2019-22695

Federal Register, Volume 84 Issue 220 (Thursday, November 14, 2019) 
[Federal Register Volume 84, Number 220 (Thursday, November 14, 2019)]
[Rules and Regulations]
[Pages 61974-62277]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-22695]

 

[[Page 61973]]

Vol. 84

Thursday,

No. 220

November 14, 2019

Part II

 

 

Department of Treasury

 

 

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Office of the Comptroller of the Currency

 

 

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12 CFR Part 44

 

 

Federal Reserve System

 

 

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12 CFR Part 248

 

 

Federal Deposit Insurance Corporation

 

 

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12 CFR Part 351

 

 

Commodity Futures Trading Commission

 

 

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17 CFR Part 75

 

 

Securities and Exchange Commission

 

 

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17 CFR Part 255

 

 

Prohibitions and Restrictions on Proprietary Trading and Certain
Interests in, and Relationships With, Hedge Funds and Private Equity
Funds; Final Rule

Federal Register / Vol. 84 , No. 220 / Thursday, November 14, 2019 /
Rules and Regulations

[[Page 61974]]


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DEPARTMENT OF TREASURY

Office of the Comptroller of the Currency

12 CFR Part 44

[Docket No. OCC-2018-0010]
RIN 1557-AE27

FEDERAL RESERVE SYSTEM

12 CFR Part 248

[Docket No. R-1608]
RIN 7100-AF 06

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 351

RIN 3064-AE67

COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 75

RIN 3038-AE72

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 255

[Release no. BHCA-7; File no. S7-14-18]
RIN 3235-AM10


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

AGENCY: Office of the Comptroller of the Currency, Treasury (OCC);
Board of Governors of the Federal Reserve System (Board); Federal
Deposit Insurance Corporation (FDIC); Securities and Exchange
Commission (SEC); and Commodity Futures Trading Commission (CFTC).

ACTION: Final rule.

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SUMMARY: The OCC, Board, FDIC, SEC, and CFTC are adopting amendments to
the regulations implementing section 13 of the Bank Holding Company
Act. Section 13 contains certain restrictions on the ability of a
banking entity and nonbank financial company supervised by the Board to
engage in proprietary trading and have certain interests in, or
relationships with, a hedge fund or private equity fund. These final
amendments are intended to provide banking entities with clarity about
what activities are prohibited and to improve supervision and
implementation of section 13.

DATES:
    Effective date: The effective date for amendatory instructions 1
through 14 (OCC), 16 through 29 (Board), 31 through 44 (FDIC), and 46
through 58 (CFTC) is January 1, 2020; the effective date for amendatory
instructions 60 through 73 (SEC) is January 13, 2020; and the effective
date for the addition of appendices Z at amendatory instructions 15
(OCC), 30 (Board), and 45 (FDIC) is January 1, 2020, through December
31, 2020, except for amendatory instruction 74 (SEC), which is
effective January 13, 2020, through December 31, 2020.
    Compliance date: Banking entities must comply with the final
amendments by January 1, 2021. Until the compliance date, banking
entities must continue to comply with the 2013 rule (as set forth in
appendices Z to 12 CFR parts 44, 248, and 351 and 17 CFR parts 75 and
255). Alternatively, a banking entity may voluntarily comply, in whole
or in part, with the amendments adopted in this release prior to the
compliance date, subject to the agencies' completion of necessary
technological changes.

FOR FURTHER INFORMATION CONTACT:
    OCC: Roman Goldstein, Risk Specialist, Treasury and Market Risk
Policy, (202) 649-6360; Tabitha Edgens, Counsel; Mark O'Horo, Senior
Attorney, Chief Counsel's Office, (202) 649-5490; for persons who are
deaf or hearing impaired, TTY, (202) 649-5597, Office of the
Comptroller of the Currency, 400 7th Street SW, Washington, DC 20219.
    Board: Flora Ahn, Special Counsel, (202) 452-2317, Gregory
Frischmann, Senior Counsel, (202) 452-2803, Kirin Walsh, Attorney,
(202) 452-3058, or Sarah Podrygula, Attorney, (202) 912-4658, Legal
Division, Cecily Boggs, Senior Financial Institution Policy Analyst,
(202) 530-6209, David Lynch, Deputy Associate Director, (202) 452-2081,
David McArthur, Senior Economist, (202) 452-2985, Division of
Supervision and Regulation; Board of Governors of the Federal Reserve
System, 20th and C Streets NW, Washington, DC 20551.
    FDIC: Bobby R. Bean, Associate Director, [email protected], Michael E.
Spencer, Chief, Capital Markets Strategies, [email protected],
Andrew D. Carayiannis, Senior Policy Analyst, [email protected], or
Brian Cox, Senior Policy Analyst, [email protected], Capital Markets
Branch, (202) 898-6888; Michael B. Phillips, Counsel,
[email protected], Benjamin J. Klein, Counsel, [email protected], or
Annmarie H. Boyd, Counsel, [email protected], Legal Division, Federal
Deposit Insurance Corporation, 550 17th Street NW, Washington, DC
20429.
    SEC: Andrew R. Bernstein, Senior Special Counsel, Sam Litz,
Attorney-Adviser, Aaron Washington, Special Counsel, or Carol McGee,
Assistant Director, at (202) 551-5870, Office of Derivatives Policy and
Trading Practices, Division of Trading and Markets, and Matthew Cook,
Senior Counsel, Benjamin Tecmire, Senior Counsel, and Jennifer Songer,
Branch Chief at (202) 551-6787 or [email protected], Division of
Investment Management, U.S. Securities and Exchange Commission, 100 F
Street NE, Washington, DC 20549.
    CFTC: Cantrell Dumas, Special Counsel, (202) 418-5043,
[email protected]; Jeffrey Hasterok, Data and Risk Analyst, (646) 746-
9736, [email protected], Division of Swap Dealer and Intermediary
Oversight; Mark Fajfar, Assistant General Counsel, (202) 418-6636,
[email protected], Office of the General Counsel; Stephen Kane, Research
Economist, (202) 418-5911, [email protected], Office of the Chief
Economist; Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background
II. Notice of Proposed Rulemaking
III. Overview of the Final Rule and Modifications From the Proposal
    A. The Final Rule
    B. Agency Coordination and Other Comments
IV. Section by Section Summary of the Final Rule
    A. Subpart A--Authority and Definitions
    B. Subpart B--Proprietary Trading Restrictions
    C. Subpart C--Covered Fund Activities and Investments
    D. Subpart D--Compliance Program Requirement; Violations
    E. Subpart E--Metrics
V. Administrative Law Matters
    A. Use of Plain Language
    B. Paperwork Reduction Act
    C. Regulatory Flexibility Act Analysis
    D. Riegle Community Development and Regulatory Improvement Act
    E. OCC Unfunded Mandates Reform Act Determination
    F. SEC Economic Analysis
    G. Congressional Review Act

I. Background

    Section 13 of the Bank Holding Company Act of 1956 (BHC Act),\1\
also known as the Volcker Rule, generally prohibits any banking entity
from engaging in proprietary trading or from

