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2012-935

  • Federal Register, Volume 77 Issue 30 (Tuesday, February 14, 2012)[Federal Register Volume 77, Number 30 (Tuesday, February 14, 2012)]

    [Proposed Rules]

    [Pages 8332-8447]

    From the Federal Register Online via the Government Printing 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:

    Agency Web site, via its Comments Online process: http://comments.cftc.gov. Follow the instructions for submitting comments

    through the Web site.

    Mail: David A. Stawick, Secretary of the Commission,

    Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st

    Street NW., Washington, DC 20581.

    Hand Delivery/Courier: Same as mail above.

    Federal eRulemaking Portal: http://www.regulations.gov.

    Follow the instructions for submitting comments. Please submit comments

    by only one method.

    All comments must be submitted in English, or if not, accompanied

    by an English translation. Comments will be posted as received to

    http://www.cftc.gov. You should submit only information that you wish

    to make available publicly. If you wish the Commission to consider

    information that may be exempt from disclosure under the Freedom of

    Information Act (``FOIA''), a petition for confidential treatment of

    the exempt information may be submitted according to the procedures

    established in 17 CFR 145.9. The Commission reserves the right, but

    shall have no obligation, to review, prescreen, filter, redact, refuse,

    or remove any or all of your submission from http://www.cftc.gov that

    it may deem to be inappropriate for publication, such as obscene

    language. All submissions that have been redacted or removed that

    contain comments on the merits of the rulemaking will be retained in

    the public comment file and will be considered as required under the

    Administrative Procedure Act and other applicable laws, and may be

    accessible under FOIA.

    FOR FURTHER INFORMATION CONTACT: Steven E. Seitz, Counsel, Office of

    the General Counsel, 202-418-5615, sseitz@cftc.gov; Gary Barnett,

    Director, Division of Swap and Intermediary Oversight, (202) 418-5977,

    gbarnett@cftc.gov; Beverly Loew, Assistant General Counsel, Office of

    the General Counsel, (202) 418-5648, bloew@cftc.gov; Adedayo Banwo,

    Counsel, Office of the General Counsel, (202) 418-6249,

    abanwo@cftc.gov; Mathew Hargrow, Attorney Advisor, Office of the

    General Counsel, (202) 418-5267, mhargrow@cftc.gov; Todd Prono,

    Financial Economist, Office of the Chief Economist, (202) 418-5640,

    tprono@cftc.gov; Commodity Futures Trading Commission, Three Lafayette

    Centre, 1155 21st Street NW., Washington, DC 20581.

    SUPPLEMENTARY INFORMATION:

    I. Background

    The Dodd-Frank Act was enacted on July 21, 2010.\4\ Section 619 of

    the 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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    Trading in certain government obligations;

    Underwriting and market making-related activities;

    Risk-mitigating hedging activity;

    Trading on behalf of customers;

    Investments in Small Business Investment Companies

    (``SBICs'') and public interest investments;

    Trading for the general account of insurance companies;

    Organizing and offering a covered fund (including limited

    investments in such funds);

    Foreign trading by non-U.S. banking entities; and

    Foreign covered fund activities by non-U.S. banking

    entities.\22\

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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:

    Subpart A of the proposed rule describes the authority,

    scope, purpose, and relationship to other authorities of the rule and

    defines terms used commonly throughout the rule;

    Subpart B of the proposed rule prohibits proprietary

    trading, defines terms relevant to covered trading activity,

    establishes exemptions from the prohibition on proprietary trading and

    limitations on those exemptions, and requires certain banking entities

    to report quantitative measurements with respect to their trading

    activities;

    Subpart C of the proposed rule prohibits or restricts

    acquiring or retaining an ownership interest in, and certain

    relationships with, a covered fund, defines terms relevant to covered

    fund activities and investments, as well as establishes exemptions from

    the restrictions on covered fund activities and investments and

    limitations on those exemptions;

    Subpart D of the proposed rule generally requires banking

    entities to establish an enhanced compliance program regarding

    compliance with section 13 of the BHC Act and the proposed rule,

    including written policies and procedures, internal controls, a

    management framework, independent testing of the compliance program,

    training, and recordkeeping;

    Appendix A of the proposed rule details the quantitative

    measurements that certain banking entities may be required to compute

    and report with respect to their trading activities;\31\

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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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    Appendix B of the proposed rule provides commentary

    regarding the factors the Agencies propose to use to help distinguish

    permitted market making-related activities from prohibited proprietary

    trading; and

    Appendix C of the proposed rule details the minimum

    requirements and standards that certain banking entities must meet with

    respect to their compliance program, as required under subpart D.\32\

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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.

