is conducted in compliance with, and 
subject to, the insurance company investment and other laws, 
regulations, and written guidance of the State or jurisdiction in which 
such insurance company is domiciled.
    (c) Permitted trading by a regulated insurance company. The 
prohibition on proprietary trading contained in Sec.  ----.3(a) does 
not apply to the purchase or sale of a covered financial position by an 
insurance company or any affiliate of an insurance company if:
    (1) The insurance company is directly engaged in the business of 
insurance and subject to regulation by a State insurance regulator or 
foreign insurance regulator;
    (2) The insurance company or its affiliate purchases or sells the 
covered financial position solely for the general account of the 
insurance company;
    (3) The purchase or sale is conducted in compliance with, and 
subject to, the insurance company investment laws, regulations, and 
written guidance of the State or jurisdiction in which such insurance 
company is domiciled; and
    (4) The appropriate Federal banking agencies, after consultation 
with the Financial Stability Oversight Council and the relevant 
insurance commissioners of the States, have not jointly determined, 
after notice and comment, that a particular law, regulation, or written 
guidance described in paragraph (c)(3) of this section is insufficient 
to protect the safety and soundness of the covered banking entity, or 
of the financial stability of the United States.
    (d) Permitted trading outside of the United States.
    (1) The prohibition on proprietary trading contained in Sec.  --
--.3(a) does not apply to the purchase or sale of a covered financial 
position by a covered banking entity if:
    (i) The covered banking entity is not directly or indirectly 
controlled by a banking entity that is organized under the laws of the 
United States or of one or more States;
    (ii) The purchase or sale is conducted pursuant to paragraph (9) or 
(13) of section 4(c) of the BHC Act; and
    (iii) The purchase or sale occurs solely outside of the United 
States.
    (2) A purchase or sale shall be deemed to be conducted pursuant to 
paragraph (9) or (13) of section 4(c) of the BHC Act only if:
    (i) With respect to a covered banking entity that is a foreign 
banking organization, the banking entity is a qualifying foreign 
banking organization and is conducting the purchase or sale in 
compliance with subpart B of the Board's Regulation K (12 CFR 211.20 
through 211.30); or
    (ii) With respect to a covered banking entity that is not a foreign 
banking organization, the covered banking entity meets at least two of 
the following requirements:
    (A) Total assets of the covered banking entity held outside of the 
United States exceed total assets of the covered banking entity held in 
the United States;
    (B) Total revenues derived from the business of the covered banking 
entity outside of the United States exceed total revenues derived from 
the business of the covered banking entity in the United States; or
    (C) Total net income derived from the business of the covered 
banking entity outside of the United States exceeds total net income 
derived from the business of the covered banking entity in the United 
States.
    (3) A purchase or sale shall be deemed to have occurred solely 
outside of the United States only if:
    (i) The covered banking entity conducting the purchase or sale is 
not organized under the laws of the United States or of one or more 
States;
    (ii) No party to the purchase or sale is a resident of the United 
States;
    (iii) No personnel of the covered banking entity who is directly 
involved in the purchase or sale is physically located in the United 
States; and
    (iv) The purchase or sale is executed wholly outside of the United 
States.


Sec.  ----.7  Reporting and recordkeeping requirements applicable to 
trading activities.

    A covered banking entity engaged in any proprietary trading 
activity permitted under Sec. Sec.  ----.4 through ----.6 shall comply 
with:
    (a) The reporting and recordkeeping requirements described in 
appendix A to this part, if the covered banking entity has, together 
with its affiliates and subsidiaries, trading assets and liabilities 
the average gross sum of which (on a worldwide consolidated basis) is, 
as measured as of the last day of each of the four prior calendar 
quarters, equal to or greater than $1 billion;

[[Page 8429]]

    (b) The recordkeeping requirements required under Sec.  ----.20 and 
appendix C to this part, as applicable; and
    (c) Such other reporting and recordkeeping requirements as [Agency] 
may impose to evaluate the covered banking entity's compliance with 
this subpart.


Sec.  ----.8  Limitations on permitted proprietary trading activities.

    (a) No transaction, class of transactions, or activity may be 
deemed permissible under Sec. Sec.  ----.4 through ----.6 if the 
transaction, class of transactions, or activity would:
    (1) Involve or result in a material conflict of interest between 
the covered banking entity and its clients, customers, or 
counterparties;
    (2) Result, directly or indirectly, in a material exposure by the 
covered banking entity to a high-risk asset or a high-risk trading 
strategy; or
    (3) Pose a threat to the safety and soundness of the covered 
banking entity or to the financial stability of the United States.
    (b) Definition of material conflict of interest. For purposes of 
this section, a material conflict of interest between a covered banking 
entity and its clients, customers, or counterparties exists if the 
covered banking entity engages in any transaction, class of 
transactions, or activity that would involve or result in the covered 
banking entity's interests being materially adverse to the interests of 
its client, customer, or counterparty with respect to such transaction, 
class of transactions, or activity, unless:
    (1) Timely and effective disclosure and opportunity to negate or 
substantially mitigate. Prior to effecting the specific transaction or 
class or type of transactions, or engaging in the specific activity, 
for which a conflict of interest may arise, the covered banking entity:
    (i) Makes clear, timely, and effective disclosure of the conflict 
of interest, together with other necessary information, in reasonable 
detail and in a manner sufficient to permit a reasonable client, 
customer, or counterparty to meaningfully understand the conflict of 
interest; and
    (ii) Makes such disclosure explicitly and effectively, and in a 
manner that provides the client, customer, or counterparty the 
opportunity to negate, or substantially mitigate, any materially 
adverse effect on the client, customer, or counterparty created by the 
conflict of interest; or
    (2) Information barriers. The covered banking entity has 
established, maintained, and enforced information barriers that are 
memorialized in written policies and procedures, such as physical 
separation of personnel, or functions, or limitations on types of 
activity, that are reasonably designed, taking into consideration the 
nature of the covered banking entity's business, to prevent the 
conflict of interest from involving or resulting in a materially 
adverse effect on a client, customer, or counterparty. A covered 
banking entity may not rely on such information barriers if, in the 
case of any specific transaction, class or type of transactions or 
activity, the banking entity knows or should reasonably know that, 
notwithstanding the covered banking entity's establishment of 
information barriers, the conflict of interest may involve or result in 
a materially adverse effect on a client, customer, or counterparty.
    (c) Definition of high-risk asset and high-risk trading strategy. 
For purposes of this section:
    (1) High-risk asset means an asset or group of related assets that 
would, if held by a covered banking entity, significantly increase the 
likelihood that the covered banking entity would incur a substantial 
financial loss or would fail.
    (2) High-risk trading strategy means a trading strategy that would, 
if engaged in by a covered banking entity, significantly increase the 
likelihood that the covered banking entity would incur a substantial 
financial loss or would fail.

Subpart C--Covered Funds Activities and Investments


Sec.  ----.10  Prohibition on acquiring or retaining an ownership 
interest in and having certain relationships with a covered fund.

    (a) Prohibition. Except as otherwise provided in this subpart, a 
covered banking entity may not, as principal, directly or indirectly, 
acquire or retain any ownership interest in or sponsor a covered fund.
    (b) Definitions. For purposes of this part:
    (1) Covered fund means:
    (i) An issuer that would be an investment company, as defined in 
the Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.), but for 
section 3(c)(1) or 3(c)(7) of that Act (15 U.S.C. 80a-3(c)(1) or (7));
    (ii) A commodity pool, as defined in section 1a(10) of the 
Commodity Exchange Act (7 U.S.C. 1a(10));
    (iii) Any issuer, as defined in section 2(a)(22) of the Investment 
Company Act of 1940 (15 U.S.C. 80a-2(a)(22)), that is organized or 
offered outside of the United States that would be a covered fund as 
defined in paragraphs (b)(1)(i), (ii), or (iv) of this section, were it 
organized or offered under the laws, or offered to one or more 
residents, of the United States or of one or more States; and
    (iv) Any such similar fund as the appropriate Federal banking 
agencies, the SEC, and the CFTC may determine, by rule, as provided in 
section 13(b)(2) of the BHC Act.
    (2) Director has the same meaning as provided in Sec.  215.2(d)(1) 
of the Board's Regulation O (12 CFR 215.2(d)(1)).
    (3) Ownership interest.
    (i) Ownership interest means any equity, partnership, or other 
similar interest (including, without limitation, a share, equity 
security, warrant, option, general partnership interest, limited 
partnership interest, membership interest, trust certificate, or other 
similar instrument) in a covered fund, whether voting or nonvoting, or 
any derivative of such interest.
    (ii) Ownership interest does not include, with respect to a covered 
fund:
    (A) Carried interest. An interest held by a covered banking entity 
(or an affiliate, subsidiary or employee thereof) in a covered fund for 
which the covered banking entity (or an affiliate, subsidiary or 
employee thereof) serves as investment manager, investment adviser or 
commodity trading adviser, so long as:
    (1) The sole purpose and effect of the interest is to allow the 
covered banking entity (or the affiliate, subsidiary or employee 
thereof) to share in the profits of the covered fund as performance 
compensation for services provided to the covered fund by the covered 
banking entity (or the affiliate, subsidiary or employee thereof), 
provided that the covered banking entity (or the affiliate, subsidiary 
or employee thereof) may be obligated under the terms of such interest 
to return profits previously received;
    (2) All such profit, once allocated, is distributed to the covered 
banking entity (or the affiliate, subsidiary or employee thereof) 
promptly after being earned or, if not so distributed, the reinvested 
profit of the covered banking entity (or the affiliate, subsidiary or 
employee thereof) does not share in the subsequent profits and losses 
of the covered fund;
    (3) The covered banking entity (or the affiliate, subsidiary or 
employee thereof) does not provide funds to the covered fund in 
connection with acquiring or retaining this interest; and
    (4) The interest is not transferable by the covered banking entity 
(or the affiliate, subsidiary or employee thereof) except to another 
affiliate or subsidiary thereof.

[[Page 8430]]

    (4) Prime brokerage transaction means one or more products or 
services provided by a covered banking entity to a covered fund, such 
as custody, clearance, securities borrowing or lending services, trade 
execution, or financing, data, operational, and portfolio management 
support.
    (5) Sponsor, with respect to a covered fund, means:
    (i) To serve as a general partner, managing member, trustee, or 
commodity pool operator of a covered fund;
    (ii) In any manner to select or to control (or to have employees, 
officers, or directors, or agents who constitute) a majority of the 
directors, trustees, or management of a covered fund; or
    (iii) To share with a covered fund, for corporate, marketing, 
promotional, or other purposes, the same name or a variation of the 
same name.
    (6) Trustee. (i) For purposes of this subpart, a trustee does not 
include a trustee that does not exercise investment discretion with 
respect to a covered fund, including a directed trustee, as that term 
is used in section 403(a)(1) of the Employee's Retirement Income 
Security Act (29 U.S.C. 1103(a)(1)).
    (ii) Any covered banking entity that directs a person identified in 
paragraph (b)(6)(i) of this section, or that possesses authority and 
discretion to manage and control the assets of a covered fund for which 
such person identified in paragraph (b)(6)(i) of this section serves as 
trustee, shall be considered a trustee of such covered fund.


Sec.  ----.11  Permitted organizing and offering of a covered fund.

    Section ----.10(a) does not prohibit a covered banking entity from, 
directly or indirectly, organizing and offering a covered fund, 
including serving as a general partner, managing member, trustee, or 
commodity pool operator of the covered fund and in any manner selecting 
or controlling (or having employees, officers, directors, or agents who 
constitute) a majority of the directors, trustees, or management of the 
covered fund, including any necessary expenses for the foregoing, only 
if:
    (a) The covered banking entity provides bona fide trust, fiduciary, 
investment advisory, or commodity trading advisory services;
    (b) The covered fund is organized and offered only in connection 
with the provision of bona fide trust, fiduciary, investment advisory, 
or commodity trading advisory services and only to persons that are 
customers of such services of the covered banking entity, pursuant to a 
credible plan or similar documentation outlining how the covered 
banking entity intends to provide advisory or similar services to its 
customers through organizing and offering such fund;
    (c) The covered banking entity does not acquire or retain an 
ownership interest in the covered fund except as permitted under this 
subpart;
    (d) The covered banking entity complies with the restrictions under 
Sec.  ----.16 of this subpart;
    (e) The covered banking entity does not, directly or indirectly, 
guarantee, assume, or otherwise insure the obligations or performance 
of the covered fund or of any covered fund in which such covered fund 
invests;
    (f) The covered fund, for corporate, marketing, promotional, or 
other purposes:
    (1) Does not share the same name or a variation of the same name 
with the covered banking entity (or an affiliate or subsidiary 
thereof); and
    (2) Does not use the word ``bank'' in its name;
    (g) No director or employee of the covered banking entity takes or 
retains an ownership interest in the covered fund, except for any 
director or employee of the covered banking entity who is directly 
engaged in providing investment advisory or other services to the 
covered fund; and
    (h) The covered banking entity:
    (1) Clearly and conspicuously discloses, in writing, to any 
prospective and actual investor in the covered fund (such as through 
disclosure in the covered fund's offering documents):
    (i) That ``any losses in [such covered fund] will be borne solely 
by investors in [the covered fund] and not by [the covered banking 
entity and its affiliates or subsidiaries]; therefore, [the covered 
banking entity's and its affiliates' or subsidiaries'] losses in [such 
covered fund] will be limited to losses attributable to the ownership 
interests in the covered fund held by the [covered banking entity and 
its affiliates or subsidiaries] in their capacity as investors in the 
[covered fund]'';
    (ii) That such investor should read the fund offering documents 
before investing in the covered fund;
    (iii) That the ``ownership interests in the covered fund are not 
insured by the FDIC, and are not deposits, obligations of, or endorsed 
or guaranteed in any way, by any banking entity'' (unless that happens 
to be the case);
    (iv) The role of the covered banking entity and its affiliates, 
subsidiaries and employees in sponsoring or providing any services to 
the covered fund; and
    (2) Complies with any additional rules of the appropriate Federal 
banking agencies, the SEC, or the CFTC, as provided in section 13(b)(2) 
of the BHC Act, designed to ensure that losses in such covered fund are 
borne solely by investors in the covered fund and not by the covered 
banking entity and its affiliates or subsidiaries.


Sec.  ----.12  Permitted investment in a covered fund.