[[Page 61975]]

acquiring or retaining an ownership interest in, sponsoring, or having
certain relationships with a hedge fund or private equity fund (covered
fund).\2\ The statute expressly exempts from these prohibitions various
activities, including among other things:
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    \1\ 12 U.S.C. 1851.
    \2\ Id.
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     Trading in U.S. government, agency, and municipal
obligations;
     Underwriting and market making-related activities;
     Risk-mitigating hedging activities;
     Trading on behalf of customers;
     Trading for the general account of insurance companies;
and
     Foreign trading by non-U.S. banking entities.\3\
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    \3\ 12 U.S.C. 1851(d)(1).
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    In addition, section 13 of the BHC Act contains several exemptions
that permit banking entities to engage in certain activities with
respect to covered funds, subject to certain restrictions designed to
ensure that banking entities do not rescue investors in those funds
from loss, and do not guarantee nor expose themselves to significant
losses due to investments in or other relationships with these
funds.\4\
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    \4\ E.g., 12 U.S.C. 1851(d)(1)(G).
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    Authority under section 13 for developing and adopting regulations
to implement the prohibitions and restrictions of section 13 of the BHC
Act is shared among the Board, the FDIC, the OCC, the SEC, and the CFTC
(individually, an agency, and collectively, the agencies).\5\ The
agencies issued a final rule implementing section 13 of the BHC Act in
December 2013 (the 2013 rule), and those provisions became effective on
April 1, 2014.\6\
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    \5\ 12 U.S.C. 1851(b)(2).
    \6\ Prohibitions and Restrictions on Proprietary Trading and
Certain Interests in, and Relationships with, Hedge Funds and
Private Equity Funds; Final Rule, 79 FR 5535 (Jan. 31, 2014).
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    Since the adoption of the 2013 rule, the agencies have gained
several years of experience implementing the 2013 rule, and banking
entities have had more than five years of becoming familiar and
complying with the 2013 rule. The agencies have received various
communications from the public and other sources since adoption of the
2013 rule and over the course of the 2013 rule's implementation. Staffs
of the agencies also have held numerous meetings with banking entities
and other market participants to discuss the 2013 rule and its
implementation. In addition, the data collected in connection with the
2013 rule, compliance efforts by banking entities, and the agencies'
experiences in reviewing trading, investment, and other activity under
the 2013 rule have provided valuable insights into the effectiveness of
the 2013 rule. Together, these experiences have highlighted areas in
which the 2013 rule may have resulted in ambiguity, overbroad
application, or unduly complex compliance routines or may otherwise not
have been as effective or efficient in achieving its purpose as
intended or expected.

II. Notice of Proposed Rulemaking

    Based on their experience implementing the 2013 rule, the agencies
published a notice of proposed rulemaking (the proposed rule or
proposal) on July 17, 2018, that proposed amendments to the 2013 rule.
These amendments sought to provide greater clarity and certainty about
what activities are prohibited under the 2013 rule and to improve the
effective allocation of compliance resources where possible.\7\
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    \7\ Proposed Revisions to Prohibitions and Restrictions on
Proprietary Trading and Certain Interests in, and Relationships
With, Hedge Funds and Private Equity Funds, 83 FR 33432 (July 17,
2018).
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    The agencies sought to address a number of targeted areas for
revision in the proposal. First, the agencies proposed further
tailoring to make the scale of compliance activity required by the 2013
rule commensurate with a banking entity's size and level of trading
activity. In particular, the agencies proposed to establish three
categories of banking entities based on the firms' level of trading
activity--those with significant trading assets and liabilities, those
with moderate trading assets and liabilities, and those with limited
trading assets and liabilities.\8\ The agencies also invited comments
on whether certain definitions, including ``banking entity'' \9\ and
``trading desk,'' \10\ and ``covered fund'' \11\ should be modified.
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    \8\ See 83 FR 33437, 40-42.
    \9\ See 83 FR 33442-46.
    \10\ See 83 FR 33453-54.
    \11\ See 83 FR 33471-82.
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    The agencies also proposed making several changes to subpart B of
the 2013 rule, which implements the statutory prohibition on
proprietary trading and the various statutory exemptions to this
prohibition. The agencies proposed revisions to the trading account
definition,\12\ including replacing the short-term intent prong of the
trading account definition in the 2013 rule with a new prong based on
the accounting treatment of a position (the accounting prong) and, with
respect to trading activity subject only to the accounting prong,
establishing a presumption of compliance with the prohibition on
proprietary trading, based on the absolute value of a trading desk's
profit and loss.\13\ Under the proposed accounting prong, the trading
account would have encompassed financial instruments recorded at fair
value on a recurring basis under applicable accounting standards.
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    \12\ The definition of ``trading account'' is a threshold
definition that determines whether the purchase or sale of a
financial instrument by a banking entity is subject to the
restrictions and requirements of section 13 of the BHC Act and the
2013 rule.
    \13\ See 83 FR 33446-51.
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    In addition, the proposal would have modified several of the
exemptions and exclusions from the prohibition on proprietary trading
in subpart B to clarify how banking entities may qualify for those
exemptions and exclusions, as well as to reduce associated compliance
burdens. For example, the agencies proposed revising the 2013 rule's
exemptions for underwriting and market making-related activities,\14\
the exemption for risk-mitigating hedging activities,\15\ the exemption
for trading by a foreign banking entity that occurs solely outside of
the United States,\16\ and the liquidity management exclusion.\17\ In
addition, the agencies proposed establishing an exclusion for
transactions to correct trading errors.\18\
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    \14\ See 83 FR 33454-62.
    \15\ See 83 FR 33464-67.
    \16\ See 83 FR 33467-70.
    \17\ See 83 FR 33451-52.
    \18\ See 83 FR 33452-53.
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    The agencies also proposed certain modifications to the
prohibitions in subpart C on banking entities directly or indirectly
acquiring or retaining an ownership interest in, or having certain
relationships with, a covered fund. For example, the proposed rule
would have modified provisions related to the underwriting or market
making of ownership interests in covered funds \19\ and the exemption
for certain permitted covered fund activities and investments outside
of the United States. The proposal also would have expanded a banking
entity's ability to engage in hedging activities involving an ownership
interest in a covered fund.\20\ In addition, the agencies requested
comment regarding tailoring the definition of ``covered fund,''
including potential additional exclusions,\21\ and revising the
provisions limiting banking entities' relationships with covered
funds.\22\
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    \19\ See 83 FR 33482-83
    \20\ See 83 FR 33483-86.
    \21\ See 83 FR 33471-82.
    \22\ See 83 FR 33486-87.
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    To enhance compliance efficiencies, the agencies proposed tailoring
the