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

    Internal written policies and procedures reasonably

    designed to document, describe, and monitor the covered trading

    activities and covered fund activities and investments of the banking

    entity to ensure that such activities comply with section 13 of the BHC

    Act and the proposed rule;

    A system of internal controls reasonably designed to

    monitor and identify potential areas of noncompliance with section 13

    of the BHC Act and the proposed rule in the banking entity's covered

    trading and covered fund activities and to prevent the occurrence of

    activities that are prohibited by section 13 of the BHC Act and the

    proposed rule;

    A management framework that clearly delineates

    responsibility and accountability for compliance with section 13 of the

    BHC Act and the proposed rule;

    Independent testing for the effectiveness of the

    compliance program, conducted by qualified banking entity personnel or

    a qualified outside party;

    Training for trading personnel and managers, as well as

    other appropriate personnel, to effectively implement and enforce the

    compliance program; and

    Making and keeping records sufficient to demonstrate

    compliance with section 13 of the BHC Act and the proposed rule, which

    a relevant banking entity must promptly provide to the CFTC upon

    request and retain for a period of no less than 5 years.

    For a banking entity with significant covered trading activities or

    covered fund activities and investments, the compliance program must

    also meet a number of minimum standards that are specified in Appendix

    C of the proposed rule.\75\ The application of detailed minimum

    standards for these types of banking entities is intended to reflect

    the heightened compliance risks of large covered trading activities and

    covered fund activities and investments and to provide clear, specific

    guidance to such banking entities regarding the compliance measures

    that would be required for purposes of the proposed rule. For banking

    entities with smaller, less complex covered trading activities and

    covered fund activities and investments, these detailed minimum

    standards are not applicable, though the CFTC expects that such smaller

    entities will consider these minimum standards as guidance in designing

    an appropriate compliance program.

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

    \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.

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

    \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.

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

    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\

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

    \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.

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

    \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\

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

    \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.

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

    \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.''

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

    \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).

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

    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:

    Short-term resale;

    Benefitting from actual or expected short-term price

    movements;

    Realizing short-term arbitrage profits; or

    Hedging one or more such positions.

    This prong reflects the statutory definition's reference to

    positions acquired or taken ``principally for the

    [[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\

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

    \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.

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

    \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.

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

    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\

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

    \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.

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

    \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.

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

    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).

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

    Assisting an issuer in capital raising;

    Performing due diligence;

    Advising the issuer on market conditions and assisting in

    the preparation of a registration statement or other offering

    documents;

    Purchasing securities from an issuer, a selling security

    holder, or an underwriter for resale to the public;

    Participating in or organizing a syndicate of investment

    banks;

    Marketing securities; and

    Transacting to provide a 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\

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

    \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.

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

    [[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.

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

    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.

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

    \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\

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

    \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.

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

    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.

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

    \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:

    Making continuous, two sided quotes and holding oneself

    out as willing to buy and sell on a continuous basis;

    A pattern of trading that includes both purchases and

    sales in roughly comparable amounts to provide liquidity;

    Making continuous quotations that are at or near the

    market on both sides; and

    Providing widely accessible and broadly disseminated

    quotes.\155\

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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:

    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.

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

    With respect to securities, regularly purchasing covered

    financial positions from, or selling the positions to, clients,

    customers, or counterparties in the secondary market; and

    Transaction volumes and risk proportionate to historical

    customer liquidity and investments needs.

    The CFTC would apply these indicia when evaluating when a banking

    entity is eligible for the market making-related activities exemption,

    but also recognize that these indicia cannot be applied at all times

    and under all circumstances because some may be inapplicable to the

    specific asset class or market in which the market making activity is

    conducted.

    The bona fide market making-related activity described in 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.

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

    \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.

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

    \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.

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

    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.

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

    \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.'').

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

    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).

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

    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.

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

    \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.

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

    \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.

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

    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.

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

    \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.

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

    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.

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

    \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:

    The banking entity is an insurance company engaging in the

    transaction for a separate account;

    The banking entity is directly engaged in the business of

    insurance and subject to regulation by a State insurance regulator or

    foreign insurance regulator;\174\

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    \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).