    (a) Authority and limitations on permitted investments in covered 
funds. (1) The prohibition contained in Sec.  ----.10(a) does not apply 
with respect to a covered banking entity acquiring and retaining any 
ownership interest in a covered fund that the covered banking entity or 
an affiliate or subsidiary thereof organizes and offers, for the 
purposes of:
    (i) Establishment. Establishing the covered fund and providing the 
fund with sufficient initial equity for investment to permit the fund 
to attract unaffiliated investors as required by paragraph (a)(2)(i) of 
this section; or
    (ii) De minimis investment. Making and retaining an investment in 
the covered fund that does not exceed 3 percent of the total 
outstanding ownership interests in the fund.
    (2) Ownership limits.
    (i) With respect to an investment in any covered fund pursuant to 
paragraph (a)(1)(i) of this section, the covered banking entity:
    (A) Must actively seek unaffiliated investors to reduce through 
redemption, sale, dilution, or other methods the aggregate amount of 
all ownership interests of the covered banking entity in any covered 
fund under Sec.  ----.12 to the amount permitted in paragraph 
(a)(2)(i)(B) of this section; and
    (B) May not exceed 3 percent of the total amount or value of 
outstanding ownership interests of the fund not later than 1 year after 
the date of establishment of the fund (or such longer period as may be 
provided by the Board pursuant to paragraph (e) of this section); and
    (ii) The aggregate value of all ownership interests of the covered 
banking entity in all covered funds under Sec.  ----.12 may not exceed 
3 percent of the tier 1 capital of the covered banking entity, as 
provided under paragraph (c) of this section.
    (b) Limitations on investments in a single covered fund. For 
purposes of determining whether a covered banking entity is in 
compliance with the limitations and restrictions on permitted 
investments in covered funds contained in paragraph (a) of this 
section, a covered banking entity shall calculate its amount and value 
of a permitted

[[Page 8431]]

investment in a single covered fund as follows:
    (1) Attribution of ownership interests to a covered banking entity. 
The amount and value of a banking entity's permitted investment in any 
single covered fund shall include:
    (i) Controlled investments. Any ownership interest held under Sec.  
----.12 by any entity that is controlled, directly or indirectly, by 
the covered banking entity for purposes of this part; and
    (ii) Noncontrolled investments. The pro rata share of any ownership 
interest held under Sec.  ----.12 by any covered fund that is not 
controlled by the covered banking entity but in which the covered 
banking entity owns, controls, or holds with the power to vote more 
than 5 percent of the voting shares.
    (2) Calculation of amount of ownership interests in a single 
covered fund. For purposes of determining whether an investment in a 
single covered fund does not exceed 3 percent of the total outstanding 
ownership interests of the fund under paragraph (a)(2)(i)(B) of this 
section:
    (i) The aggregate amount of all ownership interests of the covered 
banking entity shall be the greater of (without regard to committed 
funds not yet called for investment):
    (A) The value of any investment or capital contribution made with 
respect to all ownership interests held under Sec.  ----.12 by the 
covered banking entity in the covered fund, divided by the value of all 
investments or capital contributions, respectively, made by all persons 
in that covered fund; or
    (B) The total number of ownership interests held under Sec.  --
--.12 by the covered banking entity in a covered fund divided by the 
total number of ownership interests held by all persons in that covered 
fund.
    (ii) Inclusion of certain parallel investments. To the extent that 
a covered banking entity is contractually obligated to directly invest 
in, or is found to be acting in concert through knowing participation 
in a joint activity or parallel action toward a common goal of 
investing in, one or more investments with a covered fund that is 
organized and offered by the covered banking entity, whether or not 
pursuant to an express agreement, such investments shall be included in 
any calculation required under paragraph (a)(2) of this section.
    (3) Timing of single covered fund investment calculation. The 
aggregate amount of all ownership interests of a covered banking entity 
in a single covered fund may at no time exceed the limits in this 
paragraph after the conclusion of the period provided in paragraph 
(a)(2)(i)(B) of this section.
    (4) Methodology and standards for calculation. For purposes of 
determining the amount or value of its investment in a covered fund 
under this paragraph (b), a covered banking entity must calculate its 
investment in the same manner and according to the same standards 
utilized by the covered fund for determining the aggregate value of the 
fund's assets and ownership interests.
    (c) Aggregate permitted investments in all covered funds. (1) For 
purposes of determining the aggregate value of all permitted 
investments in all covered funds by a covered banking entity under 
paragraph (a)(2)(ii) of this section, the aggregate value of all 
ownership interests held by that covered banking entity shall be the 
sum of the value of each investment in a covered fund held under Sec.  
----.12, as determined in accordance with applicable accounting 
standards.
    (2) Calculation of tier 1 capital. For purposes of determining 
compliance with paragraph (a)(2)(ii) of this section:
    (i) Entities that are required to hold and report tier 1 capital. 
If a covered banking entity is required to calculate and report tier 1 
capital, the covered banking entity's tier 1 capital shall be equal to 
the amount of tier 1 capital calculated by that covered banking entity 
as of the last day of the most recent calendar quarter that has ended, 
as reported to its primary financial regulatory agency, as defined in 
section 2(12) of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act; and
    (ii) If a covered banking entity is not required to calculate and 
report tier 1 capital, the covered banking entity's tier 1 capital 
shall be determined to be equal to:
    (A) In the case of a covered banking entity that is controlled, 
directly or indirectly, by a depository institution that calculates and 
reports tier 1 capital, the amount of tier 1 capital reported by such 
controlling depository institution pursuant to paragraph (c)(2)(i) of 
this section;
    (B) In the case of a covered banking entity that is not controlled, 
directly or indirectly, by a depository institution that calculates and 
reports tier 1 capital:
    (1) Bank holding company subsidiaries. If the covered banking 
entity is a subsidiary of a bank holding company or company that is 
treated as a bank holding company, the amount of tier 1 capital 
reported by the top-tier affiliate of such covered banking entity that 
calculates and reports tier 1 capital, pursuant to paragraph (c)(2)(i) 
of this section; and
    (2) Other holding companies and any subsidiary or affiliate 
thereof. If the covered banking entity is not a subsidiary of a bank 
holding company or a company that is treated as a bank holding company, 
the total amount of shareholders' equity of the top-tier affiliate 
within such organization as of the last day of the most recent calendar 
quarter that has ended, as determined under applicable accounting 
standards.
    (3) A covered banking entity's aggregate permitted investment in 
all covered funds shall be calculated as of the last day of each 
calendar quarter.
    (d) Capital treatment for a permitted investment in a covered fund. 
For purposes of calculating capital pursuant to the applicable capital 
rules, a covered banking entity shall deduct the aggregate value of all 
permitted investments in all covered funds made or retained by a 
covered banking entity pursuant to this section (as determined under 
paragraph (c)(1) of this section) from the banking entity's tier 1 
capital (as determined under paragraph (c)(2) of this section).
    (e) Extension of time to divest an ownership interest. (1) Upon 
application by a covered banking entity, the Board may extend the 
period of time to meet the requirements under paragraphs (a)(2)(i)(A) 
and (B) of this section for up to 2 additional years, if the Board 
finds that an extension would be consistent with safety and soundness 
and not detrimental to the public interest. An application for 
extension must:
    (i) Be submitted to the Board at least 90 days prior to the 
expiration of the applicable time period;
    (ii) Provide the reasons for application, including information 
that addresses the factors in paragraph (e)(2) of this section; and
    (iii) Explain the covered banking entity's plan for reducing the 
permitted investment in a covered fund through redemption, sale, 
dilution or other methods as required in paragraph (a)(2)(i) of this 
section.
    (2) Factors governing Board determinations. In reviewing any 
application under paragraph (e)(1) of this section, the Board may 
consider all the facts and circumstances related to the permitted 
investment in a covered fund, including:
    (i) Whether the investment would:
    (A) Involve or result in material conflicts of interest between the 
covered banking entity and its clients, customers or counterparties;
    (B) Result, directly or indirectly, in a material exposure by the 
covered

[[Page 8432]]

banking entity to high-risk assets or high-risk trading strategies;
    (C) Pose a threat to the safety and soundness of the covered 
banking entity; or
    (D) Pose a threat to the financial stability of the United States;
    (ii) Market conditions;
    (iii) The contractual terms governing the covered banking entity's 
interest in the covered fund;
    (iv) The date on which the covered fund is expected to have 
attracted sufficient investments from investors unaffiliated with the 
covered banking entity to enable the covered banking entity to comply 
with the limitations in paragraph (a)(2)(i) of this section;
    (iv) The total exposure of the covered banking entity to the 
investment and the risks that disposing of, or maintaining, the 
investment in the covered fund may pose to the covered banking entity 
and the financial stability of the United States;
    (v) The cost to the covered banking entity of divesting or 
disposing of the investment within the applicable period;
    (vi) Whether the divestiture or conformance of the investment would 
involve or result in a material conflict of interest between the 
covered banking entity and unaffiliated clients, customers or 
counterparties to which it owes a duty;
    (vii) The covered banking entity's prior efforts to reduce through 
redemption, sale, dilution, or other methods its ownership interests in 
the covered fund, including activities related to the marketing of 
interests in such covered fund; and
    (viii) Any other factor that the Board believes appropriate.
    (3) Consultation. In the case of a covered banking entity that is 
primarily regulated by another Federal banking agency, the SEC, or the 
CFTC, the Board will consult with such agency prior to approval of an 
application by the covered banking entity for an extension under 
paragraph (e)(1) of this section.
    (4) Authority to impose restrictions on activities or investment 
during any extension period. (i) The Board may impose such conditions 
on any extension approved under paragraph (e)(1) of this section as the 
Board determines are necessary or appropriate to protect the safety and 
soundness of the covered banking entity or the financial stability of 
the United States, address material conflicts of interest or other 
unsound banking practices, or otherwise further the purposes of section 
13 of the BHC Act (12 U.S.C. 1851) and this part.
    (ii) Consultation. In the case of a covered banking entity that is 
primarily regulated by another Federal banking agency, the SEC, or the 
CFTC, the Board will consult with such agency prior to imposing 
conditions on the approval of a request by the covered banking entity 
for an extension under paragraph (e)(1) of this section.


Sec.  ----.13  Other permitted covered fund activities and investments.

    (a) Permitted investments in SBICs and related investments. The 
prohibition contained in Sec.  ----.10(a) does not apply with respect 
to acquiring or retaining an ownership interest in, or acting as 
sponsor to, a covered fund by a covered banking entity or an affiliate 
or subsidiary thereof:
    (1) In one or more small business investment companies, as defined 
in section 102 of the Small Business Investment Act of 1958 (15 U.S.C. 
662);
    (2) That is designed primarily to promote the public welfare, of 
the type permitted under paragraph (11) of section 5136 of the Revised 
Statutes of the United States (12 U.S.C. 24), including the welfare of 
low- and moderate-income communities or families (such as providing 
housing, services, or jobs); or
    (3) That is a qualified rehabilitation expenditure with respect to 
a qualified rehabilitation building or certified historic structure, as 
such terms are defined in section 47 of the Internal Revenue Code of 
1986 or a similar State historic tax credit program.
    (b) Permitted Risk-Mitigating Hedging Activities.
    (1) The prohibition contained in Sec.  ----.10(a) does not apply 
with respect to an ownership interest in a covered fund by a covered 
banking entity, provided that the acquisition or retention of the 
ownership interest is:
    (i) Made in connection with and related to individual or aggregated 
obligations or liabilities of the covered banking entity that are:
    (A) Taken by the covered banking entity when acting as intermediary 
on behalf of a customer that is not itself a banking entity to 
facilitate the exposure by the customer to the profits and losses of 
the covered fund, or
    (B) Directly connected to a compensation arrangement with an 
employee that directly provides investment advisory or other services 
to the covered fund; and
    (ii) Designed to reduce the specific risks to the covered banking 
entity in connection with and related to such obligations or 
liabilities.
    (2) Requirements. For purposes of paragraph (b)(1) of this section, 
acquiring or retaining an ownership interest in a covered fund by a 
covered banking entity shall be a permissible risk-mitigating hedging 
activity under this section only if:
    (i) The covered banking entity has established the internal 
compliance program required by subpart D designed to ensure the covered 
banking entity's compliance with the requirements of this paragraph 
(b)(2) of this section including reasonably designed written policies 
and procedures regarding the instruments, techniques and strategies 
that may be used for hedging, internal controls and monitoring 
procedures, and independent testing;
    (ii) The acquisition or retention of an ownership interest in a 
covered fund:
    (A) Is made in accordance with the written policies, procedures and 
internal controls established by the covered banking entity pursuant to 
subpart D of this part;
    (B) Hedges or otherwise mitigates an exposure to a covered fund 
through an offsetting exposure to the same covered fund and in the same 
amount of ownership interest in that covered fund that:
    (1) Arises out of a transaction conducted solely to accommodate a 
specific customer request with respect to, or
    (2) Is directly connected to its compensation arrangement with an 
employee that directly provides investment advisory or other services 
to, that covered fund;
    (C) Does not give rise, at the inception of the hedge, to 
significant exposures that were not already present in individual or 
aggregated positions, contracts, or other holdings of a covered banking 
entity and that are not hedged contemporaneously; and
    (D) Is subject to continuing review, monitoring and management by 
the covered banking entity that:
    (1) Is consistent with its written hedging policies and procedures;
    (2) Maintains a substantially similar offsetting exposure to the 
same amount and type of ownership interest, based upon the facts and 
circumstances of the underlying and hedging positions and the risks and 
liquidity of those positions, to the risk or risks the purchase or sale 
is intended to hedge or otherwise mitigate; and
    (3) Mitigates any significant exposure arising out of the hedge 
after inception; and
    (iii) The compensation arrangements of persons performing the risk-
mitigating hedging activities are designed not to reward proprietary 
risk-taking.

[[Page 8433]]

    (3) Documentation. With respect to any acquisition or retention of 
an ownership interest in a covered fund by a covered banking entity 
pursuant to this paragraph (b), the covered banking entity must 
document, at the time the transaction is conducted:
    (i) The risk-mitigating purpose of the acquisition or retention of 
an ownership interest in a covered fund;
    (ii) The risks of the individual or aggregated obligation or 
liability of a covered banking entity that the acquisition or retention 
of an ownership interest in a covered fund is designed to reduce; and
    (iii) The level of organization that is establishing the hedge.
    (c) Certain permitted covered fund activities and investments 
outside of the United States.
    (1) The prohibition contained in Sec.  ----.10(a) does not apply to 
the acquisition or retention of any ownership interest in, or the 
sponsorship of, a covered fund by a covered banking entity if:
    (i) The covered banking entity is not directly or indirectly 
controlled by a banking entity that is organized under the laws of the 
United States or of one or more States;
    (ii) The activity is conducted pursuant to paragraph (9) or (13) of 
section 4(c) of the BHC Act;
    (iii) No ownership interest in such covered fund is offered for 
sale or sold to a resident of the United States; and
    (iv) The activity occurs solely outside of the United States.
    (2) An activity shall be considered to be conducted pursuant to 
paragraph (9) or (13) of section 4(c) of the BHC Act only if:
    (i) With respect to a covered banking entity that is a foreign 
banking organization, the covered banking entity is a qualifying 
foreign banking organization and is conducting the activity in 
compliance with subpart B of the Board's Regulation K (12 CFR 211.20 
through 211.30); or
    (ii) With respect to a covered banking entity that is not a foreign 
banking organization, the covered banking entity meets at least two of 
the following requirements:
    (A) Total assets of the covered banking entity held outside of the 
United States exceed total assets of the covered banking entity held in 
the United States;
    (B) Total revenues derived from the business of the covered banking 
entity outside of the United States exceed total revenues derived from 
the business of the covered banking entity in the United States; or
    (C) Total net income derived from the business of the covered 
banking entity outside of the United States exceeds total net income 
derived from the business of the covered banking entity in the United 
States.
    (3) An activity shall be considered to have occurred solely outside 
of the United States only if:
    (i) The covered banking entity engaging in the activity is not 
organized under the laws of the United States or of one or more States;
    (ii) No subsidiary, affiliate, or employee of the covered banking 
entity that is involved in the offer or sale of an ownership interest 
in the covered fund is incorporated or physically located in the United 
States or in one or more States; and
    (iii) No ownership interest in such covered fund is offered for 
sale or sold to a resident of the United States.
    (d) Loan securitizations. The prohibition contained in Sec.  --
--.10(a) does not apply with respect to the acquisition or retention by 
a covered banking entity of any ownership interest in, or acting as 
sponsor to, a covered fund that is an issuer of asset-backed 
securities, the assets or holdings of which are solely comprised of:
    (1) Loans;
    (2) Contractual rights or assets directly arising from those loans 
supporting the asset-backed securities; and
    (3) Interest rate or foreign exchange derivatives that:
    (i) Materially relate to the terms of such loans or contractual 
rights or assets; and
    (ii) Are used for hedging purposes with respect to the 
securitization structure.


Sec.  ----.14  Covered fund activities determined to be permissible.