[[Page 61976]]

compliance requirements based on new compliance tiers. The proposed
rule would have applied the six-pillar compliance program, and a CEO
attestation requirement largely consistent with the 2013 rule, to firms
with significant trading assets and liabilities and eliminated the
enhanced minimum standards for compliance programs in Appendix B of the
2013 rule.\23\ Firms with moderate trading assets and liabilities would
have been required to adhere to a simplified compliance program, with a
CEO attestation requirement,\24\ and firms with limited trading assets
and liabilities would have had a presumption of compliance with the
rule.\25\ The proposal also included a reservation of authority
specifying that the agencies could impose additional requirements on
banking entities with limited or moderate trading assets and
liabilities if warranted.\26\ The proposal would have revised the
metrics reporting and recordkeeping requirements by, for example,
applying those requirements based on a banking entity's size and level
of trading activity, eliminating some metrics, and adding a limited set
of new metrics to enhance compliance efficiencies.\27\ In addition, the
agencies requested comment on whether some or all of the reported
quantitative measurements should be made publically available.
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    \23\ See 83 FR 33487-89; 33490-94.
    \24\ See 83 FR 33489.
    \25\ See 83 FR 33490.
    \26\ See 83 FR 33454.
    \27\ See 83 FR 33494-514.
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    The agencies invited comment on all aspects of the proposal,
including specific proposed revisions and questions posed by the
agencies. The agencies received over 75 unique comments from banking
entities and industry groups, public interest groups, and other
organizations and individuals. In addition, the agencies received
approximately 3,700 comments from individuals using a version of a
short form letter to express opposition to the proposed rule. For the
reasons discussed below, the agencies are now adopting a final rule
that incorporates a number of modifications.

III. Overview of the Final Rule and Modifications From the Proposal

A. The Final Rule

    Similar to the proposal, the final rule includes a risk-based
approach to revising the 2013 rule that relies on a set of clearly
articulated standards for both prohibited and permitted activities and
investments. The final rule is intended to further tailor and simplify
the rule to allow banking entities to more efficiently provide
financial services in a manner that is consistent with the requirements
of section 13 of the BHC Act.
    The comments the agencies received from banking entities and
financial services industry trade groups were generally supportive of
the proposal, with the exception of the proposed accounting prong, and
provided recommendations for further targeted changes. The agencies
also received a few comments in opposition to the proposal from various
organizations and individuals.\28\ As described further below, the
agencies have adopted many of the proposed changes to the 2013 rule,
with certain targeted adjustments based on comments received.
Furthermore, the agencies intend to issue an additional notice of
proposed rulemaking that would propose additional, specific changes to
the restrictions on covered fund investments and activities and other
issues related to the treatment of investment funds under the
regulations implementing section 13 of the BHC Act.
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    \28\ See, e.g., Senators Merkley et al.; Elise J. Bean (Bean);
National Association of Federally-Insured Credit Unions (NAFCU);
Better Markets, Inc. (Better Markets); Americans for Financial
Reform (AFR); Volcker Alliance; Occupy the SEC; and Volcker 2.0 Form
Letter.
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    The final rule includes the same general three-tiered approach to
tailoring the compliance program requirements as the proposal. However,
based on comments received, the agencies have modified the threshold
for banking entities in the ``significant'' compliance category from
$10 billion in gross trading assets and liabilities to $20 billion in
gross trading assets and liabilities. The final rule also includes
modifications to the calculation of trading assets and liabilities for
purposes of determining which compliance tier a banking entity falls
into by excluding certain financial instruments that banking entities
are permitted to trade without limit under section 13. Additionally,
the final rule aligns the methodologies for calculating the ``limited''
and ``significant'' compliance thresholds for foreign banking
organizations by basing both thresholds on the trading assets and
liabilities of the firm's U.S. operations.\29\
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    \29\ Under the proposal, the ``limited'' compliance threshold
would have been based on the trading assets and liabilities of a
foreign banking organization's worldwide operations whereas the
``significant'' compliance threshold would have been based on the
trading assets and liabilities of a foreign banking organization's
U.S. operations.
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    The final rule also includes many of the proposed changes to the
proprietary trading restrictions, with certain changes based on
comments received. One such change is that the final rule does not
include the proposed accounting prong in the trading account
definition. Instead, the final rule retains a modified version of the
short-term intent prong and replaces the 2013 rule's rebuttable
presumption that financial instruments held for fewer than 60 days are
within the short-term intent prong of the trading account with a
rebuttable presumption that financial instruments held for 60 days or
longer are not within the short-term intent prong of the trading
account. The final rule also provides that a banking entity that is
subject to the market risk capital rule prong of the trading account
definition is not also subject to the short-term intent prong, and a
banking entity that is not subject to the market risk capital rule
prong may elect to apply the market risk capital rule prong (as an
alternative to the short-term intent prong). Additionally, the final
rule modifies the liquidity management exclusion from the proprietary
trading restrictions to permit banking entities to use a broader range
of financial instruments to manage liquidity, and it adds new
exclusions for error trades, certain customer-driven swaps, hedges of
mortgage servicing rights, and purchases or sales of instruments that
do not meet the definition of trading assets or liabilities.
Furthermore, the final rule revises the trading desk definition to
provide more flexibility to banking entities to align the definition
with other trading desk definitions in existing or planned compliance
programs. This modified definition also will provide for consistent
treatment across different regulatory regimes.
    The final rule also includes the proposed changes to the exemptions
from the prohibitions in section 13 of the BHC Act for underwriting and
market making-related activities, risk-mitigating hedging, and trading
by foreign banking entities solely outside the United States. The final
rule also includes the proposed changes to the covered funds provisions
for which specific rule text was proposed, including with respect to
permitted underwriting and market making and risk-mitigating hedging
with respect to a covered fund, as well as investment in or sponsorship
of covered funds by foreign banking entities solely outside the United
States and the exemption for prime brokerage transactions. With respect
to the exemptions for underwriting and market making-related
activities, the final rule adopts the presumption of compliance with
the

[[Page 61977]]

reasonably expected near-term demand requirement for trading within
certain internal limits, but instead of requiring banking entities to
promptly report limit breaches or increases to the agencies, banking
entities are required to maintain and make available upon request
records of any such breaches or increases and follow certain internal
escalation and approval procedures in order to remain qualified for the
presumption of compliance.
    With respect to the compliance program requirements, the final rule
includes the changes from the proposal to eliminate the enhanced
compliance requirements in Appendix B of the 2013 rule and to tailor
the compliance program requirements based on the size of the banking
entity's trading activity. However, different from the proposal, the
final rule only applies the CEO attestation requirement to firms with
significant trading assets and liabilities. Also, in response to
comments, the final rule includes modifications to the metrics
collection requirements to, among other things, eliminate certain
metrics and reduce the compliance burden associated with the
requirement.
    For the OCC, Board, FDIC, and CFTC, the final amendments will be
effective on January 1, 2020. For the SEC, the final amendments will be
effective on January 13, 2020. In order to give banking entities a
sufficient amount of time to comply with the changes adopted, banking
entities will not be required to comply with the final amendments until
January 1, 2021. During that time, the 2013 rule will remain in effect
as codified in appendix Z, which is a temporary appendix that will
expire on the compliance date. However, banking entities may
voluntarily comply, in whole or in part, with the amendments adopted in
this release prior to the compliance date, subject to the agencies'
completion of necessary technical changes. In particular, the agencies
need to complete certain technological programming in order to accept
metrics compliant with the final amendments. The agencies will conduct
a test run with banking entities of the revised metrics submission
format. A banking entity seeking to switch to the revised metrics prior
to January 1, 2021, must first successfully test submission of the
revised metrics in the new XML format. Accordingly, banking entities
should work with each appropriate agency to determine how and when to
voluntarily comply with the metrics requirements under the final rules
and to notify such agencies of their intent to comply, prior to the
January 1, 2021, compliance date.