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

    The banking entity purchases or sells the covered

    financial position solely for a separate account established by the

    insurance company in connection with one or more insurance policies

    issued by that insurance company;

    All profits and losses arising from the purchase or sale

    of the covered financial position are allocated to the separate account

    and inure to the benefit or detriment of the owners of the insurance

    policies supported by the separate account, and not the banking entity;

    and

    The purchase or sale is conducted in compliance with, and

    subject to, the insurance company investment and other laws,

    regulations, and written guidance of the State or jurisdiction in which

    such insurance company is domiciled.

    This category is included within the exemption for transactions on

    behalf of customers because such 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).

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    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).

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

    The insurance company must directly engage in the business

    of insurance and be subject to regulation by a State insurance

    regulator or foreign insurance regulator;

    The insurance company or its affiliate must purchase or

    sell the covered financial position solely for the general account of

    the insurance company;

    The purchase or sale must be conducted in compliance with,

    and subject to, the insurance company investment laws, regulations, and

    written guidance of the State or jurisdiction in which such insurance

    company is domiciled; and

    The appropriate Federal banking agencies, after

    consultation with the Council and the relevant insurance commissioners

    of the States, must not have jointly determined, after notice and

    comment, that a particular law, regulation, or written guidance

    described above is insufficient to protect the safety and soundness of

    the banking entity or of the financial stability of the United

    States.\178\

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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.

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

    \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.

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

    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.

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

    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.

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

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

    \185\ See 12 CFR 211.20 et seq.

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

    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\

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

    \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:

    The transaction is conducted by a banking entity that is

    not organized under the laws of the United States or of one or more

    States;

    No party to the transaction is a resident of the United

    States;

    No personnel of the banking entity that is directly

    involved in the transaction is physically located in the United States;

    \188\ and

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

    \188\ Personnel directly involved in the transaction would

    generally not include persons performing purely administrative,

    clerical, or ministerial functions.

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

    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).

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

    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:

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

    \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.

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

    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:

    Better understanding and evaluating the scope, type, and

    profile of the banking entity's covered trading activities;

    Monitoring the banking entity's covered trading

    activities;

    Identifying covered trading activities that warrant

    further review or examination by the banking entity to verify

    compliance with the proprietary trading restrictions;

    Evaluating whether the trading activities of trading units

    engaged in market making-related activities under Sec. ----.4(b) of

    the proposed rule are consistent with the requirements governing

    permitted market making-related activities;

    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;

    Identifying the profile of particular trading activities

    of the banking entity, and the individual trading units of the banking

    entity, to help establish the appropriate frequency and scope of

    examination by the CFTC of such activities; and

    Assessing and addressing the risks associated with the

    banking entity's trading activities.

    The types of trading and market making-related activities in which

    banking entities engage is often highly complex, and any quantitative

    measurement is capable of producing both ``false negatives'' and

    ``false positives'' that suggest that prohibited proprietary trading is

    occurring when it is not, or vice versa. Recognizing this, section I of

    proposed Appendix A makes clear that the quantitative measurements that

    may be required to be reported would not be intended to serve as a

    dispositive tool for identifying permissible or impermissible

    activities.

    Section II of proposed Appendix A defines relevant terms used in

    the appendix. These include certain definitions that clarify how and

    when certain calculations must be made, as well as a definition of

    ``trading unit'' that governs the level of organization at which a

    banking entity must calculate quantitative measurements. The proposed

    definition of ``trading unit'' covers multiple organizational levels of

    a banking entity, including:

    Each discrete unit engaged in the coordinated

    implementation of a revenue generation strategy that participates in

    the execution of any covered trading activity; \197\

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

    \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.

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

    Each organizational unit used to structure and control the

    aggregate risk-taking activities and employees of one or more trading

    units described above;

    All trading operations, collectively; and

    Any other unit of organization specified by the CFTC with

    respect to a particular banking entity.\198\

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

    \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.

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

    \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:

    Risk-management measurements--VaR, Stress VaR, VaR

    Exceedance, Risk Factor Sensitivities, and Risk and Position Limits;

    Source-of-revenue measurements--Comprehensive Profit and

    Loss, Portfolio Profit and Loss, Fee Income and Expense, Spread Profit

    and Loss, and Comprehensive Profit and Loss Attribution;

    Revenues-relative-to-risk measurements--Volatility of

    Comprehensive Profit and Loss, Volatility of Portfolio Profit and Loss,

    Comprehensive Profit and Loss to Volatility Ratio, Portfolio Profit and

    Loss to Volatility Ratio, Unprofitable Trading Days based on

    Comprehensive Profit and Loss, Unprofitable Trading Days based on

    Portfolio Profit and Loss, Skewness of Portfolio Profit and Loss, and

    Kurtosis of Portfolio Profit and Loss;

    Customer-facing activity measurements--Inventory Turnover,

    Inventory Aging, and Customer-facing Trade Ratio; and

    Payment of fees, commissions, and spreads measurements--

    Pay-to-Receive Spread Ratio.