    (a) The prohibition contained in Sec.  ----.10(a) does not apply to 
the acquisition or retention by a covered banking entity of any 
ownership interest in or acting as sponsor to:
    (1) Bank owned life insurance. A separate account which is used 
solely for the purpose of allowing a covered banking entity to purchase 
an insurance policy for which the covered banking entity is the 
beneficiary, provided that the covered banking entity that purchases 
the insurance policy:
    (i) Does not control the investment decisions regarding the 
underlying assets or holdings of the separate account; and
    (ii) Holds its ownership interest in the separate account in 
compliance with applicable supervisory guidance regarding bank owned 
life insurance.
    (2) Certain other covered funds. Any of the following entities that 
would otherwise qualify as a covered fund:
    (i) A joint venture between the covered banking entity or one of 
its affiliates and any other person, provided that the joint venture:
    (A) Is an operating company; and
    (B) Does not engage in any activity or make any investment that is 
prohibited under this part;
    (ii) An acquisition vehicle, provided that the sole purpose and 
effect of such entity is to effectuate a transaction involving the 
acquisition or merger of one entity with or into the covered banking 
entity or one of its affiliates;
    (iii) An issuer of an asset-backed security, but only with respect 
to that amount or value of economic interest in a portion of the credit 
risk for an asset-backed security that is retained by a covered banking 
entity that is a ``securitizer'' or ``originator'' in compliance with 
the minimum requirements of section 15G of the Exchange Act (15 U.S.C. 
78o-11) and any implementing regulations issued thereunder;
    (iv) A wholly-owned subsidiary of the covered banking entity that 
is:
    (A) Engaged principally in performing bona fide liquidity 
management activities described in Sec.  ----.3(b)(2)(iii)(C), and
    (B) Carried on the balance sheet of the covered banking entity; and
    (v) A covered fund that is an issuer of asset-backed securities 
described in Sec.  ----.13(d), the assets or holdings of which are 
solely comprised of:
    (A) Loans;
    (B) Contractual rights or assets directly arising from those loans 
supporting the asset-backed securities; and
    (C) Interest rate or foreign exchange derivatives that:
    (1) Materially relate to the terms of such loans or contractual 
rights or assets, and
    (2) Are used for hedging purposes with respect to the 
securitization structure.
    (b) The prohibition contained in Sec.  ----.10(a) does not apply to 
the acquisition or retention by a covered banking entity of any 
ownership interest in, or acting as sponsor to, a covered fund, but 
only if such ownership interest is acquired or retained by a covered 
banking entity (or an affiliate or subsidiary thereof):
    (1) In the ordinary course of collecting a debt previously 
contracted in good faith, if the covered banking entity divests the 
ownership interest within applicable time periods provided for by the 
[Agency]; or

[[Page 8434]]

    (2) Pursuant to and in compliance with the conformance or extended 
transition period authorities provided for in subpart E of the Board's 
rules implementing section 13 of the BHC Act (12 CFR 248.30 through 
248.35).


Sec.  ----.15  Internal controls, reporting and recordkeeping 
requirements applicable to covered fund activities and investments.

    A covered banking entity engaged in any covered fund activity or 
making or holding any investment permitted under this subpart shall 
comply with:
    (a) The internal controls, reporting, and recordkeeping 
requirements required under Sec.  ----.20 and appendix C to this part, 
as applicable; and
    (b) Such other reporting and recordkeeping requirements as the 
[Agency] may deem necessary to appropriately evaluate the covered 
banking entity's compliance with this subpart.


Sec.  ----.16  Limitations on relationships with a covered fund.

    (a) Relationships with a covered fund.
    (1) Except as provided for in paragraph (a)(2) of this section, no 
covered banking entity that serves, directly or indirectly, as the 
investment manager, investment adviser, commodity trading advisor, or 
sponsor to a covered fund, or that organizes and offers a covered fund 
pursuant to Sec.  ----.11, and no affiliate of such entity, may enter 
into a transaction with the covered fund, or with any other covered 
fund that is controlled by such covered fund, that would be a covered 
transaction as defined in section 23A of the Federal Reserve Act (12 
U.S.C. 371c), as if such covered banking entity and the affiliate 
thereof were a member bank and the covered fund were an affiliate 
thereof.
    (2) Notwithstanding paragraph (a)(1) of this section, a covered 
banking entity may:
    (i) Acquire and retain any ownership interest in a covered fund in 
accordance with the requirements of this subpart; and
    (ii) Enter into any prime brokerage transaction with any covered 
fund in which a covered fund managed, sponsored, or advised by such 
covered banking entity (or an affiliate or subsidiary thereof) has 
taken an ownership interest, if:
    (A) The covered banking entity is in compliance with each of the 
limitations set forth in Sec.  ----.11 with respect to a covered fund 
organized and offered by such covered banking entity (or an affiliate 
or subsidiary thereof);
    (B) The chief executive officer (or equivalent officer) of the top-
tier affiliate of the covered banking entity certifies in writing 
annually (with a duty to update the certification if the information in 
the certification materially changes) that the covered banking entity 
does not, directly or indirectly, guarantee, assume, or otherwise 
insure the obligations or performance of the covered fund or of any 
covered fund in which such covered fund invests; and
    (C) The Board has not determined that such transaction is 
inconsistent with the safe and sound operation and condition of the 
covered banking entity.
    (b) Restrictions on transactions with covered funds. A covered 
banking entity that serves, directly or indirectly, as the investment 
manager, investment adviser, commodity trading advisor, or sponsor to a 
covered fund, or that organizes and offers a covered fund pursuant to 
Sec.  ----.11, shall be subject to section 23B of the Federal Reserve 
Act (12 U.S.C. 371c-1), as if such covered banking entity were a member 
bank and such covered fund were an affiliate thereof.
    (c) Restrictions on prime brokerage transactions. A prime brokerage 
transaction permitted under paragraph (a)(2)(ii) of this section shall 
be subject to section 23B of the Federal Reserve Act (12 U.S.C. 371c-1) 
as if the counterparty were an affiliate of the covered banking entity.


Sec.  ----.17  Other limitations on permitted covered fund activities.

    (a) No transaction, class of transactions, or activity may be 
deemed permissible under Sec. Sec.  ----.11 through ----.14 and Sec.  
----.16 if the transaction, class of transactions, or activity would:
    (1) Involve or result in a material conflict of interest between 
the covered banking entity and its clients, customers, or 
counterparties;
    (2) Result, directly or indirectly, in a material exposure by the 
covered banking entity to a high-risk asset or a high-risk trading 
strategy; or
    (3) Pose a threat to the safety and soundness of the covered 
banking entity or the financial stability of the United States.
    (b) Definition of material conflict of interest. For purposes of 
this section, a material conflict of interest between a covered banking 
entity and its clients, customers, or counterparties exists if the 
covered banking entity engages in any transaction, class of 
transactions, or activity that would involve or result in the covered 
banking entity's interests being materially adverse to the interests of 
its client, customer, or counterparty with respect to such transaction, 
class of transactions, or activity, unless:
    (1) Timely and effective disclosure and opportunity to negate or 
substantially mitigate. Prior to effecting the specific transaction or 
class or type of transactions, or engaging in the specific activity, 
for which a conflict of interest may arise, the covered banking entity:
    (i) Makes clear, timely, and effective disclosure of the conflict 
of interest, together with other necessary information, in reasonable 
detail and in a manner sufficient to permit a reasonable client, 
customer, or counterparty to meaningfully understand the conflict of 
interest; and
    (ii) Makes such disclosure explicitly and effectively, and in a 
manner that provides the client, customer, or counterparty the 
opportunity to negate, or substantially mitigate, any materially 
adverse effect on the client, customer, or counterparty created by the 
conflict of interest; or
    (2) Information barriers. The covered banking entity has 
established, maintained, and enforced information barriers that are 
memorialized in written policies and procedures, such as physical 
separation of personnel, or functions, or limitations on types of 
activity, that are reasonably designed, taking into consideration the 
nature of the covered banking entity's business, to prevent the 
conflict of interest from involving or resulting in a materially 
adverse effect on a client, customer, or counterparty. A covered 
banking entity may not rely on such information barriers if, in the 
case of any specific transaction, class or type of transactions or 
activity, the banking entity knows or should reasonably know that, 
notwithstanding the covered banking entity's establishment of 
information barriers, the conflict of interest may involve or result in 
a materially adverse effect on a client, customer, or counterparty.
    (c) Definition of high-risk asset and high-risk trading strategy. 
For purposes of this section:
    (1) High-risk asset means an asset or group of related assets that 
would, if held by a covered banking entity, significantly increase the 
likelihood that the covered banking entity would incur a substantial 
financial loss or would fail.
    (2) High-risk trading strategy means a trading strategy that would, 
if engaged in by a covered banking entity, significantly increase the 
likelihood that the covered banking entity would incur a substantial 
financial loss or would fail.

[[Page 8435]]

Sec.  ----.18  [Reserved]


Sec.  ----.19  [Reserved]

Subpart D--Compliance Program Requirement; Violations


Sec.  ----.20  Program for monitoring compliance; enforcement.

    (a) Program requirement. Except as provided in paragraph (d) of 
this section, each covered banking entity shall develop and provide for 
the continued administration of a program reasonably designed to ensure 
and monitor compliance with the prohibitions and restrictions on 
proprietary trading and covered fund activities and investments set 
forth in section 13 of the BHC Act and this part, and such program 
shall be appropriate for the size, scope and complexity of activities 
and business structure of the covered banking entity.
    (b) Contents of compliance program. The compliance program required 
by paragraph (a) of this section, at a minimum, shall include:
    (1) Internal written policies and procedures reasonably designed to 
document, describe, and monitor trading activities subject to subpart B 
and activities and investments with respect to a covered fund subject 
to subpart C (including those permitted under Sec. Sec.  ----.4 through 
----.6 or Sec. Sec.  ----.11 through ----.16) to ensure that such 
activities and investments comply with section 13 of the BHC Act and 
this part;
    (2) A system of internal controls reasonably designed to monitor 
and identify potential areas of noncompliance with section 13 of the 
BHC Act and this part in the covered banking entity's trading 
activities subject to subpart B and activities and investments with 
respect to a covered fund subject to subpart C (including those 
permitted under Sec. Sec.  ----.4 through ----.6 or Sec. Sec.  ----.11 
through ----.16) and to prevent the occurrence of activities or 
investments that are prohibited by section 13 of the BHC Act and this 
part;
    (3) A management framework that clearly delineates responsibility 
and accountability for compliance with section 13 of the BHC Act and 
this part;
    (4) Independent testing for the effectiveness of the compliance 
program conducted by qualified personnel of the covered banking entity 
or by a qualified outside party;
    (5) Training for trading personnel and managers, as well as other 
appropriate personnel, to effectively implement and enforce the 
compliance program; and
    (6) Making and keeping records sufficient to demonstrate compliance 
with section 13 of the BHC Act and this part, which a covered banking 
entity must promptly provide to [Agency] upon request and retain for a 
period of no less than 5 years.
    (c) Additional Standards. (1) In the case of any covered banking 
entity described in paragraph (c)(2) of this section, the compliance 
program required by paragraph (a) of this section shall also satisfy 
the requirements and other standards contained in appendix C to this 
part.
    (2) A covered banking entity is subject to paragraph (c)(1) of this 
section if:
    (i) The covered banking entity engages in proprietary trading and 
has, together with its affiliates and subsidiaries, trading assets and 
liabilities the average gross sum of which (on a worldwide consolidated 
basis), as measured as of the last day of each of the four prior 
calendar quarters:
    (A) Is equal to or greater than $1 billion; or
    (B) Equals 10 percent or more of its total assets;
    (ii) The covered banking entity invests in, or has relationships 
with, a covered fund and:
    (A) The covered banking entity has, together with its affiliates 
and subsidiaries, aggregate investments in one or more covered funds, 
the average value of which is, as measured as of the last day of each 
of the four prior calendar quarters, equal to or greater than $1 
billion; or
    (B) Sponsors or advises, together with its affiliates and 
subsidiaries, one or more covered funds, the average total assets of 
which are, as measured as of the last day of each of the four prior 
calendar quarters, equal to or greater than $1 billion; or
    (iii) [Agency] deems it appropriate.
    (d) No program required for certain banking entities. To the extent 
that a covered banking entity does not engage in activities or 
investments prohibited or restricted by subpart B or subpart C of this 
part, a covered banking entity will have satisfied the requirements of 
this section if its existing compliance policies and procedures include 
measures that are designed to prevent the covered banking entity from 
becoming engaged in such activities or making such investments and 
which require the covered banking entity to develop and provide for the 
compliance program required under paragraph (a) of this section prior 
to engaging in such activities or making such investments.


Sec.  ----.21  Termination of activities or investments; penalties for 
violations.

    (a) Any covered banking entity that engages in an activity or makes 
an investment in violation of section 13 of the BHC Act or this part or 
in a manner that functions as an evasion of the requirements of section 
13 of the BHC Act or this part, including through an abuse of any 
activity or investment permitted under subparts B or C of this part, or 
otherwise violates the restrictions and requirements of section 13 of 
the BHC Act or this part, shall terminate the activity and, as 
relevant, dispose of the investment.
    (b) After due notice and an opportunity for hearing, if the 
[Agency] finds reasonable cause to believe any covered banking entity 
has engaged in an activity or made an investment described in paragraph 
(a) of this section, the [Agency] may, by order, direct the banking 
entity to restrict, limit, or terminate the activity and, as relevant, 
dispose of the investment.
    (c) [Reserved]

Appendix A to Part [ ]--Reporting and Recordkeeping Requirements for 
Covered Trading Activities

I. Purpose

    This appendix sets forth reporting and recordkeeping 
requirements that certain covered banking entities must satisfy in 
connection with the restrictions on proprietary trading set forth in 
subpart B (``proprietary trading restrictions''). Pursuant to Sec.  
----.7, this appendix generally applies to a covered banking entity 
that has, together with its affiliates and subsidiaries, trading 
assets and liabilities the average gross sum of which (on a 
worldwide consolidated basis) is, as measured as of the last day of 
each of the four prior calendar quarters, equal to or greater than 
$1 billion. These entities are required to (i) furnish periodic 
reports to [Agency] regarding a variety of quantitative measurements 
of their covered trading activities, which vary depending on the 
scope and size of covered trading activities, and (ii) create and 
maintain records documenting the preparation and content of these 
reports. The requirements of this appendix should be incorporated 
into the covered banking entity's internal compliance program under 
Sec.  ----.20 and Appendix C.
    The purpose of this appendix is to assist covered banking 
entities and [Agency] in:
    (i) Better understanding and evaluating the scope, type, and 
profile of the covered banking entity's trading activities;
    (ii) Monitoring the covered banking entity's trading activities;
    (iii) Identifying trading activities that warrant further review 
or examination by the covered banking entity to verify compliance 
with the proprietary trading restrictions;
    (iv) Evaluating whether the trading activities of trading units 
engaged in market making-related activities subject to Sec.  --
--.4(b) are consistent with the requirements governing permitted 
market making-related activities;
    (v) Evaluating whether the covered trading activities of trading 
units that are engaged in permitted trading activity subject to

[[Page 8436]]

Sec. Sec.  ----.4, ----.5, or ----.6(a) (i.e., underwriting and 
market making-related activity, risk-mitigating hedging, or trading 
in certain government obligations) are consistent with the 
requirement that such activity not result, directly or indirectly, 
in a material exposure to high-risk assets or high-risk trading 
strategies;
    (vi) Identifying the profile of particular trading activities of 
the covered banking entity, and the individual trading units of the 
banking entity, to help establish the appropriate frequency and 
scope of examination by [Agency] of such activities; and
    (vii) Assessing and addressing the risks associated with the 
covered banking entity's covered trading activities.
    The quantitative measurements that must be furnished pursuant to 
this appendix are not intended to serve as a dispositive tool for 
the identification of permissible or impermissible activities.
    In addition to the quantitative measurements required in this 
appendix, a covered banking entity may need to develop and implement 
other quantitative measurements in order to effectively monitor its 
covered trading activities for compliance with section 13 of the BHC 
Act and this part and to have an effective compliance program, as 
required by Sec.  ----.20 and appendix C to this part. The 
effectiveness of particular quantitative measurements may differ 
based on the profile of the banking entity's businesses in general 
and, more specifically, of the particular trading unit, including 
types of instruments traded, trading activities and strategies, and 
history and experience (e.g., whether the trading desk is an 
established, successful market maker or a new entrant to a 
competitive market). In all cases, covered banking entities must 
ensure that they have robust measures in place to identify and 
monitor the risks taken in their trading activities, to ensure that 
the activities are within risk tolerances established by the covered 
banking entity, and to monitor and examine for compliance with the 
proprietary trading restrictions in this part.
    On an ongoing basis, covered banking entities should carefully 
monitor, review, and evaluate all furnished quantitative 
measurements, as well as any others that they choose to utilize in 
order to maintain compliance with section 13 of the BHC Act and this 
part. All measurement results that indicate a heightened risk of 
impermissible proprietary trading, including with respect to 
otherwise-permitted activities under Sec. Sec.  ----.4 through --
--.6 that result in a material exposure to high-risk assets or high-
risk trading strategies, should be escalated within the banking 
entity for review, further analysis, explanation to [Agency], and 
remediation, where appropriate. Many of the quantitative 
measurements discussed in this appendix will also be helpful to 
covered banking entities in identifying and managing the risks 
related to their covered trading activities.