B. Interagency Coordination and Other Comments

    Section 13(b)(2)(B)(ii) of the BHC Act directs the agencies to
``consult and coordinate'' in developing and issuing the implementing
regulations ``for the purpose of assuring, to the extent possible, that
such regulations are comparable and provide for consistent application
and implementation of the applicable provisions of [section 13 of the
BHC Act] to avoid providing advantages or imposing disadvantages to the
companies affected . . . .'' \30\ The agencies recognize that
coordinating with each other to the greatest extent practicable with
respect to regulatory interpretations, examinations, supervision, and
sharing of information is important to maintaining consistent
oversight, promoting compliance with section 13 of the BHC Act and
implementing regulations, and to fostering a level playing field for
affected market participants. The agencies further recognize that
coordinating these activities helps to avoid unnecessary duplication of
oversight, reduces costs for banking entities, and provides for more
efficient regulation.
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    \30\ 12 U.S.C. 1851(b)(2)(B)(ii).
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    In the proposal, the agencies requested comment on interagency
coordination regarding the Volcker Rule in general and asked several
specific questions relating to transparency, efficiency, and safety and
soundness.\31\ Numerous commenters, including banking entities and
industry groups, suggested that the agencies more effectively
coordinate Volcker Rule related supervision, examinations, and
enforcement, in order to improve efficiency and predictability in
supervision and oversight.\32\ For example, several commenters
suggested that Volcker Rule related supervision should be conducted
solely by a bank's prudential onsite examiner,\33\ and that the two
market regulators be required to consult and coordinate with the
prudential onsite examiner.\34\ Several commenters encouraged the
agencies to memorialize coordination and information sharing between
the agencies by entering into a formal written agreement, such as an
interagency Memorandum of Understanding.\35\
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    \31\ 83 FR 33436.
    \32\ See, e.g., American Bankers Association (ABA); Institute of
International Bankers (IIB); BB&T; Committee on Capital Markets
Regulation (CCMR); Japanese Bankers Association (JBA); and the CFA
Institute (CFA). Commenters also recommended designating to one
agency the task of interpreting the implementing regulations and
issuing guidance to smaller banking entities. See, e.g., Credit
Suisse and Lori Nuckolls.
    \33\ See, e.g., ABA; Arvest Bank (Arvest); Credit Suisse; and
Financial Services Forum (FSF).
    \34\ See ABA.
    \35\ See, e.g., ABA; BB&T; CCMR; and FSF.
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    Several comment letters from public interest organizations
suggested that the agencies have not provided sufficient transparency
when implementing and enforcing the Volcker Rule, and urged the
agencies to make public certain information related to enforcement
actions, metrics, and covered funds activities.\36\ In addition,
several commenters, including a member of Congress, argued that the
agencies have not adequately explained or provided evidence to support
the current rulemaking.\37\
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    \36\ See, e.g., AFR; Public Citizen; Volcker Alliance; and CFA.
    \37\ See, e.g., CAP; Merkley; and Public Citizen.
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    The agencies agree with commenters that interagency coordination
plays an important role in the effective implementation and enforcement
of the Volcker Rule, and acknowledge the benefits of providing
transparency in proposing and adopting rules to implement section 13 of
the BHC Act. Accordingly, the agencies have endeavored to provide
specificity and clarity in the final rule to avoid conflicting
interpretations or uncertainty. The final rule also includes notice and
response procedures that provide a greater degree of certainty about
the process by which the agencies will make certain determinations
under the final rule. The agencies continue to recognize the benefits
of consistent application of the rules implementing section 13 of the
BHC Act and intend to continue to consult with each other when
formulating guidance on the final rule that would be shared with the
public generally. That said, the agencies also are mindful of the need
to strike an appropriate balance between public disclosure and the
protection of sensitive, confidential information, and the agencies are
generally restricted from disclosing sensitive, confidential business
and supervisory information on a firm-specific basis.
    Several commenters provided general comments regarding the proposal
and the current rulemaking. For example, several public interest
commenters suggested that the proposed rule did not provide a
sufficient financial disincentive against proprietary trading and
encouraged the agencies to adopt certain limitations on compensation
arrangements.\38\ A commenter also suggested possible penalties for
rule violations and encouraged the agencies to elaborate on the
consequences of

[[Page 61978]]

significant violations of the rule.\39\ Other commenters recommended
that the agencies impose strong penalties on banking entities that
break the law.\40\ The agencies believe that the appropriate
consequences for a violation of the rule will likely depend on the
specific facts and circumstances in individual cases, as well as each
agency's statutory authority under section 13, and therefore are not
amending the rule to provide for specific penalties or financial
disincentives for violations. Finally, several commenters suggested
that the proposed rule is too complex and may provide too much
deference to a banking entity's internal procedures and models (for
example, in provisions related to underwriting, market making, and
hedging), and that the proposed revisions would make the rule less
effective.\41\ As discussed further below, the agencies believe that
the particular changes adopted in the final rule are meaningfully
simpler and streamlined compared to the 2013 rule, and are appropriate
for the reasons described in greater detail below.
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    \38\ See, e.g., Public Citizen and CAP.
    \39\ See Public Citizen.
    \40\ See Volcker 2.0 Form Letter.
    \41\ See, e.g., Systemic Risk Council and Oonagh McDonald.
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IV. Section by Section Summary of the Final Rule

A. Subpart A--Authority and Definitions

1. Section __.2: Definitions
a. Banking Entity
    Section 13(a)(1)(A) of the BHC Act prohibits a banking entity from
engaging in proprietary trading or acquiring or retaining an ownership
interest, or sponsoring, a covered fund, unless the activity is
otherwise permissible under section 13.\42\ Therefore, the definition
of the term ``banking entity'' defines the scope of entities subject to
restrictions under the rule. Section 13(h)(1) of the BHC Act defines
the term ``banking entity'' to include (i) any insured depository
institution (as defined by statute); (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; and (iv) any affiliate or subsidiary of any such
entity.\43\ The regulations implementing this provision are consistent
with the statute and also exclude covered funds that are not themselves
banking entities, certain portfolio companies, and the FDIC acting in
its corporate capacity as conservator or receiver.\44\
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    \42\ 12 U.S.C. 1851(a)(1)(A). A banking entity may engage in an
activity that is permissible under section 13 of the BHC Act only to
the extent permitted by any other provision of Federal and State
law, and subject to other applicable restrictions. See 12 U.S.C.
1851(d)(1).
    \43\ 12 U.S.C. 1851(h)(1).
    \44\ See 2013 rule Sec.  __.2(c).
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    In addition, the agencies note that, consistent with the statute,
for purposes of this definition, the term ``insured depository
institution'' does not include certain institutions that function
solely in a trust or fiduciary capacity, and certain community banks
and their affiliates.\45\ Section 203 of the Economic Growth,
Regulatory Relief, and Consumer Protection Act (EGRRCPA) amended the
definition of ``banking entity'' in the Volcker Rule to exclude certain
community banks from the definition of insured depository institution,
the general result of which was to exclude community banks and their
affiliates and subsidiaries from the scope of the Volcker Rule.\46\ On
July 22, 2019, the agencies adopted a final rule amending the
definition of ``insured depository institution,'' in a manner
consistent with EGRRCPA.\47\
---------------------------------------------------------------------------