    The CFTC has proposed these quantitative measurements because,

    taken together, these measurements appear useful for understanding the

    context in which trading activities occur and identifying activities

    that may warrant additional scrutiny to determine whether these

    activities involve prohibited proprietary trading because the trading

    activity either is inconsistent with permitted market making-related

    activities or presents a material exposure to high-risk assets or high-

    risk trading strategies. As described below, different quantitative

    measurements are proposed to identify different aspects and

    characteristics of trading activity for the purpose of helping to

    identify prohibited proprietary trading, and the CFTC expects that the

    quantitative measurements will be most useful for this purpose when

    implemented and reviewed collectively, rather than in isolation. The

    CFTC believes that, in the aggregate, many banking entities already

    collect and review many of these

    [[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:

    Is the use of the quantitative measurement to help

    distinguish between permitted and prohibited trading activities

    effective? If not, what alternative would be more effective? Does the

    quantitative measurement provide any additional information of value

    relative to other quantitative measurements proposed?

    Is the use of the quantitative measurement to help

    determine whether an otherwise-permitted trading activity is consistent

    with the requirement that such activity must not result, directly or

    indirectly, in a material exposure by the banking entity to high-risk

    assets and high-risk trading strategies effective? If not, what

    alternative would be more effective?

    What factors should be considered in order to further

    refine the proposed quantitative measurement to better distinguish

    prohibited proprietary trading from permitted trading activity? For

    example, should the timing of a calculation be considered significant

    in certain contexts (e.g., should specific quantitative measurements be

    calculated during the middle of a trading day instead of at the end of

    the day)?

    If the quantitative measurement is proposed to be applied

    to a trading unit

    [[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?

    Is the description of the quantitative measurement

    sufficiently clear? What alternative would be more appropriate or

    clearer? Is the description of the quantitative measurement

    appropriate, or is it overly broad or narrow? If it is overly broad,

    what additional clarification is needed? Should the CFTC provide this

    additional clarification in the appendix's description of the

    quantitative measurement? If the description is overly narrow, how

    should it be modified to appropriately describe the quantitative

    measurement, and why?

    Is the general calculation guidance effective and

    sufficiently clear? If not, what alternative would be more effective or

    clearer? Is more or less specific calculation guidance necessary? If

    so, what level of specificity is needed to calculate the quantitative

    measurement? What are the different calculation options and

    methodologies that could be used to reach the desired level of

    specificity? What are the costs and benefits of these different

    options? If the proposed calculation guidance is not sufficiently

    specific, how should the calculation guidance be modified to reach the

    appropriate level of specificity? For example, rather than provide this

    level of specificity in proposed Appendix A, should the CFTC instead

    make each banking entity responsible for determining the best method of

    calculating the quantitative measurement at this level of specificity,

    based on the banking entity's business and profile, which would then be

    subject to supervision, review, or examination by the CFTC? If the

    proposed calculation guidance is overly specific, why is it too

    specific and how should the guidance be modified to reach the

    appropriate level of specificity?

    Is the general calculation guidance for the measurement

    consistent with how banking entities currently calculate the

    quantitative measurement, if they do so? If not, how does the proposed

    guidance differ from methodology currently used by banking entities?

    What is the purpose of the current calculation methodology used by

    banking entities?

    What operational or logistical challenges might be

    associated with performing the calculation of the quantitative

    measurement and obtaining any necessary informational inputs?

    Is the quantitative measurement not calculable for any

    specific type of trading unit? If so, what type of trading unit, and

    why is the quantitative measurement not calculable for that type of

    trading unit? Is there an alternative quantitative measurement that

    would reflect the same trading activity but not pose the same

    calculation difficulty? Are there particular challenges to documenting

    that a specific quantitative measurement is not calculable?

    Is the quantitative measurement substantially likely to

    frequently produce false negatives or false positives that suggest that

    prohibited proprietary trading is occurring when it is not, or vice

    versa? If so, why? If so, what alternative quantitative measurement

    would better help identify prohibited proprietary trading?