II. Definitions

    The terms used in this appendix have the same meanings as set 
forth in Sec. Sec.  ----.2 and ----.3. In addition, for purposes of 
this appendix, the following definitions apply:
    Covered trading activity means proprietary trading, as defined 
in paragraph (b)(1) of Sec.  ----.3.
    Trading unit means each of the following units of organization 
of a covered banking entity:
    (i) Each discrete unit that is engaged in the coordinated 
implementation of a revenue-generation strategy and that 
participates in the execution of any covered trading activity; \1\
---------------------------------------------------------------------------

    \1\ [Agency] expects that this will generally be the smallest 
unit of organization used by the covered banking entity to structure 
and control its risk-taking activities and employees, and will 
include each unit generally understood to be a single ``trading 
desk.''
---------------------------------------------------------------------------

    (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); \2\
---------------------------------------------------------------------------

    \2\ [Agency] expects that this will generally include management 
or reporting divisions, groups, sub-groups, or other intermediate 
units of organization used by the covered banking entity to manage 
one or more discrete trading units (e.g., ``North American Credit 
Trading,'' ``Global Credit Trading,'' etc.).
---------------------------------------------------------------------------

    (iii) All trading operations, collectively; and
    (iv) Any other unit of organization specified by the [Agency] 
with respect to a particular banking entity.
    Calculation period means the period of time for which a 
particular quantitative measurement must be calculated.

III. Reporting and Recordkeeping of Quantitative Measurements

A. Scope of Required Reporting

    General scope. The quantitative measurements that must be 
furnished by a covered banking entity depend on the aggregate size 
of the covered banking entity's trading activities and the 
activities in which its trading units engage, as follows:
    (i) With respect to any covered banking entity that is engaged 
in any covered trading activity, and has trading assets and 
liabilities the average gross sum of which (on a worldwide 
consolidated basis) is, as measured as of the last day of each of 
the four prior calendar quarters, equal to or greater than $5 
billion:
    (a) Each trading unit of the covered banking entity that is 
engaged in market making-related activities subject to Sec.  --
--.4(b) must furnish the following quantitative measurements, 
calculated in accordance with this appendix:
    <bullet> Value-at-Risk and Stress VaR;
    <bullet> VaR Exceedance;
    <bullet> Risk Factor Sensitivities;
    <bullet> Risk and Position Limits;
    <bullet> Comprehensive Profit and Loss;
    <bullet> Portfolio Profit and Loss;
    <bullet> Fee Income and Expense;
    <bullet> Spread Profit and Loss;
    <bullet> Comprehensive Profit and Loss Attribution;
    <bullet> Pay-to-Receive Spread Ratio;
    <bullet> Unprofitable Trading Days Based on Comprehensive Profit 
and Loss and Unprofitable Trading Days Based on Portfolio Profit and 
Loss;
    <bullet> Skewness of Portfolio Profit and Loss and Kurtosis of 
Portfolio Profit and Loss;
    <bullet> Volatility of Comprehensive Profit and Loss and 
Volatility of Portfolio Profit and Loss;
    <bullet> Comprehensive Profit and Loss to Volatility Ratio and 
Portfolio Profit and Loss to Volatility Ratio;
    <bullet> Inventory Risk Turnover;
    <bullet> Inventory Aging; and
    <bullet> Customer-facing Trade Ratio; and
    (b) Each trading unit of the covered banking entity that is 
engaged in permitted trading activity subject to Sec. Sec.  --
--.4(a), ----.5, or ----.6(a) must furnish the following 
quantitative measurements, calculated in accordance with this 
appendix:
    <bullet> Value-at-Risk and Stress VaR;
    <bullet> Risk Factor Sensitivities;
    <bullet> Risk and Position Limits;
    <bullet> Comprehensive Profit and Loss; and
    <bullet> Comprehensive Profit and Loss Attribution; and
    (ii) With respect to any covered banking entity that is engaged 
in any covered trading activity, and has trading assets and 
liabilities the average gross sum of which (on a worldwide 
consolidated basis) is, as measured as of the last day of each of 
the four prior calendar quarters, equal to or greater than $1 
billion and less than $5 billion, each trading unit of the covered 
banking entity that is engaged in market making-related activities 
under Sec.  ----.4(b) must furnish the following quantitative 
measurement, calculated in accordance with this appendix:
    <bullet> Comprehensive Profit and Loss;
    <bullet> Portfolio Profit and Loss;
    <bullet> Fee Income and Expense;
    <bullet> Spread Profit and Loss;
    <bullet> Value-at-Risk;
    <bullet> Comprehensive Profit and Loss Attribution;
    <bullet> Volatility of Comprehensive Profit and Loss and 
Volatility of Portfolio Profit and Loss; and
    <bullet> Comprehensive Profit and Loss to Volatility Ratio and 
Portfolio Profit and Loss to Volatility Ratio.

B. Frequency of Required Calculation and Reporting

    A covered banking entity must calculate any applicable 
quantitative measurement for each trading day. A covered banking 
entity must report each applicable quantitative measurement to 
[Agency] on a monthly basis, or on any other reporting schedule 
requested by [Agency]. All quantitative measurements for any 
calendar month must be reported to [Agency] no later than 30 days 
after the end of that calendar month or on any other time basis 
requested by [Agency].\3\
---------------------------------------------------------------------------

    \3\ For example, under section IV.B.1 of this appendix, a 
banking entity is required to report to [Agency] the Comprehensive 
Profit and Loss quantitative measurement, as calculated for all 
trading days in June of any year, no later than July 30 of that 
year.
---------------------------------------------------------------------------

C. Recordkeeping

    A covered banking entity must, for any quantitative measurement 
furnished to [Agency] pursuant to this appendix and Sec.  ----.7, 
create and maintain records documenting the preparation and content 
of

[[Page 8437]]

these reports, as well as such information as is necessary to permit 
[Agency] to verify the accuracy of such reports, for a period of 5 
years.

IV. Quantitative Measurements

A. Risk-Management Measurements

1. Value-at-Risk and Stress Value-at-Risk

    Description: For purposes of this appendix, Value-at-Risk 
(``VaR'') is the commonly used percentile measurement of the risk of 
future financial loss in the value of a given portfolio over a 
specified period of time, based on current market conditions. For 
purposes of this appendix, Stress Value-at-Risk (``Stress VaR'') is 
the percentile measurement of the risk of future financial loss in 
the value of a given portfolio over a specified period of time, 
based on market conditions during a period of significant financial 
stress.
    General Calculation Guidance: Banking entities should compute 
and report VaR and Stress VaR by employing generally accepted 
standards and methods of calculation. VaR should reflect a loss in a 
trading unit that is expected to be exceeded less than one percent 
of the time over a one-day period. For those banking entities that 
are subject to regulatory capital requirements imposed by a Federal 
banking agency, VaR and Stress VaR should be computed and reported 
in a manner that is consistent with such regulatory capital 
requirements. In cases where a trading unit does not have a 
standalone VaR or Stress VaR calculation but is part of a larger 
portfolio for which a VaR or Stress VaR calculation is performed, a 
VaR or Stress VaR calculation that includes only the trading unit's 
holdings should be performed consistent with the VaR or Stress VaR 
model and methodology used by the larger portfolio.
    Calculation Period: One trading day.

2. VaR Exceedance

    Description: For purposes of this appendix, VaR Exceedance is 
the difference between VaR and Portfolio Profit and Loss, exclusive 
of Spread Profit and Loss, for a trading unit for any given 
calculation period.
    Calculation Period: One trading day.
    3. Risk Factor Sensitivities
    Description: For purposes of this appendix, Risk Factor 
Sensitivities are changes in a trading unit's Portfolio Profit and 
Loss, exclusive of Spread Profit and Loss, that are expected to 
occur in the event of a change in a trading unit's ``risk factors'' 
(i.e., one or more underlying market variables that are significant 
sources of the trading unit's profitability and risk).
    General Calculation Guidance: A covered banking entity should 
report the Risk Factor Sensitivities that are monitored and managed 
as part of the trading unit's overall risk management policy. The 
underlying data and methods used to compute a trading unit's Risk 
Factor Sensitivities should depend on the specific function of the 
trading unit and the internal risk management models employed. The 
number and type of Risk Factor Sensitivities that are monitored and 
managed by a trading unit, and furnished to [Agency], should depend 
on the explicit risks assumed by the trading unit. In general, 
however, reported Risk Factor Sensitivities should be sufficient to 
account for a preponderance of the price variation in the trading 
unit's holdings.
    Trading units should take into account any relevant factors in 
calculating Risk Factor Sensitivities, including, for example, the 
following with respect to particular asset classes:
    <bullet> Commodity derivative positions: sensitivities with 
respect to the related commodity type (e.g., precious metals, oil 
and petroleum or agricultural products), the maturity of the 
positions, volatility and/or correlation sensitivities (expressed in 
a manner that demonstrates any significant non-linearities), and the 
maturity profile of the positions;
    <bullet> Credit positions: sensitivities with respect to credit 
spread factors that are sufficiently granular to account for 
specific credit sectors and market segments, the maturity profile of 
the positions, and sensitivities to interest rates at all relevant 
maturities;
    <bullet> Credit-related derivative positions: credit positions 
sensitivities and volatility and/or correlation sensitivities 
(expressed in a manner that demonstrates any significant non-
linearities), and the maturity profile of the positions;
    <bullet> Equity positions: sensitivity to equity prices and 
sensitivities that differentiate between important equity market 
sectors and segments, such as a small capitalization equities and 
international equities;
    <bullet> Equity derivative positions: equity position 
sensitivities and volatility and/or correlation sensitivities 
(expressed in a manner that demonstrates any significant non-
linearities), and the maturity profile of the positions;
    <bullet> Foreign exchange derivative positions: sensitivities 
with respect to major currency pairs and maturities, sensitivity to 
interest rates at relevant maturities, and volatility and/or 
correlation sensitivities (expressed in a manner that demonstrates 
any significant non-linearities), as well as the maturity profile of 
the positions; and
    <bullet> Interest rate positions, including interest rate 
derivative positions: sensitivities with respect to major interest 
rate categories and maturities and volatility and/or correlation 
sensitivities (expressed in a manner that demonstrates any 
significant non-linearities), as well as the maturity profile of the 
positions.
    The methods used by a covered banking entity to calculate 
sensitivities to a common factor shared by multiple trading units, 
such as an equity price factor, should be applied consistently 
across its trading units so that the sensitivities can be compared 
from one trading unit to another.
    Calculation Period: One trading day.

4. Risk and Position Limits

    Description: For purposes of this appendix, Risk and Position 
Limits are the constraints that define the amount of risk that a 
trading unit is permitted to take at a point in time, as defined by 
the covered banking entity for a specific trading unit.
    General Calculation Guidance: Risk and Position Limits should be 
reported in the format used by the covered banking entity for the 
purposes of risk management of each trading unit. Risk and Position 
Limits are often expressed in terms of risk measures, such as VaR 
and Risk Factor Sensitivities, but may also be expressed in terms of 
other observable criteria, such as net open positions. When criteria 
other than VaR or Risk Factor Sensitivities are used to define the 
Risk and Position Limits, both the value of the Risk and Position 
Limits and the value of the variables used to assess whether these 
limits have been reached should be reported.
    Calculation Period: One trading day.

B. Source-of-Revenue Measurements

1. Comprehensive Profit and Loss

    Description: For purposes of this appendix, Comprehensive Profit 
and Loss is the net profit or loss of a trading unit's material 
sources of trading revenue, including, for example, dividend and 
interest income and expense, over a specific period of time. A 
trading unit's Comprehensive Profit and Loss for any given 
calculation period should generally equal the sum of the trading 
unit's Portfolio Profit and Loss and Fee Income.
    General Calculation Guidance: Comprehensive Profit and Loss 
generally should be computed using data on the value of a trading 
unit's underlying holdings, the prices at which those holdings were 
bought and sold, and the value of any fees, commissions, sales 
credits, spreads, dividends, interest income and expense, or other 
sources of income from trading activities, whether realized or 
unrealized. Comprehensive Profit and Loss should not include: 
compensation costs or other costs required to operate the unit, such 
as information technology costs; or charges and adjustments made for 
internal reporting and management purposes, such as accounting 
reserves.
    Calculation Period: One trading day.

2. Portfolio Profit and Loss

    Description: For purposes of this appendix, Portfolio Profit and 
Loss is a trading unit's net profit or loss on its underlying 
holdings over a specific period of time, whether realized or 
unrealized. Portfolio Profit and Loss should generally include any 
increase or decrease in the market value of a trading unit's 
holdings, including, for example, any dividend, interest income, or 
expense of a trading unit's holdings. Portfolio Profit and Loss 
should not include direct fees, commissions, sales credits, or other 
sources of trading revenue that are not directly related to the 
market value of the trading unit's holdings.
    General Calculation Guidance: In general, Portfolio Profit and 
Loss should be computed using data on a trading unit's underlying 
holdings and the prices at which those holdings are marked for 
valuation purposes. Portfolio Profit and Loss should not include: 
compensation costs or other costs required to operate the trading 
unit, such as information technology costs; or charges and 
adjustments made for internal reporting and management purposes, 
such as accounting reserves.
    Calculation Period: One trading day.

3. Fee Income and Expense

    Description: For purposes of this appendix, Fee Income and 
Expense generally includes direct fees, commissions and other 
distinct

[[Page 8438]]

income for services provided by or to a trading unit over a specific 
period of time.
    General Calculation Guidance: Fee Income and Expense should be 
computed using data on direct fees that are earned by the trading 
unit for services it provides to clients, customers, or 
counterparties, such as fees earned for structured transactions or 
sales commissions and credits earned for fulfilling a customer 
request, whether realized or unrealized, and similar fees paid by 
the trading unit to other service providers.
    Calculation Period: One trading day.

4. Spread Profit and Loss

    Description: For purposes of this appendix, Spread Profit and 
Loss is the portion of Portfolio Profit and Loss that generally 
includes revenue generated by a trading unit from charging higher 
prices to buyers than the trading unit pays to sellers of comparable 
instruments over the same period of time (i.e., charging a 
``spread,'' such as the bid-ask spread).
    General Calculation Guidance: Spread Profit and Loss generally 
should be computed using data on the prices at which comparable 
instruments are either bought or sold by the trading unit, as well 
as the turnover of these instruments. Spread Profit and Loss should 
be measured with respect to both the purchase and the sale of any 
position, and should include both the spreads that are earned by the 
trading unit to execute transactions (expressed as positive 
amounts), and the spreads that are paid by the trading unit to 
initiate transactions (expressed as negative amounts). Spread Profit 
and Loss should be computed by calculating the difference between 
the bid price or the ask price (whichever is paid or received) and 
the mid-market price. The mid-market price is the average of bid and 
ask.
    For some asset classes in which a trading unit is engaged in 
market making-related activities, bid-ask or similar spreads are 
widely disseminated, constantly updated, and readily available, or 
otherwise reasonably ascertainable. For purposes of calculating the 
Spread Profit and Loss attributable to a transaction in such asset 
classes, the trading unit should utilize the prevailing bid-ask or 
similar spread on the relevant position at the time the purchase or 
sale is completed.
    For other asset classes in which a trading unit is engaged in 
market making-related activities, bid-ask or similar spreads may not 
be widely disseminated on a consistent basis or otherwise reasonably 
ascertainable. A covered banking entity must identify any trading 
unit engaged in market making-related activities in an asset class 
for which the covered banking entity believes bid-ask or similar 
spreads are not widely disseminated on a consistent basis or are not 
otherwise reasonably ascertainable and must be able to demonstrate 
that bid-ask or similar spreads for the asset class are not 
reasonably ascertainable. In such cases, the trading unit should 
calculate the Spread Profit and Loss for the relevant purchase or 
sale of a position in a particular asset class by using whichever of 
the following three alternatives the banking entity believes more 
accurately reflects prevailing bid-ask or similar spreads for 
transactions in that asset class:
    (i) End of Day Spread Proxy: A proxy based on the bid-ask or 
similar spread that is used to estimate, or is otherwise implied by, 
the market price at which the trading entity marks (or in the case 
of a sale, would have marked) the position for accounting purposes 
at the close of business on the day it executes the purchase or sale 
(``End of Day Spread Proxy'');
    (ii) Historical Data Spread Proxy: A proxy based on historical 
bid-ask or similar spread data in similar market conditions 
(``Historical Data Spread Proxy''); or
    (iii) Any other proxy that the banking entity can demonstrate 
accurately reflects prevailing bid-ask or similar spreads for 
transactions in the specific asset class.
    A covered banking entity selecting any of these alternatives 
should be able to demonstrate that the alternative it has chosen 
most accurately reflects prevailing bid-ask or similar spreads for 
the relevant asset class. If a covered banking entity chooses to 
calculate Spread Profit and Loss for a particular trading unit using 
the End of Day Spread Proxy, then the banking entity should 
separately identify the portion of Spread Profit and Loss that is 
attributable to positions acquired and disposed of on the same 
trading day. If a banking entity chooses to calculate Spread Profit 
and Loss for a particular trading unit using the Historical Data 
Spread Proxy, the covered banking entity should be able to 
demonstrate that the Historical Data Proxy is appropriate and 
continually monitor market conditions and adjust, as necessary, the 
Historical Data Proxy to reflect any changes.
    Calculation Period: One trading day.