    \45\ See final rule Sec.  __.2(r).
    \46\ Public Law 115-174 (May 24, 2018).
    \47\ See 84 FR 35008.
---------------------------------------------------------------------------

    The proposed rule did not propose specific rule text to amend the
definition of ``banking entity,'' but invited comment on a number of
specific issues.\48\ The agencies received several comments about the
``banking entity'' definition, many of which asked that the agencies
revise this definition to exclude specific types of entities.
---------------------------------------------------------------------------

    \48\ See 83 FR 33442-446.
---------------------------------------------------------------------------

    Several commenters expressed concern about the treatment of certain
funds that are excluded from the definition of ``covered fund'' in the
2013 rule, including registered investment companies (RICs), foreign
public funds (FPFs), and, with respect to a foreign banking entity,
certain foreign funds offered and sold outside of the United States
(foreign excluded funds).\49\ In particular, these commenters noted
that when a banking entity invests in such funds, or has certain
corporate governance rights or other control rights with respect to
such funds, the funds could meet the definition of ``banking entity''
for purposes of the Volcker Rule.\50\ Concerns about certain funds'
potential status as banking entities arise, in part, because of the
interaction between the statute's and the 2013 rule's definitions of
the terms ``banking entity'' and ``covered fund.'' Sponsors of RICs,
FPFs, and foreign excluded funds have noted that the treatment of such
funds as ``banking entities'' would disrupt bona fide asset management
activities (including fund investment strategies that may include
proprietary trading or investing in covered funds), which these
sponsors argued would be inconsistent with section 13 of the BHC
Act.\51\ Commenters also noted that treatment of RICs, FPFs, and
foreign excluded funds as ``banking entities'' would put such banking
entity-affiliated funds at a competitive disadvantage compared to funds
not affiliated with a banking entity, and therefore not subject to
restrictions under section 13 of the BHC Act.\52\ In general,
commenters also asserted that the treatment of RICs, FPFs, and foreign
excluded funds as banking entities would not further the policy
objectives of section 13 of the BHC Act.\53\
---------------------------------------------------------------------------

    \49\ See, e.g., ABA; American Investment Council (AIC);
Bundesverband Investment (BVI); Canadian Bankers Association (CBA);
European Banking Federation (EBF); Federated Investors II; Financial
Services Agency and Bank of Japan (FSA/Bank of Japan); European Fund
and Asset Management Association (EFAMA); and IIB.
    \50\ Id.
    \51\ See, e.g., IIB and Securities Industry and Financial
Markets Association (SIFMA).
    \52\ See, e.g., Capital One et al.; Credit Suisse; EBF; and
Investment Adviser Association (IAA).
    \53\ See, e.g., ABA; EBF; and Investment Company Institute
(ICI).
---------------------------------------------------------------------------

    Several commenters suggested that the agencies exclude from the
definition of ``banking entity'' foreign excluded funds.\54\ These
commenters generally noted that failing to exclude such funds from the
definition of ``banking entity'' in the 2013 rule has the unintended
consequence of imposing proprietary trading restrictions and compliance
obligations on foreign excluded funds that are in some ways more
burdensome than the requirements that would apply under the 2013 rule
to covered funds. Another commenter expressed opposition to carving out
foreign excluded funds from the definition of banking entity.\55\ The
staffs of the agencies continue to consider ways in which the
regulations may be amended in a manner consistent with the statutory
definition of ``banking entity,'' or other appropriate actions that may
be taken, to address any unintended consequences of section 13 of the
BHC Act and the 2013 rule. The agencies intend to issue a separate
proposed

[[Page 61979]]

rulemaking that specifically addresses the fund structures under the
rule, including the treatment of foreign excluded funds.
---------------------------------------------------------------------------

    \54\ Id. In addition to the requests from commenters for the
agencies to exclude foreign excluded funds from the ``banking
entity'' definition, commenters also asked the agencies to adopt
other amendments to address the treatment of such funds, including
by providing a presumption of compliance for such funds (CBA; EBF;
and IIB), to permit a banking entity to elect to treat a foreign
excluded fund as a covered fund (CBA; EBF; and IIB), and to
permanently extend the temporary relief currently provided to
foreign excluded funds (IIB).
    \55\ See Data Boiler Technologies, LLC (Data Boiler).
---------------------------------------------------------------------------

    To provide additional time to complete this rulemaking, the Federal
banking agencies released a policy statement on July 17, 2019, in
response to concerns about the treatment of foreign excluded funds.
This policy statement provides that the Federal banking agencies would
not propose to take action during the two-year period ending on July
21, 2021, against a foreign banking entity based on attribution of the
activities and investments of a qualifying foreign excluded fund to the
foreign banking entity,\56\ or against a qualifying foreign excluded
fund as a banking entity, in each case where the foreign banking
entity's acquisition or retention of any ownership interest in, or
sponsorship of, the qualifying foreign excluded fund would meet the
requirements for permitted covered fund activities and investments
solely outside the United States, as provided in section 13(d)(1)(I) of
the BHC Act and Sec.  __.13(b) of the 2013 rule, as if the qualifying
foreign excluded fund were a covered fund.\57\
---------------------------------------------------------------------------

    \56\ Foreign banking entity was defined for purposes of the
policy statement to mean a banking entity that is not, and is not
controlled directly or indirectly by, a banking entity that is
located in or organized under the laws of the United States or any
State.
    \57\ See Board of Governors of the Federal Reserve System,
Federal Deposit Insurance Corporation, and Office of the Comptroller
of the Currency, ``Statement regarding Treatment of Certain Foreign
Funds under the Rules Implementing Section 13 of the Bank Holding
Company Act'' (July 17, 2019). This policy statement continued the
position of the Federal banking agencies that was released on July
21, 2017, and the position that the agencies expressed in the
proposal. See 83 FR 33444.
---------------------------------------------------------------------------