    Should the quantitative measurement better account for

    distinctions among trading activities, trading strategies, and asset

    classes? If so, how? For example, should the quantitative measurements

    better account for distinctions between trading activities in cash and

    derivatives markets? If so, how? Are there any other distinctions for

    which the quantitative measurements may need to account? If so, what

    distinctions, and why?

    Does the quantitative measurement provide useful

    information as applied to all types of trading activities, or only a

    certain subset of trading activities? If it only provides useful

    information for a subset of trading activities, how should this issue

    be addressed? How beneficial is the information that the quantitative

    measurement provides for this subset of trading activities? Do any of

    the other quantitative measurements provide the same level of

    beneficial information for this subset of trading activities? Should

    the quantitative measurement be required to be reported for all trading

    activities, only a relevant subset of trading activities, or not at

    all?

    Does the quantitative measurement provide useful

    information as applied to all asset classes, or only a certain subset

    of asset classes? If it only provides useful information for a subset

    of asset classes, how should this issue be addressed? How beneficial is

    the information the quantitative measurement provides for this subset

    of asset classes? Do any of the other quantitative measurements provide

    the same level of beneficial information for this subset of asset

    classes? Should the quantitative measurement be required to be reported

    for all asset classes, only a relevant subset of asset classes, or not

    at all?

    Is the calculation period effective and sufficiently

    clear? If not, what alternative would be more effective or clearer?

    How burdensome and costly would it be to calculate the

    measurement at the specified calculation frequency and calculation

    period? Are there any difficulties or costs associated with calculating

    the measurement for particular trading units? How significant are those

    potential costs relative to the potential benefits of the measurement

    in monitoring for impermissible proprietary trading? Are there

    potential modifications that could be made to the measurement that

    would reduce the burden or cost? If so, what are those modifications?

    Please quantify your answers, to the extent feasible.

    Question 175. In light of the size, scope, complexity, and risk of

    covered trading activities, are there certain types of quantitative

    measurements that will not be appropriate for some types of banking

    entities, desks, or levels? If so, would it be appropriate to require

    only certain quantitative measurements for such banking entities,

    desks, or levels?

    Question 176. How might the number of quantitative measurements

    impact behavior of banking entities? Is there a cost of requiring more

    quantitative measurements, such as the cost of increased uncertainty

    regarding the combined results of such quantitative measurements? To

    what extent and in what ways might uncertainty as to how the

    quantitative measurements are applied and evaluated impact behavior?

    Proposed Appendix B--Commentary Regarding Identification of Permitted

    Market Making-Related Activities

    Proposed Appendix B provides commentary that is intended to assist

    a banking entity in distinguishing permitted market making-related

    activities from trading activities that, even if conducted in the

    context of a banking entity's market making operations, would

    constitute prohibited proprietary trading. As noted in Part I of

    proposed Appendix B, the commentary applies to all banking entities

    that are engaged in market making-related activities in reliance on

    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:

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

    \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.

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

    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.''

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

    Trading activity in which a trading unit primarily

    generates revenues from price movements of retained principal positions

    and risks, rather than customer revenues;

    Trading activity in which a trading unit: (i) Generates

    only very small or very large amounts of revenue per unit of risk

    taken; (ii) does not demonstrate consistent profitability; or (iii)

    demonstrates high earnings volatility;

    Trading activity in which a trading unit either (i) does

    not transact through a trading system that interacts with orders of

    others or primarily with customers of the banking entity's market

    making desk to provide liquidity services, or (ii) holds principal

    positions in excess of reasonably expected near term customer demands;

    Trading activity in which a trading unit routinely pays

    rather than earns fees, commissions, or spreads; and

    The use of compensation incentives for employees of a

    particular trading activity that primarily reward proprietary risk-

    taking.\206\

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

    \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\

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

    \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?

    ``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.''

    ``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.''

    ``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.''

    ``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.''

    ``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).

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

    Involve or result in a material conflict of interest

    between the banking entity and its clients, customers, or

    counterparties;

    Result, directly or indirectly, in a material exposure by

    the banking entity to a high-risk asset or a high-risk trading

    strategy; or

    Pose a threat to the safety and soundness of the banking

    entity or U.S. financial stability.

    The proposed rule further defines ``material conflict of

    interest,'' ``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\

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

    \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\

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

    \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\

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

    \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\

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

    \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.

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

    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\

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

    \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).

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

    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.

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

    \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.

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

    \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.

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

    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.

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

    \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\

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

    \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.

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

    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\

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

    \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.

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

    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.