5. Comprehensive Profit and Loss Attribution

    Description: For purposes of this appendix, Comprehensive Profit 
and Loss Attribution is an attribution analysis that divides the 
trading unit's Comprehensive Profit and Loss into the separate 
sources of risk and revenue that have caused any observed variation 
in Comprehensive Profit and Loss. This attribution analysis should 
attribute Comprehensive Profit and Loss to specific market and risk 
factors that can be accurately and consistently measured over time. 
Any component of Comprehensive Profit and Loss that cannot be 
specifically identified in the attribution analysis should be 
identified as an unexplained portion of the Comprehensive Profit and 
Loss.
    General Calculation Guidance: The specific market and risk 
factors used by a trading unit in the attribution analysis should be 
tailored to the trading activities undertaken by the unit. These 
factors should be measured consistently over time to facilitate 
historical comparisons. The attribution analysis should also 
identify any significant factors that have a consistent and regular 
influence on Comprehensive Profit and Loss, such as Risk Factor 
Sensitivities that have a significant influence on portfolio income, 
customer spreads, bid-ask spreads, or commissions that are earned. 
Factors that influence Comprehensive Profit and Loss across 
different trading units should be measured and included in the 
attribution analysis in a comparable fashion.
    Calculation Period: One trading day.

C. Revenue-Relative-to-Risk Measurements

1. Volatility of Comprehensive Profit and Loss and Volatility of 
Portfolio Profit and Loss

    Description: For purposes of this appendix, Volatility of 
Comprehensive Profit and Loss generally is the standard deviation of 
the trading unit's Comprehensive Profit and Loss estimated over a 
given calculation period. For purposes of this appendix, Volatility 
of Portfolio Profit and Loss generally is the standard deviation of 
the trading unit's Portfolio Profit and Loss, exclusive of Spread 
Profit and Loss, estimated over a given calculation period.
    Calculation Period: 30 days, 60 days, and 90 days.

2. Comprehensive Profit and Loss to Volatility Ratio and Portfolio 
Profit and Loss to Volatility Ratio

    Description: For purposes of this appendix, Comprehensive Profit 
and Loss to Volatility Ratio is a ratio of Comprehensive Profit and 
Loss to the Volatility of Comprehensive Profit and Loss for a 
trading unit over a given calculation period. For purposes of this 
appendix, Portfolio Profit and Loss to Volatility Ratio is a ratio 
of Portfolio Profit and Loss, exclusive of Spread Profit and Loss, 
to the Volatility of Portfolio Profit and Loss, exclusive of Spread 
Profit and Loss, for a trading unit over a given calculation period.
    Calculation Period: 30 days, 60 days, and 90 days.

3. Unprofitable Trading Days Based on Comprehensive Profit and Loss and 
Unprofitable Trading Days Based on Portfolio Profit and Loss

    Description: For purposes of this appendix, Unprofitable Trading 
Days Based on Comprehensive Profit and Loss is the number or 
proportion of trading days on which a trading unit's Comprehensive 
Profit and Loss is less than zero over a given calculation period. 
For purposes of this appendix, Unprofitable Trading Days Based on 
Portfolio Profit and Loss, exclusive of Spread Profit and Loss, is 
the number or proportion of trading days on which a trading unit's 
Portfolio Profit and Loss, exclusive of Spread Profit and Loss, is 
less than zero over a given calculation period.
    Calculation Period: 30 days, 90 days, and 360 days.

4. Skewness of Portfolio Profit and Loss and Kurtosis of Portfolio 
Profit and Loss

    Description: Skewness of Portfolio Profit and Loss and Kurtosis 
of Portfolio Profit and Loss should be calculated using standard 
statistical methods with respect to Portfolio Profit and Loss, 
exclusive of Spread Profit and Loss.
    Calculation Period: 30 days, 60 days, and 90 days.

D. Customer-Facing Activity Measurements

1. Inventory Risk Turnover

    Description: For purposes of this appendix, Inventory Risk 
Turnover is a ratio that measures the amount of risk associated with 
a trading unit's inventory, as measured by Risk Factor 
Sensitivities, that is turned over by the trading unit over a 
specific period of

[[Page 8439]]

time. For each Risk Factor Sensitivity, the numerator of the 
Inventory Risk Turnover ratio generally should be the absolute value 
of the Risk Factor Sensitivity associated with each transaction over 
the calculation period. The denominator of the Inventory Risk 
Turnover ratio generally should be the value of each Risk Factor 
Sensitivity for all of the trading unit's holdings at the beginning 
of the calculation period.
    General Calculation Guidance: As a general matter, a trading 
unit should measure and report the Inventory Risk Turnover ratio for 
each of the Risk Factor Sensitivities calculated and furnished for 
that trading unit.
    Calculation Period: 30 days, 60 days, and 90 days.

2. Inventory Aging

    Description: For purposes of this appendix, Inventory Aging 
generally describes the trading unit's aggregate assets and 
liabilities and the amount of time that those assets and liabilities 
have been held for the following periods: 0-30 days; 30-60 days; 60-
90 days; 90-180 days; 180-360 days; and greater than 360 days. 
Inventory Aging should measure the age profile of the trading unit's 
assets and liabilities.
    General Calculation Guidance: In general, Inventory Aging should 
be computed using a trading unit's trading activity data and should 
identify the trading unit's aggregate assets and liabilities. In 
addition, Inventory Aging should include two schedules, an asset-
aging schedule and a liability-aging schedule. The asset-aging 
schedule should record the value of the trading unit's assets that 
have been held for: 0-30 days; 30-60 days; 60-90 days; 90-180 days; 
180-360 days; and greater than 360 days. The liability-aging 
schedule should record the value of the trading unit's liabilities 
that have been held for: 0-30 days; 30-60 days; 60-90 days; 90-180 
days; 180-360 days; and more than 360 days.
    Calculation Period: 30 days, 60 days, and 90 days.

3. Customer-Facing Trade Ratio

    Description: For purposes of this appendix, the Customer-Facing 
Trade Ratio is a ratio comparing the number of transactions 
involving a counterparty that is a customer of the trading unit to 
the number of transactions involving a counterparty that is not a 
customer of the trading unit. For purposes of calculating the 
Customer-Facing Trade Ratio, a counterparty is considered to be a 
customer of the trading unit if the counterparty is neither (i) a 
counterparty to a transaction executed on a designated contract 
market registered under the Commodity Exchange Act or national 
securities exchange registered under the Exchange Act, nor (ii) a 
broker-dealer, swap dealer, security-based swap dealer, any other 
entity engaged in market making-related activities, or any affiliate 
thereof. A broker-dealer, swap dealer, or security-based swap 
dealer, any other entity engaged in market making-related 
activities, or any affiliate thereof may be considered a customer of 
the trading unit for these purposes if the covered banking entity 
treats that entity as a customer and has documented how and why the 
entity is treated as such.
    Calculation Period: 30 days, 60 days, and 90 days.

E. Payment of Fees, Commissions, and Spreads Measurement

1. Pay-to-Receive Spread Ratio

    Description: For purposes of this appendix, the Pay-to-Receive 
Spread Ratio is a ratio comparing the amount of Spread Profit and 
Loss and Fee Income that is earned by a trading unit to the amount 
of Spread Profit and Loss and Fee Income that is paid by the trading 
unit.
    General Calculation Guidance: The Pay-to-Receive Spread Ratio 
will depend on the amount of Spread Profit and Loss and Fee Income 
that is earned by the trading unit for facilitating buy and sell 
orders and the amount of Spread Profit and Loss that is paid by a 
trading unit as it initiates buy and sell orders. The Pay-to-Receive 
Spread Ratio generally should be computed using the calculation of 
Spread Profit and Loss described in this appendix, except that 
spread paid should include the aggregate Spread Profit and Loss of 
all transactions producing a negative Spread Profit and Loss, and 
spread received should include the aggregate Spread Profit and Loss 
of all transactions producing a positive Spread Profit and Loss.
    Calculation Period: One trading day.

Appendix B to Part [ ]--Commentary Regarding Identification of 
Permitted Market Making-Related Activities

I. Purpose

    This appendix provides commentary describing the features of 
permitted market making-related activities and distinctions between 
permitted market making-related activities and prohibited 
proprietary trading. The appendix applies to all covered banking 
entities that are engaged in market making-related activities in 
reliance on Sec.  ----.4(b). The following commentary must be 
incorporated into the covered banking entity's internal compliance 
program under Sec.  ----.20, as applicable.

II. Definitions

    The terms used in this appendix have the same meanings as those 
set forth in Sec. Sec.  ----.2 and ----.3 and appendix A to this 
part.

III. Commentary

    Section 13 of the BHC Act and Sec.  ----.3 prohibit any covered 
banking entity from engaging in proprietary trading, which is 
generally defined as engaging as principal for the trading account 
of the covered banking entity in any transaction to purchase or sell 
a covered financial position. However, section 13(d)(1)(B) of the 
BHC Act and Sec.  ----.4(b) permit a covered banking entity to 
engage in proprietary trading that would otherwise be prohibited if 
the activity is conducted in connection with the covered banking 
entity's market making-related activities, to the extent that such 
activities are designed not to exceed the reasonably expected near 
term demands of clients, customers, and counterparties. This 
commentary is intended to assist covered banking entities in 
identifying permitted market making-related activities and 
distinguishing such activities from trading activities that, even if 
conducted in the context of the covered banking entity's market 
making operations, would constitute prohibited proprietary trading.

A. Overview of Market Making-Related Activities

    In the context of trading activities in which a covered banking 
entity acts as principal, market making-related activities generally 
involve the covered banking entity either (i) in the case of market 
making in a security that is executed on an organized trading 
facility or exchange, passively providing liquidity by submitting 
resting orders that interact with the orders of others on an 
organized trading facility or exchange and acting as a registered 
market maker, where such exchange or organized trading facility 
provides the ability to register as a market maker,\1\ or (ii) in 
other cases, providing an intermediation service to its customers by 
assuming the role of a counterparty that stands ready to buy or sell 
a position that the customer wishes to sell or buy. A market maker's 
``customers'' generally vary depending on the asset class and market 
in which the market maker is providing intermediation services. In 
the context of market making in a security that is executed on an 
organized trading facility or an exchange, a ``customer'' is any 
person on behalf of whom a buy or sell order has been submitted by a 
broker-dealer or any other market participant. In the context of 
market making in a covered financial position in an over-the-counter 
market, a ``customer'' generally would be a market participant that 
makes use of the market's maker intermediation services, either by 
requesting such services or entering into a continuing relationship 
with the market maker with respect to such services.\2\
---------------------------------------------------------------------------

    \1\ The status of being a registered market maker is not, on its 
own, a sufficient basis for relying on the exemption for market 
making-related activity contained in Sec.  ----.4(b). Registration 
as a market maker generally involves filing a prescribed form with 
an exchange or organized trading facility, in accordance with its 
rules and procedures, and complying with the applicable requirements 
for market makers set forth in the rules of that exchange or 
organized trading facility. See, e.g., Nasdaq Rule 4612, New York 
Stock Exchange Rule 104, CBOE Futures Exchange Rule 515, BATS 
Exchange Rule 11.5.
    \2\ In certain cases, depending on the conventions of the 
relevant market (e.g., the over-the-counter derivatives market), 
such a ``customer'' may consider itself or refer to itself more 
generally as a ``counterparty.''
---------------------------------------------------------------------------

    The primary purpose of market making-related activities is to 
intermediate between buyers and sellers of similar positions, for 
which service market makers are compensated, resulting in more 
liquid markets and less volatile prices. The purpose of such 
activities is not to earn profits as a result of movements in the 
price of positions and risks acquired or retained; rather, a market 
maker generally manages and limits the extent to which it is exposed 
to movements in the price of principal positions and risks that it 
acquires or retains, or in the price of one or more material 
elements of those positions. To the extent that it can, a

[[Page 8440]]

market maker will eliminate some or all of the price risks to which 
it is exposed. However, in some cases, the risks posed by one or 
more positions may be sufficiently complex or specific that the risk 
cannot be fully hedged. In other cases, although it may be possible 
to hedge the risks posed by one or more positions, the cost of doing 
so may be so high as to effectively make market making in those 
positions uneconomic if complete hedges were acquired. In such 
cases, in order to provide effective intermediation services, market 
makers are required to retain at least some risk for at least some 
period of time with respect to price movements of retained principal 
positions and risks. The size and type of risk that must be retained 
in such cases may vary widely depending on the type and size of the 
positions, the liquidity of the specific market, and the market's 
structure. As the liquidity of positions increases, the frequency 
with which a market maker must take or retain risk in order to make 
a market in those positions generally decreases.
    The profitability of market making-related activities relies on 
forms of revenues that reflect the value of the intermediation 
services that are provided to the market maker's customers. These 
revenues typically take the form of explicit fees and commissions 
or, in markets where no such fees or commission are charged, a bid-
ask or similar spread that is generated by charging higher prices to 
buyers than is paid to sellers of comparable instruments. In the 
case of a derivative contract, these revenues reflect the difference 
between the cost of entering into the derivative contract and the 
cost of hedging incremental, residual risks arising from the 
contract. These types of ``customer revenues'' provide the primary 
source of a market maker's profitability. Typically, a market maker 
holds at least some risk with respect to price movements of retained 
principal positions and risks. As a result, the market maker also 
incurs losses or generates profits as price movements actually 
occur, but such losses or profits are incidental to customer 
revenues and significantly limited by the banking entity's hedging 
activities. Customer revenues, not revenues from price movements, 
predominate. The appropriate proportion of ``customer revenues'' to 
profits and losses resulting from price movements of retained 
principal positions and risks varies depending on the type of 
positions involved, the typical fees, commissions, and spreads 
payable for transactions in those positions, and the risks of those 
positions. As a general matter, the proportion of ``customer 
revenues'' generated when making a market in certain positions 
increases as the fees, commissions, or spreads payable for those 
positions increase, the volatility of those positions' prices 
decrease, and the prices for those positions are less transparent.
    Because a market maker's business model entails managing and 
limiting the extent to which it is exposed to movements in the 
prices of retained principal positions and risks while generating 
customer revenues that are earned, regardless of movements in the 
price of retained principal positions and risks, a market maker 
typically generates significant revenue relative to the risks that 
it retains. Accordingly, a market maker will typically demonstrate 
consistent profitability and low earnings volatility under normal 
market conditions. The appropriate extent to which a market maker 
will demonstrate consistent profitability and low earnings 
volatility varies depending on the type of positions involved, the 
liquidity of the positions, the price transparency of the positions, 
and the volatility of the positions' prices. As a general matter, 
consistent profitability will decrease and earnings volatility will 
increase as the liquidity of the positions decrease, the volatility 
of the positions' prices increase, and the prices for the positions 
are less transparent.
    As the primary purpose of market making-related activities is to 
provide intermediation services to its customers, market makers 
focus their activities on servicing customer demands and typically 
only engage in transactions with non-customers to the extent that 
these transactions directly facilitate or support customer 
transactions. In particular, a market maker generally only transacts 
with non-customers to the extent necessary to hedge or otherwise 
manage the risks of its market making-related activities, including 
managing its risk with respect to movements of the price of retained 
principal positions and risks, to acquire positions in amounts 
consistent with reasonably expected near term demand of its 
customers, or to sell positions acquired from its customers. The 
appropriate proportion of a market maker's transactions that are 
with customers versus non-customers varies depending on the type of 
positions involved and the extent to which the positions are 
typically hedged in non-customer transactions. In the case of a 
derivatives market maker that engages in dynamic hedging, the number 
of non-customer transactions significantly outweighs the number of 
customer transactions, as the derivatives market maker must 
constantly enter into transactions to appropriately manage its 
retained principal positions and risks as market prices for the 
positions and risks move and additional transactions with customers 
change the risk profile of the market makers retained principal 
positions.
    Because a market maker generates revenues primarily by 
transacting with, and providing intermediation services to, 
customers, a market maker typically engages in transactions that 
earn fees, commissions, or spreads as payment for its services. 
Transactions in which the market maker pays fees, commissions, or 
spreads--i.e., where it pays another market maker for providing it 
with liquidity services-are much less frequent, although in some 
cases obtaining liquidity services from another market maker and 
paying fees, commissions, or spreads may be necessary to prudently 
manage its risk with respect to price movements of retained 
principal positions and risks. The appropriate proportion of a 
market maker's transactions that earn, rather than pay, fees, 
commissions or spreads varies depending on the type of positions 
involved, the liquidity of the positions, and the extent to which 
market trends increase the volatility of its risk with respect to 
price movements of retained principal positions and risks. As a 
general matter, the proportion of a market maker's transactions that 
earn rather than pay fees, commissions or spreads decreases as the 
liquidity of the positions decreases, and the extent to which the 
price volatility of retained principal positions and risks 
increases.
    Finally, because the primary purpose of market making-related 
activities is to provide intermediation services to its customers, a 
market maker does not provide compensation incentives to its 
personnel that primarily reward proprietary risk-taking. Although a 
market maker may take into account revenues resulting from movements 
in the price of retained principal positions and risks to the extent 
that such revenues reflect the effectiveness with which personnel 
have effectively managed the risk of movements in the price of 
retained principal positions and risks, a market maker that provides 
compensation incentives relating to revenues generally does so 
through incentives that primarily reward customer revenues and 
effective customer service.