    Several commenters expressed concern with the treatment of RICs and
FPFs, which are subject to significant regulatory requirements in the
United States and foreign jurisdictions, respectively. These commenters
encouraged the agencies to consider excluding such entities from the
definition of ``banking entity.'' \58\ In the past, the staffs of the
agencies issued several FAQs to address the treatment of RICs and
FPFs.\59\ One of these staff FAQs provides guidance about the treatment
of RICs and FPFs during the period in which the banking entity is
testing the fund's investment strategy, establishing a track record of
the fund's performance for marketing purposes, and attempting to
distribute the fund's shares (the so-called seeding period).\60\
Another FAQ stated that staffs of the agencies would not view the
activities and investments of an FPF that meets certain eligibility
requirements in the 2013 rule as being attributed to the banking entity
for purposes of section 13 of the BHC Act or the 2013 rule, where the
banking entity (i) does not own, control, or hold with the power to
vote 25 percent or more of any class of voting shares of the FPF (after
the seeding period), and (ii) provides investment advisory, commodity
trading advisory, administrative, and other services to the fund in
compliance with applicable limitations in the relevant foreign
jurisdiction. Similarly, this FAQ stated that the staffs of the
agencies would not view the FPF to be a banking entity for purposes of
section 13 of the BHC Act and the 2013 rule solely by virtue of its
relationship with the sponsoring banking entity, where these same
conditions are met.\61\
---------------------------------------------------------------------------

    \58\ See, e.g., CCMR; IAA; ICI; and Capital One et al. One
commenter also expressed support for a narrower exclusion for RICs
and FPFs that would apply only during a non-time-limited seeding
period. JP Morgan Asset Management.
    \59\ See https://www.occ.treas.gov/topics/capitalmarkets/financial-markets/trading-volcker-rule/volcker-rule-implementation-faqs.html (OCC); https://www.federalreserve.gov/bankinforeg/volcker-rule/faq.htm (Board); https://www.fdic.gov/regulations/reform/volcker/faq.html (FDIC); https://www.sec.gov/divisions/marketreg/faq-volcker-rulesection13.htm (SEC); https://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_28_VolckerRule/index.htm
(CFTC).
    \60\ Id., FAQ 16.
    \61\ Id., FAQ 14.
---------------------------------------------------------------------------

    As noted above, the agencies intend to issue a separate proposal
addressing and requesting comment on the covered fund provisions and
other fund-related issues. The final rule does not modify or revoke any
previously issued staff FAQs or guidance related to RICs, FPFs, and
foreign excluded funds.\62\
---------------------------------------------------------------------------

    \62\ The FAQs represent the views of staff of the agencies. They
are not rules, regulations, or statements of the agencies.
Furthermore, the agencies have neither approved nor disapproved
their content. The FAQs, like all staff guidance, have no legal
force or effect: They do not alter or amend applicable law, and they
create no new or additional obligations for any person.
---------------------------------------------------------------------------

    Apart from these topics, the agencies received numerous other
comments about the treatment of entities as ``banking entities'' under
section 13 of the BHC Act. In general, these commenters requested that
the agencies provide additional exclusions from the definition of
``banking entity'' for various types of entities. One commenter
suggested that, as an alternative to excluding certain entities from
the banking entity definition, the agencies could exempt the activities
of these entities from the proprietary trading and covered fund
prohibitions.\63\
---------------------------------------------------------------------------

    \63\ See Bank Policy Institute (BPI).
---------------------------------------------------------------------------

    One commenter recommended that the agencies provide a general
exemption from the banking entity definition for investment funds,
except in circumstances where the investment fund is determined to have
been organized to permit the banking entity sponsor to engage in
impermissible proprietary trading.\64\ Some commenters encouraged the
agencies to exclude employee securities companies from the definition
of ``banking entity.'' \65\ One commenter argued that despite a banking
entity's role as a general partner in employee securities companies,
treating such entities as ``banking entities'' does not further the
policy goals of section 13 of the BHC Act.\66\ Several commenters
encouraged the agencies to exclude from the definition of ``banking
entity'' any non-consolidated subsidiaries not operated or managed by a
banking entity, on the basis that such entities were never intended to
be subject to section 13 of the BHC Act.\67\ Another commenter said the
agencies should exclude from the definition of ``banking entity'' all
employee compensation plans, regardless of whether such plans are
qualified or non-qualified.\68\ Other commenters suggested that the
agencies should exclude subsidiaries of foreign banking entities that
do not engage in trading activities in the United States, or otherwise
limit application to foreign subsidiaries of foreign banking
groups.\69\ Other commenters requested modification of the definition
of ``banking entity'' to exclude parent companies and affiliates of
industrial loan companies, noting that such companies are generally not
subject to other restrictions on their activities under the BHC
Act.\70\
---------------------------------------------------------------------------

    \64\ See EFAMA.
    \65\ See, e.g., ABA and FSF.
    \66\ See ABA.
    \67\ See, e.g., ABA; BPI; SIFMA; JBA.
    \68\ See BB&T.
    \69\ See JBA. This commenter suggested that in the absence of an
exclusion for such entities, simplified compliance program
requirements should apply to foreign subsidiaries of foreign banking
entities that do not engage in trading activities in the United
States. The agencies believe that several of the other changes in
this final rule will provide relief to foreign banking entities that
engage in no trading activities in the United States, including
simplifications to the exemption for foreign banking entities
engaged in trading outside of the United States, and more tailored
compliance program requirements. See also FSA/Bank of Japan; IIB.
    \70\ See, e.g., EnerBank USA (EnerBank); Marketplace Lending
Association; National Association of Industrial Bankers.
---------------------------------------------------------------------------

    One commenter encouraged the agencies to exclude international
banks from the definition of ``banking entity'' if they have limited
U.S. trading assets and liabilities.\71\ This commenter also

[[Page 61980]]

encouraged the agencies to exclude certain non-U.S. commercial
companies that are comparable to U.S. merchant banking portfolio
companies.\72\ This commenter argued that excluding these entities
would not pose material risks to the financial stability of the United
States.
---------------------------------------------------------------------------

    \71\ See IIB. This commenter also proposed modifying the manner
in which ``banking entity'' status is determined by disaggregating
separate, independent corporate groups.
    \72\ Id.
---------------------------------------------------------------------------

    Some commenters suggested that the agencies should clarify the
standards for what constitutes ``control'' in the context of
determining whether an entity is an ``affiliate'' or ``subsidiary'' for
purposes of the definition of ``banking entity'' in the Volcker
Rule.\73\ One commenter suggested that the definition of ``banking
entity'' should include only a company in which a banking entity owns,
controls, or has the power to vote 25 percent or more of a class of
voting securities of the company.\74\
---------------------------------------------------------------------------

    \73\ See, e.g., EnerBank and Capital One et al. See 12 U.S.C.
1841(a)(2)(C).
    \74\ See Capital One et al.
---------------------------------------------------------------------------

    The definition of ``banking entity'' in section 13 of the BHC Act
uses the definition of control in section 2 of the BHC Act.\75\ Under
the BHC Act, ``control'' is defined by a three-pronged test. A company
has control over another company if the first company (i) directly or
indirectly or acting through one or more other persons owns, controls,
or has power to vote 25 percent or more of any class of voting
securities of the other company; (ii) controls in any manner the
election of a majority of the directors of the other company; or (iii)
directly or indirectly exercises a controlling influence over the
management or policies of the other company.\76\ The Board recently
issued a proposed rulemaking that would clarify the standards for
evaluating whether one company exercises a controlling influence over
another company for purposes of the BHC Act.\77\
---------------------------------------------------------------------------