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

    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\

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    \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.

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

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    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\

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    \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).

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    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).

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    \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:

    The transaction or activity is conducted by a banking

    entity that is not organized under the laws of the United States or of

    one or more States;

    No subsidiary, affiliate, or employee of the banking

    entity that is involved in the offer or sale of an ownership interest

    in the covered fund is incorporated or physically located in the United

    States; and

    No ownership interest in such covered fund is offered for

    sale or sold to a resident of the United States.

    These three criteria reflect statutory constraints and are intended to

    ensure that a transaction or activity conducted in reliance on the

    exemption does not involve either investors that are residents of the

    United States or a relevant U.S. employee of the banking entity, as

    such involvement would appear to constitute a sufficient locus of

    activity in the U.S. marketplace so as to preclude the availability of

    the exemption.

    A resident of the United States is defined in 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).

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

    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\

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

    \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.

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

    \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\

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

    \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\

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    \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:

    Involve or result in a material conflict of interest

    between the banking entity and its clients, customers, or

    counterparties;

    Result, directly or indirectly, in a material exposure by

    the banking entity to a high-risk asset or a high-risk trading

    strategy; or

    Pose a threat to the safety and soundness of the banking

    entity or the financial stability of the United States.

    Section ----.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:

    Internal written policies and procedures reasonably

    designed to document, describe, and monitor the covered trading

    activities and covered fund activities and investments of the banking

    entity to ensure that such activities and investments comply with

    section 13 of the BHC Act and the proposed rule;

    A system of internal controls reasonably designed to

    monitor and identify potential areas of noncompliance with section 13

    of the BHC Act and the proposed rule in the banking entity's covered

    trading activities and covered fund activities and investments and to

    prevent the occurrence of activities that are prohibited by section 13

    of the BHC Act and the proposed rule;

    A management framework that clearly delineates

    responsibility and accountability for compliance with section 13 of the

    BHC Act and the proposed rule;

    Independent testing for the effectiveness of the

    compliance program, conducted by qualified banking entity personnel or

    a qualified outside party;

    Training for trading personnel and managers, as well as

    other appropriate personnel, to effectively implement and enforce the

    compliance program; and

    Making and keeping records sufficient to demonstrate

    compliance with section 13 of the BHC Act and the proposed rule, which

    a banking entity must promptly provide to the CFTC upon request and

    retain for a period of no less than 5 years.

    In addition, for a banking entity with significant covered trading

    activities or covered fund activities and investments, 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:

    With respect to its covered trading activities, it engages

    in any covered trading activities and has, together with its affiliates

    and subsidiaries, trading assets and liabilities the average gross sum

    of which (on a worldwide consolidated basis), as measured as of the

    last day of each of the four prior calendar quarters, (i) is equal to

    or greater than $1 billion or (ii) equals 10 percent or more of its

    total assets; and

    With respect to its covered fund activities and

    investments, it engages in any covered fund activities and investments

    and either (i) has, together with its affiliates and subsidiaries,

    aggregate investments in one or more covered funds the average value of

    which is, as measured as of the last day of each of the four prior

    calendar quarters, equal to or greater than $1 billion or (ii) sponsors

    or advises, together with its affiliates and subsidiaries, one or more

    covered funds the average total assets of which are, as measured as of

    the last day of each of the four prior calendar quarters, equal to or

    greater than $1 billion.

    The application of detailed minimum standards to these types of

    banking entities is intended to reflect the heightened compliance risks

    of large covered trading and large covered fund activities and

    investments and provide guidance to such banking entities regarding the

    minimum compliance measures that would be required under the proposed

    rule.

    If a banking entity does not meet the thresholds specified in 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.

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

    Is designed to clearly document, describe, and monitor the

    covered trading activities and covered fund activities or investments

    and the risks of the banking entity related to such activities or

    investments, identify potential areas of noncompliance, and prevent

    activities or investments prohibited by, or that do not comply with,

    section 13 of the BHC Act and the proposed rule;

    Specifically addresses the varying nature of activities or

    investments conducted by different units of the banking entity's

    organization, including the size, scope, complexity, and risks of the

    individual activity or investment;

    Subjects the effectiveness of the compliance program to

    independent review and testing;

    Makes senior management and intermediate managers

    accountable for the effective implementation of the compliance program,

    and ensures that the board of directors or chief executive office

    (``CEO'') review the effectiveness of the compliance program; and

    Facilitate supervision of the banking entity's covered

    trading activities and covered fund activities or investments by the

    CFTC.