B. Overview of Prohibited Proprietary Trading Activities

    Like permitted market making-related activities, prohibited 
proprietary trading involves the taking of principal positions by a 
covered banking entity. Unlike permitted market making-related 
activities, the purpose of prohibited proprietary trading is to 
generate profits as a result of, or otherwise benefit from, changes 
in the price of positions and risks taken. Whereas a market maker 
attempts to eliminate some or all of the price risks inherent in its 
retained principal positions and risks by hedging or otherwise 
managing those risks in a reasonable period of time after positions 
are acquired or risks arise, a proprietary trader seeks to 
capitalize on those risks, and generally only hedges or manages a 
portion of those risks when doing so would improve the potential 
profitability of the risk it retains. A proprietary trader does not 
have ``customers'' because a proprietary trader simply seeks to 
obtain the best price and execution in purchasing or selling its 
proprietary positions. A proprietary trader generates few if any 
fees, commissions, or spreads from its trading activities because it 
is not providing an intermediation service to any customer or other 
third party. Instead, a proprietary trader is likely to pay fees, 
commissions, or spreads to other market makers when obtaining their 
liquidity services is beneficial to execution of its trading 
strategy. Because a proprietary trader seeks to generate profits 
from changes in the price of positions taken, a proprietary trader 
typically provides compensation incentives to its personnel that 
primarily reward successful proprietary risk taking.

C. Distinguishing Permitted Market Making-Related Activities From 
Prohibited Proprietary Trading

    Because both permitted market making-related activities and 
prohibited proprietary trading involve the taking of principal 
positions, certain challenges arise in distinguishing permitted 
market making-related activities and prohibited proprietary

[[Page 8441]]

trading, particularly in cases where both of these activities occur 
in the context of a market making operation. Particularly during 
periods of significant market disruption, it may be difficult to 
distinguish between retained principal positions and risks that 
appropriately support market making-related activities and positions 
taken, or positions or risks not hedged, for proprietary purposes.
    In connection with these challenges, [Agency] will apply the 
following factors in distinguishing permitted market making-related 
activities from trading activities that, even if conducted in the 
context of the covered banking entity's market making operations, 
would constitute prohibited proprietary trading. The particular 
types of trading activity described in this appendix may involve the 
aggregate trading activities of a single trading unit, a significant 
number or series of transactions occurring at one or more trading 
units, or a single significant transaction, among other potential 
scenarios. In addition to meeting the terms of this appendix, any 
transaction or activity for which a covered banking entity intends 
to rely on the market making exemption in Sec.  ----.4(b) must also 
satisfy all the requirements specified in Sec.  ----.4(b), as well 
as the other applicable requirements and conditions of this part.

1. Risk Management

    Absent explanatory facts and circumstances, particular trading 
activity in which a trading unit retains risk in excess of the size 
and type required to provide intermediation services to customers 
will be considered to be prohibited proprietary trading, and not 
permitted market making-related activity.
    [Agency] will base a determination of whether a trading unit 
retains risk in excess of the size and type required for these 
purposes on all available facts and circumstances, including a 
comparison of retained principal risk to: the amount of risk that is 
generally required to execute a particular market making function; 
hedging options that are available in the market and permissible 
under the covered banking entity's hedging policy at the time the 
particular trading activity occurred; the trading unit's prior 
levels of retained risk and its hedging practices with respect to 
similar positions; and the levels of retained risk and the hedging 
practices of other trading units with respect to similar positions.
    To help assess the extent to which a trading unit's risks are 
potentially being retained in excess of amounts required to provide 
intermediation services to customers, [Agency] will utilize the VaR 
and Stress VaR, VaR Exceedance, and Risk Factor Sensitivities 
quantitative measurements, as applicable, among other risks 
measurements described in Appendix A and any other relevant factor. 
This assessment will focus primarily on the risk measurements 
relative to: the risk required for conducting market making-related 
activities, and any significant changes in the risk over time and 
across similarly-situated trading units and banking entities.
    Explanatory facts and circumstances might include, among other 
things, market-wide changes in risk, changes in the specific 
composition of market making-related activities, temporary market 
disruptions, or other market changes that result in previously-used 
hedging or other risk management techniques no longer being possible 
or cost-effective.

2. Source of Revenues

    Absent explanatory facts and circumstances, particular trading 
activity in which a trading unit primarily generates revenues from 
price movements of retained principal positions and risks, rather 
than customer revenues, will be considered to be prohibited 
proprietary trading, and not permitted market making-related 
activity.
    [Agency] will base a determination of whether a trading activity 
primarily generates revenues from price movements of retained 
principal positions and risks, rather than customer revenues, on all 
available facts and circumstances, including: an evaluation of the 
revenues derived from price movements of retained principal 
positions and risks relative to its customer revenues; and a 
comparison of these revenue figures to the trading unit's prior 
revenues with respect to similar positions, and the revenues of 
other covered banking entities' trading units with respect to 
similar positions.
    To help assess the extent to which a trading unit's revenues are 
potentially derived from movements in the price of retained 
principal positions and risks, [Agency] will utilize the 
Comprehensive Profit and Loss, Portfolio Profit and Loss, Fee Income 
and Expense, and Spread Profit and Loss quantitative measurements, 
as applicable, both individually and in combination with one another 
(e.g., by comparing the ratio of Spread Profit and Loss to Portfolio 
Profit and Loss), and any other relevant factor.
    Explanatory facts and circumstances might include, among other 
things: general upward or downward price trends in the broader 
markets in which the trading unit is making a market, provided 
revenues from price movements in retained principal positions and 
risks are consistent; sudden market disruptions or other changes 
causing significant, unanticipated alterations in the price of 
retained principal positions and risks; sudden and/or temporary 
changes in the market (e.g., narrowing of bid/ask spreads) that 
cause significant, unanticipated reductions in customer revenues; or 
efforts to expand or contract a trading unit's market share.

3. Revenues Relative to Risk

    Absent explanatory facts and circumstances, particular trading 
activity will be considered to be prohibited proprietary trading, 
and not permitted market making-related activity, if the trading 
unit: generates only very small or very large amounts of revenue per 
unit of risk taken; does not demonstrate consistent profitability; 
or demonstrates high earnings volatility.
    [Agency] will base such a determination on all available facts 
and circumstances, including: an evaluation of the amount of revenue 
per unit of risk taken, earnings volatility, profitability, exposure 
to risks, and overall level of risk taking for the particular 
trading activities; and a comparison of these figures to the trading 
unit's prior results with respect to similar positions, and the 
results of other covered banking entities' trading units with 
respect to similar positions.
    To help assess the riskiness of revenues and the amount of 
revenue per unit of risk taken, [Agency] will utilize the Volatility 
of Comprehensive Profit and Loss and Volatility of Portfolio Profit 
and Loss, Comprehensive Profit and Loss to Volatility Ratio and 
Portfolio Profit and Loss to Volatility Ratio, and Comprehensive 
Profit and Loss Attribution quantitative measurements, as 
applicable, and any other relevant factor.
    To help assess the extent to which a trading unit demonstrates 
consistent profitability, [Agency] will utilize the Unprofitable 
Trading Days Based on Comprehensive Profit and Loss and Unprofitable 
Trading Days Based on Portfolio Profit and Loss quantitative 
measurements, as applicable, and any other relevant factor.
    To help assess the extent to which a trading unit is exposed to 
outsized risk, [Agency] will utilize the Skewness of Portfolio 
Profit and Loss and Kurtosis of Profit and Loss quantitative 
measurements, as applicable, and any other relevant factor.
    Explanatory facts and circumstances might include, among other 
things: market disruptions or other changes causing significant, 
unanticipated increases in a trading unit's risk with respect to 
movements in the price of retained principal positions and risks; 
market disruptions or other changes causing significant, 
unanticipated increases in the volatility of positions in which the 
trading unit makes a market; sudden and/or temporary changes in the 
market (e.g., narrowing of bid-ask spreads) that cause significant, 
unanticipated reductions in customer revenues and decrease overall 
profitability; or efforts to expand or contract a trading unit's 
market share.

4. Customer-Facing Activity

    Absent explanatory facts and circumstances, particular trading 
activity will be considered to be prohibited proprietary trading, 
and not permitted market making-related activity, if the trading 
unit: does not transact through a trading system that interacts with 
orders of others or primarily with customers of the banking entity's 
market making desk to provide liquidity services; or retains 
principal positions and risks in excess of reasonably expected near 
term customer demands.
    [Agency] will base such a determination on all available facts 
and circumstances, including, among other things: an evaluation of 
the extent to which a trading unit's transactions are with customers 
versus non-customers and the frequency with which the trading unit's 
retained principal positions and risks turn over; and a comparison 
of these figures to the trading unit's prior results with respect to 
similar positions and market situations, and the results of other 
covered banking entities' trading units with respect to similar 
positions.
    To help assess the extent to which a trading unit's transactions 
are with customers versus non-customers, [Agency] will utilize the 
Customer-Facing Trade Ratio quantitative measurement, as applicable, 
and any other

[[Page 8442]]

relevant factor. To help assess the frequency with which the trading 
unit's retained principal positions and risks turn over, [Agency] 
will utilize the Inventory Risk Turnover and Inventory Aging 
quantitative measurements, as applicable, and any other relevant 
factor.
    With respect to a particular trading activity in which a trading 
unit either does not transact through a trading system that 
interacts with orders of others or primarily with customers of the 
banking entity's market making desk to provide liquidity services, 
explanatory facts and circumstances might include, among other 
things: sudden market disruptions or other changes causing 
significant increases in a trading unit's hedging transactions with 
non-customers; or substantial intermediary trading required to 
satisfy customer demands and hedging management. With respect to 
particular trading activity in which a trading unit retains 
principal positions and risks in excess of reasonably expected near 
term customer demands, explanatory facts and circumstances might 
include, among other things: sudden market disruptions or other 
changes causing a significant reduction in actual customer demand 
relative to expected customer demand; documented and reasonable 
expectations for temporary increases in customer demand in the near 
term; and sudden market disruptions or other changes causing a 
significant reduction in the value of retained principal positions 
and risks, such that it would be imprudent for the trading unit to 
dispose of the positions in the near term.

5. Payment of Fees, Commissions, and Spreads

    Absent explanatory facts and circumstances, particular trading 
activity in which a trading unit routinely pays rather than earns 
fees, commissions, or spreads will be considered to be prohibited 
proprietary trading, and not permitted market making-related 
activity.
    [Agency] will base such a determination on all available facts 
and circumstances, including, among other things: an evaluation of 
the frequency with which the trading unit pay fees, commissions, or 
spreads and the relative amount of fees, commissions, or spreads 
that is paid versus earned; and a comparison of these figures to the 
trading unit's prior results with respect to similar positions, and 
the results of other covered banking entities' trading units with 
respect to similar positions.
    To help assess the extent to which a trading unit is paying 
versus earning fees, commissions, and spreads, [Agency] will utilize 
the Pay-to-Receive Spread Ratio quantitative measurement, as 
applicable, and any other relevant factor.
    Explanatory facts and circumstances might include, among other 
things, sudden market disruptions or other changes causing 
significant, increases in a trading unit's hedging transactions with 
non-customers for which it must pay fees, commissions, or spreads, 
sudden, unanticipated customer demand for liquidity that requires 
the trading unit itself to pay fees, commissions, or spreads to 
other market makers for liquidity services to obtain the inventory 
needed to meet that customer demand, or significant, unanticipated 
reductions in fees, commissions, or spreads earned by the trading 
unit. Explanatory facts and circumstances might also include a 
trading unit's efforts to expand or contract its market share.

6. Compensation Incentives

    Absent explanatory facts and circumstances, the trading activity 
of a trading unit that provides compensation incentives to employees 
that primarily reward proprietary risk taking will be considered to 
be prohibited proprietary trading, and not permitted market making-
related activity.
    [Agency] will base such a determination on all available facts 
and circumstances, including, among other things, an evaluation of: 
the extent to which compensation incentives are provided to trading 
unit personnel that reward revenues from movements in the price of 
retained principal positions and risks; the extent to which 
compensation incentives are provided to trading unit personnel that 
reward customer revenues; and the compensation incentives provided 
by other covered banking entities to similarly-situated personnel.

Appendix C to Part [ ]--Minimum Standards for Programmatic Compliance

I. Overview

A. Purpose

    This appendix sets forth the minimum standards with respect to 
the establishment, maintenance, and enforcement by banking entities 
of internal compliance programs for ensuring and monitoring 
compliance with the prohibitions and restrictions on proprietary 
trading and covered fund activities or investments set forth in 
section 13 of the BHC Act and this part.
    This appendix requires that banking entities establish, 
maintain, and enforce an effective compliance program, consisting of 
written policies and procedures, internal controls, a management 
framework, independent testing, training, and recordkeeping, that:
    <bullet> Is reasonably designed to clearly document, describe, 
and monitor the covered trading and covered fund activities or 
investments and the risks of the covered banking entity related to 
such activities or investments, identify potential areas of 
noncompliance, and prevent activities or investments prohibited by, 
or that do not comply with, section 13 of the BHC Act and this part;
    <bullet> Specifically addresses the varying nature of activities 
or investments conducted by different units of the covered banking 
entity's organization, including the size, scope, complexity, and 
risks of the individual activities or investments;
    <bullet> Subjects the effectiveness of the compliance program to 
independent review and testing;
    <bullet> Makes senior management and intermediate managers 
accountable for the effective implementation of the compliance 
program, and ensures that the board of directors and CEO review the 
effectiveness of the compliance program; and
    <bullet> Facilitates supervision and examination of the covered 
banking entity's covered trading and covered fund activities or 
investments by the Agencies.