    \75\ 12 U.S.C. 1841(a)(2); 12 CFR 225.2(e).
    \76\ Id.
    \77\ See ``Control and Divestiture Proceedings,'' 84 FR 21634-
666 (May 14, 2019).
---------------------------------------------------------------------------

    The final rule does not amend the definition of banking entity.
Commenters raised important considerations with respect to the
consequences of the current ``banking entity'' definition under section
13 of the BHC Act and the 2013 rule. The agencies believe that other
amendments to the requirements of the regulations implementing the
Volcker Rule may address some of the issues raised by commenters.
Certain concerns raised by commenters may need to be addressed through
amendments to section 13 of the BHC Act.\78\ In addition, as noted
above, the agencies intend to revisit the fund-related provisions of
the Volcker Rule in a separate rulemaking.
---------------------------------------------------------------------------

    \78\ See, e.g., Economic Growth, Regulatory Relief, and Consumer
Protection Act Sec.  203 (excluding community banks from the
definition of ``banking entity'').
---------------------------------------------------------------------------

b. Limited, Moderate, and Significant Trading Assets and Liabilities
    The proposal would have established three categories of banking
entities based on their level of trading activity, as measured by the
average gross trading assets and liabilities of the banking entity and
its subsidiaries and affiliates (excluding obligations of or guaranteed
by the United States or any agency of the United States) over the
previous four consecutive quarters.\79\ These categories would have
been used to calibrate compliance requirements for banking entities,
with the most stringent compliance requirements applicable to those
with the greatest level of trading activities.
---------------------------------------------------------------------------

    \79\ See proposed rule Sec.  __.2(t), (v), (ff). Under the
proposal, a foreign banking entity's trading assets and liabilities
would have been calculated based on worldwide trading assets and
liabilities with respect to the $1 billion threshold between limited
and moderate trading assets and liabilities, but based on the
trading assets and liabilities only of its combined U.S. operations
with respect to the $10 billion threshold between moderate and
significant trading assets and liabilities. See proposed rule Sec. 
__.2(t)(1), (ff)(2)-(3).
---------------------------------------------------------------------------

    The first category would have included firms with ``significant''
trading assets and liabilities, defined as those banking entities that
have consolidated trading assets and liabilities equal to or exceeding
$10 billion.\80\ The second category would have included firms with
``moderate'' trading assets and liabilities, which would have included
those banking entities that have consolidated trading assets and
liabilities of $1 billion or more, but with less than $10 billion in
consolidated trading assets and liabilities.\81\ The final category
would have included firms with ``limited'' trading assets and
liabilities, defined as those banking entities that have less than $1
billion in consolidated trading assets and liabilities.\82\ The
proposal would have also provided the agencies with a reservation of
authority to require a banking entity with limited or moderate trading
assets and liabilities to apply the compliance program requirements of
a higher compliance tier if an agency determined that the size or
complexity of the banking entity's trading or investment activities, or
the risk of evasion of the requirements of the rule, warranted such
treatment.\83\ The proposal also solicited comment as to whether there
should be further tailoring of the thresholds for a banking entity that
is an affiliate of another banking entity with significant trading
assets and liabilities, if that entity generally operates on a basis
that is separate and independent from its affiliates and parent
companies.\84\
---------------------------------------------------------------------------

    \80\ Proposed rule Sec.  __.2(ff).
    \81\ Proposed rule Sec.  __.2(v).
    \82\ Proposed rule Sec.  __.2(t).
    \83\ Proposed rule Sec.  __.20(h).
    \84\ See 83 FR at 33442 (question 7).
---------------------------------------------------------------------------

    Commenters provided feedback on multiple aspects of the tiered
compliance framework, including the level of the proposed thresholds
between the categories ($1 billion and $10 billion in trading assets
and liabilities), the manner in which ``trading assets and
liabilities'' should be measured, and alternative approaches that
commenters believed would be preferable to the proposed three-tiered
compliance framework. As described further below, after consideration
of the comments received, the agencies are adopting a three-tiered
compliance framework that is consistent with the proposal, with
targeted adjustments to further tailor compliance program requirements
based on the level of a firm's trading activities, and in light of
concerns raised by commenters.\85\ The agencies believe that this
approach will increase compliance efficiencies for all banking entities
relative to the 2013 rule and the proposal, and will further reduce
compliance costs for firms that have little or no activity subject to
the prohibitions and restrictions of section 13 of the BHC Act.
---------------------------------------------------------------------------

    \85\ See final rule Sec.  __.2(s), (u), (ee).
---------------------------------------------------------------------------

    Several commenters expressed support for the proposed three-tiered
compliance framework in the proposal.\86\ One commenter noted that the
2013 rule's compliance regime, which imposes significant compliance
obligations on all banking entities with $50 billion or more in total
consolidated assets, does not appropriately tailor compliance
obligations to the scope of activities covered under the regulation,
particularly for firms engaged in limited trading activities.\87\ Other
commenters expressed general opposition to the proposed three-tiered
compliance program.\88\ Another commenter expressed concern in
particular that banking entities with ``limited'' trading assets and
liabilities would have been presumed compliant with the requirements of
section 13 of the BHC

[[Page 61981]]

Act under the proposed rule.\89\ Some commenters also suggested that
the agencies adopt a two-tiered compliance program, bifurcating banking
entities into those with and without significant trading assets and
liabilities.\90\ One commenter expressed opposition to tailoring
compliance requirements for banking entities that operate separately
and independently from their affiliates, by calculating trading assets
and liabilities for such entities independent of the activities of
affiliates.\91\ The agencies believe that the three-tiered framework
set forth in the proposal, subject to the additional amendments
described below, appropriately differentiates among banking entities
for the purposes of tailoring compliance requirements. Specifically,
the agencies believe that the significant differences in business
models and activities among banking entities that would have
significant trading assets and liabilities, moderate trading assets and
liabilities, and limited trading assets and liabilities, as described
below, support having a three-tiered compliance framework.
---------------------------------------------------------------------------

    \86\ See, e.g., BB&T Corporation; CFA; CCMR; and State Street
Corporation (State Street).
    \87\ See State Street.
    \88\ See, e.g., Bean; Data Boiler Technologies; and Occupy the
SEC.
    \89\ See Occupy the SEC.
    \90\ See, e.g., ABA; Capital One et al.; and KeyCorp and KeyBank
(KeyCorp).
    \91\ See Data Boiler Technologies.
---------------------------------------------------------------------------