    A banking entity's compliance program should not be developed

    through a generic, one-size-fits-all approach, but rather should

    carefully take into account and reflect the unique manner in which a

    banking entity operates, as well as the particular compliance risks and

    challenges that its businesses present. In light of the complexities

    presented in differentiating prohibited proprietary trading from

    permitted market 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).

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    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 373 (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:

    Value-at-Risk and Stress VaR;

    VaR Exceedance;

    Risk Factor Sensitivities;

    Risk and Position Limits;

    Comprehensive Profit and Loss;

    Portfolio Profit and Loss;

    Fee Income and Expense;

    Spread Profit and Loss;

    Comprehensive Profit and Loss Attribution;

    Pay-to-Receive Spread Ratio;

    Unprofitable Trading Days Based on Comprehensive Profit

    and Loss and Unprofitable Trading Days Based on Portfolio Profit and

    Loss;

    Skewness of Portfolio Profit and Loss and Kurtosis of

    Portfolio Profit and Loss;

    Volatility of Comprehensive Profit and Loss and

    Volatility of Portfolio Profit and Loss;

    Comprehensive Profit and Loss to Volatility Ratio and

    Portfolio Profit and Loss to Volatility Ratio;

    Inventory Risk Turnover;

    Inventory Aging; and

    Customer-facing Trade Ratio; and

    (b) Each trading unit of the covered banking entity that is

    engaged in permitted trading activity subject to Sec. Sec. --

    --.4(a), ----.5, or ----.6(a) must furnish the following

    quantitative measurements, calculated in accordance with this

    appendix:

    Value-at-Risk and Stress VaR;

    Risk Factor Sensitivities;

    Risk and Position Limits;

    Comprehensive Profit and Loss; and

    Comprehensive Profit and Loss Attribution; and

    (ii) With respect to any covered banking entity that is engaged

    in any covered trading activity, and has trading assets and

    liabilities the average gross sum of which (on a worldwide

    consolidated basis) is, as measured as of the last day of each of

    the four prior calendar quarters, equal to or greater than $1

    billion and less than $5 billion, each trading unit of the covered

    banking entity that is engaged in market making-related activities

    under Sec. ----.4(b) must furnish the following quantitative

    measurement, calculated in accordance with this appendix:

    Comprehensive Profit and Loss;

    Portfolio Profit and Loss;

    Fee Income and Expense;

    Spread Profit and Loss;

    Value-at-Risk;

    Comprehensive Profit and Loss Attribution;

    Volatility of Comprehensive Profit and Loss and

    Volatility of Portfolio Profit and Loss; and

    Comprehensive Profit and Loss to Volatility Ratio and

    Portfolio Profit and Loss to Volatility Ratio.

    B. Frequency of Required Calculation and Reporting

    A covered banking entity must calculate any applicable

    quantitative measurement for each trading day. A covered banking

    entity must report each applicable quantitative measurement to

    [Agency] on a monthly basis, or on any other reporting schedule

    requested by [Agency]. All quantitative measurements for any

    calendar month must be reported to [Agency] no later than 30 days

    after the end of that calendar month or on any other time basis

    requested by [Agency].\3\

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

    \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:

    Commodity derivative positions: sensitivities with

    respect to the related commodity type (e.g., precious metals, oil

    and petroleum or agricultural products), the maturity of the

    positions, volatility and/or correlation sensitivities (expressed in

    a manner that demonstrates any significant non-linearities), and the

    maturity profile of the positions;

    Credit positions: sensitivities with respect to credit

    spread factors that are sufficiently granular to account for

    specific credit sectors and market segments, the maturity profile of

    the positions, and sensitivities to interest rates at all relevant

    maturities;

    Credit-related derivative positions: credit positions

    sensitivities and volatility and/or correlation sensitivities

    (expressed in a manner that demonstrates any significant non-

    linearities), and the maturity profile of the positions;

    Equity positions: sensitivity to equity prices and

    sensitivities that differentiate between important equity market

    sectors and segments, such as a small capitalization equities and

    international equities;

    Equity derivative positions: equity position

    sensitivities and volatility and/or correlation sensitivities

    (expressed in a manner that demonstrates any significant non-

    linearities), and the maturity profile of the positions;

    Foreign exchange derivative positions: sensitivities

    with respect to major currency pairs and maturities, sensitivity to

    interest rates at relevant maturities, and volatility and/or

    correlation sensitivities (expressed in a manner that demonstrates

    any significant non-linearities), as well as the maturity profile of

    the positions; and

    Interest rate positions, including interest rate

    derivative positions: sensitivities with respect to major interest

    rate categories and maturities and volatility and/or correlation

    sensitivities (expressed in a manner that demonstrates any

    significant non-linearities), as well as the maturity profile of the

    positions.