B. Definitions

    The terms used in this Appendix have the same meanings as set 
forth in Sec. Sec.  ----.2, ----.3, and ----.10. In addition, for 
purposes of this appendix, the following definitions apply:
    Asset management unit means any unit of organization of a 
covered banking entity that makes investments in, or acts as sponsor 
to, covered funds, or has relationships with covered funds, that the 
covered banking entity (or an affiliate of subsidiary thereof) has 
sponsored, organized and offered, or in which a covered fund 
sponsored or advised by the covered banking entity invests.
    Compliance program means the internal compliance program 
established by a covered banking entity in accordance with Sec.  --
--.20 and this appendix.
    Covered fund activity or investment means sponsoring any covered 
fund or making investments in, or otherwise having relationships 
with, any covered fund for which the covered banking entity (or an 
affiliate or subsidiary thereof) acts as sponsor or organizes and 
offers.
    Covered fund restrictions means the restrictions on covered fund 
activities or investments set forth in subpart C.
    Covered trading activity means proprietary trading, as defined 
in Sec.  ----.3(b)(1).
    Trading unit means each of the following units of organization 
of a covered banking entity:
    (i) Each discrete unit that is engaged in the coordinated 
implementation of a revenue-generation strategy and that 
participates in the execution of any covered trading activity; \1\
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    \1\ [Agency] expects that this will generally be the smallest 
unit of organization used by the covered banking entity to structure 
and control its risk-taking activities and employees, and will 
include each unit generally understood to be a single ``trading 
desk.''
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    (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); \2\
---------------------------------------------------------------------------

    \2\ [Agency] expects that this will generally include management 
or reporting divisions, groups, sub-groups, or other intermediate 
units of organization used by the covered banking entity to manage 
one or more discrete trading units (e.g.,``North American Credit 
Trading,'' ``Global Credit Trading,'' etc.).
---------------------------------------------------------------------------

    (iii) All trading operations, collectively; and
    (iv) Any other unit of organization specified by the [Agency] 
with respect to a particular banking entity.

C. Required Elements

    Section ----.20 requires that covered banking entities 
establish, maintain, and enforce a compliance program reasonably 
designed to ensure and monitor compliance with the prohibitions and 
restrictions on proprietary trading and covered fund activities or 
investments that effectively

[[Page 8443]]

implements, at a minimum, the six elements required under paragraph 
(b) of Sec.  ----.20.

D. Compliance Program Structure

    Each covered banking entity subject to Sec.  ----.20(c) must be 
governed by a compliance program meeting the requirements of this 
appendix. A covered banking entity may establish a compliance 
program on an enterprise-wide basis to satisfy the requirements of 
Sec.  ----.20 and this appendix with respect to the covered banking 
entity and all of its affiliates and subsidiaries collectively, 
provided that: the program is clearly applicable, both by its terms 
and in operation, to all such affiliates and subsidiaries; the 
program specifically addresses the requirements set forth in this 
appendix; the program takes into account and addresses the 
consolidated organization's business structure, size, and 
complexity, as well as the particular activities, risks, and 
applicable legal requirements of each subsidiary and affiliate; and 
the program is determined through periodic independent testing to be 
effective for the covered banking entity and all of its subsidiaries 
and affiliates. An enterprise-wide program established pursuant to 
this Appendix will be subject to supervisory review and examination 
by any Agency vested with rulewriting authority under section 13 of 
the BHC Act with respect to the compliance program and the 
activities or investments of any banking entity for which the Agency 
has such authority. Further, such Agency will have access to all 
records related to the enterprise-wide compliance program pertaining 
to any banking entity that is supervised by the Agency vested with 
such rulewriting authority.

E. Applicability

    This appendix applies only to covered banking entities described 
in Sec.  ----.20(c)(2). In addition, [Agency] may require any 
covered banking entity to comply with all or portions of this 
appendix if [Agency] deems it appropriate for purposes the covered 
banking entity's compliance with this part.
    Nothing in this appendix limits the authority of [Agency] under 
any other provision of law or regulation to take supervisory, 
examination, or enforcement action, including action to address 
unsafe or unsound practices or conditions, deficient capital levels, 
or violations of law.

II. Internal Policies and Procedures

A. Covered Trading Activities

    A covered banking entity must establish, maintain, and enforce 
written policies and procedures reasonably designed to document, 
describe, and monitor the covered banking entity's covered trading 
activities and the risks taken in these activities, as follows:\3\
---------------------------------------------------------------------------

    \3\ These policies and procedures must be updated with a 
frequency sufficient for the covered banking entity to adequately 
control the applicable trading unit for purposes of this part.
---------------------------------------------------------------------------

    Identification of trading account: The covered banking entity's 
policies and procedures must specify how the banking entity 
evaluates the covered financial positions it acquires or takes and 
determines which of its accounts are trading accounts for purposes 
of subpart B.
    Identification of trading units and organization structure: The 
covered banking entity's written policies and procedures must 
identify and document each trading unit within the organization and 
map each trading unit to the division, business line, or other 
organizational structure that the covered banking entity uses to 
manage or oversee the trading unit's activities.
    Description of missions and strategies: The covered banking 
entity's written policies and procedures for each trading unit must 
clearly articulate and document a comprehensive description of the 
mission (i.e., the nature of the business conducted) and strategy 
(i.e., business model for the generation of revenues) of the trading 
unit, and include a description of:
    <bullet> How revenues are intended to be generated by the 
trading unit;
    <bullet> The activities that the trading unit is authorized to 
conduct, including authorized instruments and products and 
authorized hedging strategies and instruments;
    <bullet> The expected holding period of, and the market risk 
associated with, covered financial positions in its trading account;
    <bullet> The types of clients, customers, and counterparties 
with whom trading is conducted by the trading unit;
    <bullet> How the trading unit, if engaged in market making-
related activity under Sec.  --.4(b) of this part, identifies its 
customers for purposes of computing the Customer-Facing Trade Ratio, 
if applicable, including documentation explaining when, how, and why 
a broker-dealer, swap dealer, security-based swap dealer, any other 
entity engaged in market making-related activities, or any affiliate 
thereof is considered to be a customer of the trading unit for those 
purposes; and
    <bullet> The compensation structure of the employees associated 
with the trading unit.
    Trader mandates: The covered banking entity must establish, 
maintain, document, and enforce trader mandates for each trading 
unit. At a minimum, trader mandates must:
    <bullet> Clearly inform each trader of the prohibitions and 
requirements set forth in section 13 of the BHC Act and this part 
and his or her responsibilities for compliance with such 
requirements;
    <bullet> Set forth appropriate parameters for each trader 
engaged in covered trading activities, including:
    [cir] The conditions for relying on the applicable exemptions in 
Sec. Sec.  ----.4 through ----.6;
    [cir] The financial contracts, products, and underlying assets 
that the trader is permitted to trade pursuant to the covered 
banking entity's internal controls;
    [cir] The risk limits of the trader's trading unit, and the 
types and levels of risk that may be taken; and
    [cir] The applicable trading unit's hedging policy.
    Description of risks and risk management processes: The written 
policies and procedures for each trading unit must clearly 
articulate and document a comprehensive description of the risks 
associated with the trading unit. Such descriptions must include, at 
a minimum, the following elements:
    <bullet> A description of the supervisory and risk management 
structure governing the trading units, including a description of 
processes for initial and senior-level review of new products and 
new strategies;
    <bullet> A description of the types of risks that may be taken 
to implement the mission and strategy of the trading unit, including 
an enumeration of material risks resulting from the activities in 
which the trading unit is engaged (including but not limited to all 
significant price risks, such as basis, volatility and correlation 
risks, as well as any significant counterparty credit risk 
associated with the trading activity);
    <bullet> An articulation of the amount of risk allocated by the 
covered banking entity to such trading unit to implement the 
documented mission and strategy of the trading unit;
    <bullet> An explanation of how the risks allocated to such 
trading unit will be measured; and
    <bullet> An explanation of why the allocated risk levels are 
appropriate to the mission and strategy of the trading unit.
    Hedging policies and procedures. The covered banking entity must 
establish, maintain, and enforce policies and procedures for all of 
its trading units regarding the use of risk-mitigating hedging 
instruments and strategies. At a minimum, these hedging policies and 
procedures must articulate the following:
    <bullet> The manner in which the covered banking entity will 
determine that the risks generated by each trading unit have been 
properly and effectively hedged;
    <bullet> The instruments, techniques and strategies the covered 
entity will use to hedge the risk of the positions or portfolios;
    <bullet> The level of the organization at which hedging activity 
and management will occur;
    <bullet> The manner in which hedging strategies will be 
monitored;
    <bullet> The risk management processes used to control unhedged 
or residual risks; and
    <bullet> The independent testing of hedging techniques and 
strategies.
    Explanation of compliance. The covered banking entity's written 
policies and procedures must clearly articulate and document a 
comprehensive explanation of how the mission and strategy of each 
trading unit, and its related risk levels, comply with this part. 
Such explanation must:
    <bullet> Identify which portions of the risk-taking activity of 
the trading unit would or would not constitute covered trading 
activity;
    <bullet> Identify activities of the trading unit that will be 
conducted in reliance on exemptions contained in Sec. Sec.  ----.4 
through ----.6, including an explanation of:
    [cir] How and where the activity occurs; and
    [cir] Which exemption is being relied on and how the activity 
meets the specific requirements for reliance on the applicable 
exemption.
    <bullet> Describe how the covered banking entity monitors for 
and prohibits potential or actual material exposure to high-risk 
assets or high-risk trading strategies presented by each trading 
unit, which must take into account potential or actual exposure to:

[[Page 8444]]

    [cir] Assets whose values cannot be externally priced or, where 
valuation is reliant on pricing models, whose model inputs cannot be 
externally validated;
    [cir] Assets whose changes in values cannot be adequately 
mitigated by effective hedging;
    [cir] New products with rapid growth, including those that do 
not have a market history;
    [cir] Assets or strategies that include significant embedded 
leverage;
    [cir] Assets or strategies that have demonstrated significant 
historical volatility;
    [cir] Assets or strategies for which the application of capital 
and liquidity standards would not adequately account for the risk; 
and
    [cir] Assets or strategies that result in large and significant 
concentrations to sectors, risk factors, or counterparties;
    <bullet> Explain how each trading unit will comply with the 
reporting and recordkeeping requirements of Sec.  ----.7 and 
Appendix A ;
    <bullet> Describe how the covered banking entity monitors for 
and prohibits potential or actual material conflicts of interest 
between the covered banking entity and its clients, customers, or 
counterparties present in each trading unit; and
    <bullet> Describe how the covered banking entity monitors for 
and prohibits potential or actual transactions or activities that 
may threaten the safety and soundness of the covered banking entity.
    Remediation of violations. The covered banking entity's written 
policies and procedures must require the covered banking entity to 
promptly document, address and remedy any violation of section 13 of 
the BHC Act or this part, and document all proposed and actual 
remediation efforts. Further, such policies and procedures must 
include specific procedures that are reasonably designed to 
implement and monitor any required remediation and that assess the 
extent to which any violation indicates that modification to the 
covered banking entity's compliance program is warranted.
    With respect to any trading unit that is either used by the 
covered banking entity to structure and control the aggregate risk-
taking activities and employees of one or more other trading units, 
or comprised of the entire trading operation of the covered banking 
entity, the description of missions and strategies, description of 
risks and risk management processes, and explanation of compliance 
for such trading units may incorporate by reference the policies and 
procedures of the underlying trading units that the trading unit 
oversees and manages in the aggregate.

B. Covered Fund Activities or Investments

    A covered banking entity must establish, maintain, and enforce 
written policies and procedures that are reasonably designed to 
document, describe, and monitor the covered banking entity's covered 
fund activities or investments and the risks taken in these 
activities or investments, as follows.
    Identification of covered funds: The covered banking entity's 
policies and procedures must specify how the covered banking entity 
identifies covered funds that the covered banking entity sponsors, 
organizes and offers, or in which covered banking entity invests.
    Identification of asset management units and organization 
structure: The covered banking entity's written policies and 
procedures must identify and document each asset management unit 
within the organization and map each asset management unit to the 
division, business line, or other organizational structure that the 
covered banking entity uses to manage or oversee the asset 
management unit's activities or investments.
    Description of sponsorship activities related to covered funds: 
The covered banking entity's written policies and procedures for 
each asset management unit must clearly articulate and document a 
comprehensive description of the mission (i.e., the nature of the 
business conducted) and strategy (i.e., business model for the 
generation of revenues) of the asset management unit related to its 
sponsorship or organizing and offering of covered funds, including a 
description of how such activities comply with this part and, in 
particular:
    <bullet> The activities that the asset management unit is 
authorized to conduct, including the nature of any trust, fiduciary, 
investment advisory, or commodity trading advisory services offered 
to customers of the covered banking entity;
    <bullet> The types of customers to whom the asset management 
unit provides such services and to whom ownership interests in 
covered funds are sold;
    <bullet> The extent of any co-investment activities of the 
covered banking entity (including its directors or employees) in 
covered funds offered to such customers; and
    <bullet> How the asset management unit complies with the 
requirements of subpart C.
    Description of investment activities of covered funds: The 
covered banking entity's written policies and procedures for each 
asset management unit must clearly articulate and document a 
comprehensive description of the mission (i.e., the nature of the 
business conducted) and strategy (i.e., business model for the 
generation of revenues) of the asset management unit related to its 
investments in covered funds, including a description of how such 
activities comply with this part and, in particular:
    <bullet> The asset management unit's practices with respect to 
seed capital investments in covered funds, including how the asset 
management unit reduces its investments in covered funds to amounts 
that are permitted de minimis investments within the required period 
of time;
    <bullet> The asset management unit's practices with respect to 
co-investments in covered funds, including certain parallel 
investments as identified in Sec.  ----.12;
    <bullet> How the asset management unit complies with the 
requirements of Sec.  ----.12 with respect to individual and 
aggregate investments in covered funds;
    <bullet> With respect to other permitted covered fund activities 
or investment, how the asset management unit complies with the 
requirements of Sec. Sec.  ----.13 and ----.14;
    <bullet> How the asset management unit complies with the 
limitations on relationships with a covered fund under Sec.  --
--.16;
    <bullet> How the covered banking entity monitors for and 
prohibits potential or actual material conflicts of interest between 
the covered banking entity and its clients, customers, or 
counterparties related to the asset management unit;
    <bullet> How the covered banking entity monitors for and 
prohibits potential or actual transactions or activities that may 
threaten the safety and soundness of the covered banking entity 
related to the asset management unit; and
    <bullet> How the covered banking entity monitors for and 
prohibits potential or actual material exposure to high-risk assets 
or high-risk trading strategies presented by each asset management 
unit.
    Remediation of violations. The covered banking entity's written 
policies and procedures must require the covered banking entity to 
promptly document, address and remedy any violation of section 13 of 
the BHC Act or this part, and document all proposed and actual 
remediation efforts. Further, such policies and procedures must 
include specific procedures that are designed to implement, monitor, 
and enforce any required remediation and that assess the extent to 
which any violation indicates that modification to the covered 
banking entity's compliance program is warranted.