    The methods used by a covered banking entity to calculate

    sensitivities to a common factor shared by multiple trading units,

    such as an equity price factor, should be applied consistently

    across its trading units so that the sensitivities can be compared

    from one trading unit to another.

    Calculation Period: One trading day.

    4. Risk and Position Limits

    Description: For purposes of this appendix, Risk and Position

    Limits are the constraints that define the amount of risk that a

    trading unit is permitted to take at a point in time, as defined by

    the covered banking entity for a specific trading unit.

    General Calculation Guidance: Risk and Position Limits should be

    reported in the format used by the covered banking entity for the

    purposes of risk management of each trading unit. Risk and Position

    Limits are often expressed in terms of risk measures, such as VaR

    and Risk Factor Sensitivities, but may also be expressed in terms of

    other observable criteria, such as net open positions. When criteria

    other than VaR or Risk Factor Sensitivities are used to define the

    Risk and Position Limits, both the value of the Risk and Position

    Limits and the value of the variables used to assess whether these

    limits have been reached should be reported.

    Calculation Period: One trading day.

    B. Source-of-Revenue Measurements

    1. Comprehensive Profit and Loss

    Description: For purposes of this appendix, Comprehensive Profit

    and Loss is the net profit or loss of a trading unit's material

    sources of trading revenue, including, for example, dividend and

    interest income and expense, over a specific period of time. A

    trading unit's Comprehensive Profit and Loss for any given

    calculation period should generally equal the sum of the trading

    unit's Portfolio Profit and Loss and Fee Income.

    General Calculation Guidance: Comprehensive Profit and Loss

    generally should be computed using data on the value of a trading

    unit's underlying holdings, the prices at which those holdings were

    bought and sold, and the value of any fees, commissions, sales

    credits, spreads, dividends, interest income and expense, or other

    sources of income from trading activities, whether realized or

    unrealized. Comprehensive Profit and Loss should not include:

    compensation costs or other costs required to operate the unit, such

    as information technology costs; or charges and adjustments made for

    internal reporting and management purposes, such as accounting

    reserves.

    Calculation Period: One trading day.

    2. Portfolio Profit and Loss

    Description: For purposes of this appendix, Portfolio Profit and

    Loss is a trading unit's net profit or loss on its underlying

    holdings over a specific period of time, whether realized or

    unrealized. Portfolio Profit and Loss should generally include any

    increase or decrease in the market value of a trading unit's

    holdings, including, for example, any dividend, interest income, or

    expense of a trading unit's holdings. Portfolio Profit and Loss

    should not include direct fees, commissions, sales credits, or other

    sources of trading revenue that are not directly related to the

    market value of the trading unit's holdings.

    General Calculation Guidance: In general, Portfolio Profit and

    Loss should be computed using data on a trading unit's underlying

    holdings and the prices at which those holdings are marked for

    valuation purposes. Portfolio Profit and Loss should not include:

    compensation costs or other costs required to operate the trading

    unit, such as information technology costs; or charges and

    adjustments made for internal reporting and management purposes,

    such as accounting reserves.

    Calculation Period: One trading day.

    3. Fee Income and Expense

    Description: For purposes of this appendix, Fee Income and

    Expense generally includes direct fees, commissions and other

    distinct

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    income for services provided by or to a trading unit over a specific

    period of time.

    General Calculation Guidance: Fee Income and Expense should be

    computed using data on direct fees that are earned by the trading

    unit for services it provides to clients, customers, or

    counterparties, such as fees earned for structured transactions or

    sales commissions and credits earned for fulfilling a customer

    request, whether realized or unrealized, and similar fees paid by

    the trading unit to other service providers.

    Calculation Period: One trading day.

    4. Spread Profit and Loss

    Description: For purposes of this appendix, Spread Profit and

    Loss is the portion of Portfolio Profit and Loss that generally

    includes revenue generated by a trading unit from charging higher

    prices to buyers than the trading unit pays to sellers of comparable

    instruments over the same period of time (i.e., charging a

    ``spread,'' such as the bid-ask spread).

    General Calculation Guidance: Spread Profit and Loss generally

    should be computed using data on the prices at whi