III. Internal Controls

A. Covered Trading Activities

    A covered banking entity must establish, maintain, and enforce 
written internal controls that are reasonably designed to ensure 
that the trading activity of each trading unit is appropriate and 
consistent with the description of mission, strategy, and risk 
mitigation for each trading unit contained in its written policies 
and procedures. These written internal controls must also be 
reasonably designed and established to effectively monitor and 
identify for further analysis any covered trading activity that may 
indicate potential violations of section 13 of the BHC Act and this 
part and to prevent actual violations of section 13 of the BHC Act 
and this part. Further, the internal controls must describe 
procedures for remedying violations of section 13 of the BHC Act and 
this part. The written internal controls must include, at a minimum, 
the following.
    Authorized risks, instruments, and products. The covered banking 
entity must implement and enforce internal controls for each trading 
unit that are reasonably designed to ensure that trading activity is 
conducted in conformance with the trading unit's authorized risks, 
instruments, and products, as documented in the covered banking 
entity's written policies and procedures and trader mandates. At a 
minimum, these internal controls must monitor and govern:
    <bullet> The types and levels of risks that may be taken by each 
trading unit, consistent with the covered banking entity's written 
policies and procedures;
    <bullet> The type of hedging instruments used, hedging 
strategies employed, and the amount

[[Page 8445]]

of risk effectively hedged, consistent with the covered banking 
entity's written policies and procedures; and
    <bullet> The financial contracts, products and underlying assets 
that the trading unit may trade, consistent with covered banking 
entity's written policies and procedures.
    Risk limits. The covered banking entity must establish and 
enforce risk limits appropriate for each trading unit, which shall 
include limits based on probabilistic and non-probabilistic measures 
of potential loss (e.g., Value-at-Risk and notional exposure, 
respectively), measured under normal and stress market conditions.
    Analysis and quantitative measurements. The covered banking 
entity must perform robust analysis and quantitative measurement of 
its covered trading activities that is reasonably designed to ensure 
that the trading activity of each trading unit is consistent with 
its mission, strategy and risk management process, as documented in 
the covered banking entity's written policies and procedures; 
monitor and assist in the identification of potential and actual 
prohibited proprietary trading activity; and prevent the occurrence 
of prohibited proprietary trading. In addition to the quantitative 
measurements reported by the covered banking entity to [Agency] 
pursuant to appendix A to this part, each covered banking entity 
must develop and implement, to the extent necessary to facilitate 
compliance with this part, additional quantitative measurements 
specifically tailored to the particular risks, practices, and 
strategies of its trading units. The covered banking entity's 
analysis and quantitative measurement must incorporate the 
quantitative measurements reported by the covered banking entity to 
[Agency] pursuant to appendix A to this part and include, at 
minimum, the following:
    <bullet> Internal controls and written policies and procedures 
reasonably designed to ensure the accuracy and integrity of 
quantitative measurements;
    <bullet> Ongoing, timely monitoring and review of calculated 
quantitative measurements;
    <bullet> Heightened review of a quantitative measurement when 
such quantitative measurement raises any question regarding 
compliance with section 13 of the BHC Act and this part, which shall 
include in-depth analysis, appropriate escalation procedures, and 
documentation related to the review, including the establishment of 
numerical thresholds for each trading unit for purposes of 
triggering such heightened review; and
    <bullet> Immediate review and compliance investigation of the 
trading unit's activities, escalation to senior management with 
oversight responsibilities for the applicable trading unit, timely 
notification to [Agency], appropriate remedial action (e.g., 
divesting of impermissible positions, cessation of impermissible 
activity, disciplinary actions), and documentation of the 
investigation findings and remedial action taken when the 
quantitative measurement, considered together with the facts and 
circumstances, suggests a reasonable likelihood that the trading 
unit has violated any part of section 13 of the BHC Act and this 
part.
    Surveillance of compliance program effectiveness. The covered 
banking entity must regularly monitor the effectiveness of its 
compliance program and take prompt action to address and remedy any 
deficiencies identified. Any actions taken to remedy deficiencies 
and violations shall be documented and maintained as a record of the 
banking entity.

B. Covered Fund Activities

    A covered banking entity must establish, maintain, and enforce 
internal controls that are reasonably designed to ensure that the 
covered fund activities or investments of its asset management units 
are appropriate and consistent with the description of the asset 
management unit's mission, strategy, and risk management process 
contained in the covered banking entity's written policies and 
procedures. The internal controls must, at a minimum, be designed to 
ensure that the covered banking entity complies with the 
requirements of Sec.  ----.11 for any covered fund in which it 
invests, acts as sponsor, or organizes and offers, as well as the 
following:
    Monitoring investments in a covered fund. The covered banking 
entity must implement and enforce internal controls in a way that 
monitors and limits the covered banking entity's individual and 
aggregate investments in covered funds. At a minimum, the covered 
banking entity shall establish, maintain, and enforce internal 
controls reasonably designed to ensure that such investments are in 
compliance with section 13 of the BHC Act and this part at all 
times, including:
    <bullet> Monitoring the amount and timing of seed capital 
investments for compliance with the limitations (including but not 
limited to the redemption, sale or disposition requirements of Sec.  
----.12);
    <bullet> Calculating the individual and aggregate levels of 
ownership interests in covered funds required by Sec.  ----.12;
    <bullet> Describing procedures for remedying violations of 
section 13 of the BHC Act and this part;
    <bullet> Attributing the appropriate instruments to the 
individual and aggregate ownership interest calculations above; and
    <bullet> Making the appropriate required disclosures, in 
writing, to prospective and actual investors in any covered fund 
organized and offered or sponsored by the covered banking entity, as 
provided under Sec.  ----.11(h).
    Monitoring relationships with a covered fund. The covered 
banking entity must implement and enforce internal controls in a way 
that monitors and limits the covered banking entity's sponsorship 
of, and relationships with, covered funds. At a minimum, the covered 
banking entity shall establish, maintain, and enforce internal 
controls reasonably designed to ensure that such activities and 
relationships are in compliance with section 13 of the BHC Act and 
this part at all times, including monitoring for and preventing any 
relationship or transaction between the covered banking entity and a 
covered fund that is prohibited under Sec.  ----.16.
    Surveillance of compliance program effectiveness. The covered 
banking entity must regularly monitor the effectiveness of its 
compliance program and take prompt action to address and remedy any 
deficiencies identified. Any actions taken to remedy deficiencies 
and violations shall be documented and maintained as a record of the 
covered banking entity.

IV. Responsibility and Accountability for the Compliance Program

    A covered banking entity must establish, maintain, and enforce a 
management framework to manage its business and employees with a 
view to preventing violations of section 13 of the BHC Act and this 
part. A covered banking entity must have an appropriate management 
framework reasonably designed to ensure that: appropriate personnel 
are made responsible and accountable for the effective 
implementation and enforcement of the compliance program; a clear 
reporting line with a chain of responsibility is delineated; and the 
board of directors, or similar corporate body, and CEO reviews and 
approves the compliance program. This management framework must 
include, at a minimum:
    Corporate governance. The covered banking entity must ensure 
that its compliance program is reduced to writing, approved by the 
board of directors or similar corporate body, and noted in the 
minutes.
    Trader mandates. The covered banking entity must establish, 
maintain, and enforce the trader mandates required by this appendix 
to clearly inform each trader within a trading unit of his or her 
responsibilities for compliance with section 13 of the BHC Act and 
this part.
    Management procedures. The covered banking entity must 
establish, maintain, and enforce management procedures that are 
reasonably designed to achieve compliance with section 13 of the BHC 
Act and this part, which, at a minimum, provide for:
    <bullet> The designation of at least one person with authority 
to carry out the management responsibilities of the covered banking 
entity for each trading unit;
    <bullet> Written procedures addressing the management of the 
activities of the covered banking entity that are reasonably 
designed to achieve compliance with section 13 of the BHC Act and 
this part, including:
    [cir] Procedures for the review by a manager of activities of 
the trading unit and the quantitative measurements pursuant to 
appendix A and any other quantitative measurements developed and 
tailored to the particular risks, practices, and strategies of the 
covered banking entity's trading units;
    [cir] A description of the management system, including the 
titles, qualifications, and locations of managers and the specific 
responsibilities of each person with respect to the covered banking 
entity's trading units; and
    [cir] Procedures for determining compensation arrangements for 
traders engaged in underwriting or market making-related activities 
under Sec.  ----.4 or risk-mitigating hedging activities under Sec.  
----.5 so that such compensation arrangements are designed not to 
reward proprietary risk taking.
    Business line managers. Managers with responsibility for one or 
more trading units or asset management units of the covered

[[Page 8446]]

banking entity engaged in covered trading activities or covered fund 
activities or investments are accountable for the effective 
implementation and enforcement of the compliance program with 
respect to the applicable trading unit or asset management unit.
    Senior management. Senior management is responsible for 
communicating and reinforcing the culture of compliance with section 
13 of the BHC Act and this part, as established by the board of 
directors or similar corporate body, and implementing and enforcing 
the approved compliance program. Senior management must also ensure 
that effective corrective action is taken when failures in 
compliance with section 13 of the BHC Act and this part are 
identified.\4\ Senior management and control personnel charged with 
overseeing compliance with section 13 of the BHC Act and this part 
should report to the board, or an appropriate committee thereof, on 
the effectiveness of the compliance program and compliance matters 
with a frequency appropriate to the size, scope, and risk profile of 
the covered banking entity's covered trading activities and covered 
fund activities or investments, which shall be at least once every 
twelve months.
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    \4\ Such corrective action may include, among other things 
divesture of the position, cessation of the activity, or 
disciplinary measures.
---------------------------------------------------------------------------

    Board of directors, or similar corporate body, and CEO. The 
board of directors, or similar corporate body, and CEO are 
responsible for setting an appropriate culture of compliance with 
this part and establishing clear policies regarding the management 
of covered trading activities and covered fund activities or 
investments in compliance with section 13 of the BHC Act and this 
part. The board of directors or similar corporate body must ensure 
that senior management is fully capable, qualified, and properly 
motivated to manage compliance with this part in light of the 
organization's business activities. The board of directors or 
similar corporate body must also ensure that senior management has 
established appropriate incentives to support compliance with this 
part, including the implementation of a compliance program meeting 
the requirements of this appendix into management goals and 
compensation structures across the covered banking entity.

V. Independent Testing

    A covered banking entity must ensure that independent testing is 
conducted by a qualified independent party, such as the covered 
banking entity's internal audit department, outside auditors, 
consultants, or other qualified independent parties, regarding the 
effectiveness of the covered banking entity's compliance program 
established pursuant to this appendix and Sec.  ----.20 and the 
covered banking entity's compliance with this part. A banking entity 
must take appropriate action to remedy any concerns identified by 
the independent testing (e.g., remedying deficiencies in its written 
policies and procedures and internal controls, etc.).
    The required independent testing must occur with a frequency 
appropriate to the size, scope, and risk profile of the covered 
banking entity's covered trading and covered fund activities or 
investments, which shall be no less than once every twelve months. 
This independent testing must include an evaluation of:
    <bullet> The overall adequacy and effectiveness of the covered 
banking entity's compliance program, including an analysis of the 
extent to which the program contains all the required elements of 
this appendix;
    <bullet> The effectiveness of the covered banking entity's 
written policies and procedures;
    <bullet> The effectiveness of the covered banking entity's 
internal controls, including an analysis and documentation of 
instances in which such internal controls have been breached, and 
how such breaches were addressed and resolved; and
    <bullet> The effectiveness of the covered banking entity's 
management procedures.

VI. Training

    Covered banking entities must provide adequate training to 
trading personnel and managers of the covered banking entity, as 
well as other appropriate personnel, as determined by the covered 
banking entity, in order to effectively implement and enforce the 
compliance program. This training should occur with a frequency 
appropriate to the size and the risk profile of the covered banking 
entity's covered trading activities and covered fund activities or 
investments. The training may be conducted by internal personnel or 
independent parties deemed appropriate by the covered banking entity 
based on its size and risk profile.

VII. Recordkeeping

    Covered banking entities must create and retain records 
sufficient to demonstrate compliance and support the operations and 
effectiveness of the compliance program. A covered banking entity 
must retain these records for a period that is no less than 5 years 
in a form that allows it to promptly produce such records to 
[Agency] on request.

END OF COMMON RULE

[END OF COMMON TEXT]

Adoption of the Common Rule Text

    The proposed adoption of the common rules set forth above by the 
CFTC, which are identical to the common rules adopted by the OCC, 
Board, FDIC, and SEC in the Joint Release, is modified by CFTC-specific 
text, as set forth below:

List of Subjects in 17 CFR Part 75

    Commodity pool operators, Commodity trading advisors, Futures 
commission merchants, Reporting and recordkeeping requirements, Swaps, 
Futures.

Authority and Issuance

    For the reasons set forth in the Supplementary Information, the 
Commodity Futures Trading Commission proposes to amend 17 CFR Chapter I 
as follows:

PART 75--PROPRIETARY TRADING AND RELATIONSHIPS WITH COVERED FUNDS

    1. The authority citation for part 75 is added to read as follows:

    Authority:  12 U.S.C. 1851.

    2. Part 75 is added as set forth at the end of the Common Preamble.
    3. Part 75 is amended by:
    a. Removing ``[Agency]'' wherever it appears and adding in its 
place ``CFTC''; and
    b. Removing ``[The Agency]'' wherever it appears and adding in its 
place ``The CFTC.''
    4. Section 75.1 is added to read as follows:


Sec.  75.1  Authority, purpose, scope, and relationship to other 
authorities.

    (a) Authority. This part is issued by the CFTC under section 13 of 
the Bank Holding Company Act of 1956, as amended (12 U.S.C. 1851).
    (b) Purpose. Section 13 of the Bank Holding Company Act establishes 
prohibitions and restrictions on proprietary trading and investments in 
or relationships with covered funds by certain banking entities, 
including registered commodity pool operators, registered commodity 
trading advisors, registered swap dealers, and registered major swap 
participants, among others identified in section 2(12)(C) of the Dodd-
Frank Wall Street Reform and Consumer Protection Act of 2010 (12 U.S.C. 
5301(12)(C)). This part implements section 13 of the Bank Holding 
Company Act by defining terms used in the statute and related terms, 
establishing prohibitions and restrictions on proprietary trading and 
investments in or relationships with covered funds, and explaining the 
statute's requirements.
    (c) Scope. This part implements section 13 of the Bank Holding 
Company Act with respect to covered banking entities described in Sec.  
75.2(j). This part takes effect on July 21, 2012.
    (d) Relationship to other authorities. Except as otherwise provided 
in under section 13 of the BHC Act, and notwithstanding any other 
provision of law, the prohibitions and restrictions under section 13 of 
BHC Act shall apply to the activities of a covered banking entity, even 
if such activities are authorized for a covered banking entity under 
other applicable provisions of law.
    5. Paragraph (j) of Sec.  75.2 is added to read as follows:


Sec.  75.2  Definitions.

* * * * *

[[Page 8447]]

    (j) Covered banking entity means any entity described in paragraph 
(e) of this section for which the CFTC is the primary financial 
regulatory agency, as defined in section 2(12)(C) of the Dodd-Frank 
Wall Street Reform and Consumer Protection Act of 2010 (12 U.S.C. 
5301(12)(C)).
* * * * *
    6. Section 75.10(a) is revised to read as follows:


Sec.  75.10  Prohibition on acquiring or retaining an ownership 
interest in and having certain relationships with a covered fund.

* * * * *
    (a)(1) General Prohibition. Except as otherwise provided in this 
subpart, a covered banking entity may not, as principal, directly or 
indirectly, acquire or retain any ownership interest in or sponsor a 
covered fund.
    (2) Commodity Pool Operators and Commodity Trading Advisors. A 
covered banking entity that is a covered banking entity because it is a 
commodity pool operator or commodity trading advisor identified in 
sections 2(12)(C)(ii) or 2(12)(C)(iii) of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act of 2010 shall comply with the 
restrictions on covered fund activities or investments set forth in 
subpart C and Sec.  ----.20 of subpart D issued by the agency 
identified in section 3(q) of the Federal Deposit Insurance Act (12 
U.S.C. 1813(q)) that regulates the banking entity described in Sec.  
75.2 (e)(1), (2) or (3) with which the commodity pool operator or 
commodity trading advisor is affiliated.
    Note to paragraph (a): Nothing set forth in paragraph (a)(2) of 
this section shall limit the CFTC's authority under any other provision 
of law, including pursuant to section 13 of the Bank Holding Company 
Act.
* * * * *

    Issued on January 11, 2012 in Washington, DC.
David A. Stawick,
Secretary of the Commission.

Appendices to Prohibitions and Restrictions on Proprietary Trading and 
Certain Interest In and Relationships With, Hedge Funds and Covered 
Funds. Commission Voting Summary and Statements of Commissioners

    Note: The following appendices will not appear in the Code of 
Federal Regulations.

Appendix 1--Commission Voting Summary

    On this matter, Chairman Gensler and Commissioners Chilton and 
Wetjen voted in the affirmative; Commissioners Sommers and O'Malia 
voted in the negative.

Appendix 2--Statement of Chairman Gary Gensler

    I support the proposed rule implementing the ``Volcker Rule'' 
requirements in the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (Dodd-Frank Act).
    Dodd-Frank amended the Banking Holding Company Act to provide 
the Commodity Futures Trading Commission with authority to implement 
Volcker Rule requirements for the entities for which we are the 
primary financial regulator.
    Today's proposal mirrors the joint rule proposed in October by 
the Board of Governors of the Federal Reserve System, the Federal 
Deposit Insurance Corporation, the Office of the Comptroller of the 
Currency, and the Securities and Exchange Commission.
    Consistent with the joint proposed rule, this proposal prohibits 
certain banking entities from engaging in proprietary trading. The 
proposal permits, as Congress prescribed, market-making and risk-
mitigating hedging.
    I look forward to receiving comments from market participants 
and the public on the proposed rule.

[FR Doc. 2012-935 Filed 2-13-12; 8:45 am]
BILLING CODE 6351-01-P


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