    A few commenters recommended that the agencies raise the proposed
$1 billion threshold between banking entities with limited and moderate
trading assets and liabilities.\92\ These commenters suggested that
raising this threshold to $5 billion in trading assets and liabilities
would be consistent with the objective of the proposal to have the most
streamlined requirements imposed on banking entities with a relatively
small amount of trading activities. Other commenters recommended that
the threshold between banking entities with limited and moderate
trading activities was appropriate or should be set at a lower
level.\93\ The agencies believe that the compliance obligations
applicable to banking entities with limited trading assets and
liabilities are most appropriately reserved for banking entities below
the $1 billion threshold set forth in the proposal. Such banking
entities tend to have simpler business models and do not have large
trading operations that would warrant the expanded compliance
obligations applicable to banking entities with moderate and
significant trading assets and liabilities. As discussed further below,
these banking entities also hold a relatively small amount of the
trading assets and liabilities in the U.S. banking system. Therefore,
the final rule adopts the threshold from the proposed rule for
determining whether a banking entity has limited trading assets and
liabilities.\94\
---------------------------------------------------------------------------

    \92\ See, e.g., ABA; Capital One et al.; and BPI.
    \93\ See, e.g., Data Boiler (encouraging the agencies to lower
the threshold to $500 million in trading assets and liabilities) and
B&F Capital Markets (B&F) (expressing support for the proposed $1
billion threshold).
    \94\ See final rule Sec.  __.2(s)(2)-(3).
---------------------------------------------------------------------------

    Several commenters recommended that the agencies modify the
threshold for ``significant'' trading assets and liabilities.\95\
Generally, these commenters expressed support for raising the threshold
from $10 billion in trading assets and liabilities to $20 billion in
trading assets and liabilities.\96\ These commenters noted that this
change would have minimal impact on the number of banking entities that
would remain categorized as having significant trading assets and
liabilities.\97\ Several commenters also noted that increasing the
threshold from $10 billion to $20 billion would provide additional
certainty to banking entities that are near or approaching the $10
billion threshold, because market events or unusual customer demands
could cause such banking entities to exceed (permanently or on a short-
term basis) the $10 billion trading assets and liabilities
threshold.\98\ The final rule adopts the change recommended by several
commenters to raise the threshold from $10 billion to $20 billion for
calculating whether a banking entity has significant trading assets and
liabilities.\99\
---------------------------------------------------------------------------

    \95\ See, e.g., ABA; Bank of New York Mellon Corporation,
Northern Trust Corporation, and State Street Corporation (Custody
Banks); New England Council; Capital One et al.; SIFMA; State
Street; and BPI.
    \96\ Id.
    \97\ Id.
    \98\ See, e.g., ABA; Capital One et al.; and SIFMA.
    \99\ See final rule Sec.  __.2(ee)(1)(i).
---------------------------------------------------------------------------

    The agencies estimate that, under the final rule with the increased
threshold from $10 billion to $20 billion described above, banking
entities classified as having significant trading assets and
liabilities would hold approximately 93 percent of the trading assets
and liabilities in the U.S. banking system. The agencies also estimate
that banking entities with significant trading assets and liabilities
and those with moderate trading assets and liabilities in combination
would hold approximately 99 percent of the trading assets and
liabilities in the U.S. banking system. Therefore, both of these
thresholds will tailor the compliance obligations under the final rule
for all firms by virtue of imposing greater compliance obligations on
those banking entities with the most substantial levels of trading
activities.
    One commenter suggested that the agencies index the compliance tier
thresholds to inflation.\100\ At present, the agencies do not believe
that the additional complexity associated with inflation-indexing the
thresholds in the final rule is necessary in light of the other changes
to the thresholds and calculation methodologies described below,
including the increase in the threshold for firms with significant
trading assets and liabilities from $10 billion to $20 billion, and the
modifications to the calculation of trading assets and liabilities
adopted in the final rule.\101\
---------------------------------------------------------------------------

    \100\ See Capital One et al.
    \101\ See, e.g., final rule Sec.  __.2(ee)(1)(i).
---------------------------------------------------------------------------

    Commenters recommended that the regulations incorporate a number of
changes to the methodology used in the proposed rule to classify firms
into different compliance tiers. Some commenters recommended that the
agencies apply a consistent methodology to foreign banking entities to
classify such firms as having significant trading assets and
liabilities, moderate trading assets and liabilities, or limited
trading assets and liabilities.\102\ For purposes of classifying the
banking entity as having significant trading assets and liabilities,
the proposal would have included only the trading assets and
liabilities of the combined U.S. operations of a foreign banking
entity, but used the banking entity's worldwide trading assets and
liabilities for purposes of classifying the firm as having either
limited trading assets and liabilities or moderate trading assets and
liabilities.\103\ Commenters recommended that the agencies apply a
consistent standard for classifying a foreign banking entity as having
significant trading assets and liabilities, moderate trading assets and
liabilities, or limited trading assets and liabilities, and that the
most appropriate measure would look only at the combined U.S.
operations of such a banking entity.\104\ These commenters noted that
classifying foreign banking entities based on their global trading
activities could have the result of imposing extensive compliance
obligations on the non-U.S. trading activities of a banking entity with
minimal U.S. trading activities.\105\
---------------------------------------------------------------------------

    \102\ See, e.g., IIB and JBA.
    \103\ See proposed rule Sec.  __.2(t)(1), (ff)(2)-(3).
    \104\ See, e.g., IIB and JBA.
    \105\ Id.
---------------------------------------------------------------------------

    The final rule adopts a consistent methodology for calculating the
trading assets and liabilities of foreign banking entities across all
categories, taking into account only the trading assets and

[[Page 61982]]

liabilities of such banking entities' combined U.S. operations.\106\
The agencies believe this approach is appropriate, particularly for
foreign firms with little or no U.S. trading activity but substantial
worldwide trading operations. The agencies further believe that the
trading activities of foreign banking entities that occur outside of
the United States and are booked into such foreign banking entities (or
into their foreign affiliates), pose substantially less risk to the
U.S. financial system than trading activities booked into a U.S.
banking entity, including a U.S. banking entity that is an affiliate of
a foreign banking entity. This approach is also appropriate in light of
provisions in section 13 of the BHC Act that provide foreign banking
entities with significant flexibility to conduct trading and covered
fund activities outside of the United States.\107\
---------------------------------------------------------------------------

    \106\ See final rule Sec.  __.2(s)(3), (ee)(3).
    \107\ See Section 13(d)(1)(H), (I) (12 U.S.C. 1851(d)(1)(H),
(I)).
---------------------------------------------------------------------------

    One commenter expressed concern that the regulations did not give
banking entities sufficient guidance as to how to calculate their
trading assets and liabilities, and asked that the regulations
expressly permit a banking entity to rely on home jurisdiction
accounting standards when calculating trading assets and
liabilities.\108\ In light of the changes to the methodology for
calculating trading assets and liabilities noted above, in particular
using combined U.S. trading assets and liabilities for establishing the
appropriate compliance tier for foreign banking entities, the agencies
believe that further clarifications to the standards for calculating
``trading assets and liabilities'' are not necessary for banking
entities to have sufficient information available as to the manner in
which to calculate trading assets and liabilities.
---------------------------------------------------------------------------

    \108\ See JBA.
---------------------------------------------------------------------------

    A few commenters suggested that the threshold for ``significant
trading assets and liabilities'' should be determined based on the
relative size of the banking entity's total trading assets and
liabilities as compared to other metrics, such as total consolidated
assets or capital, thereby establishing a banking entity's compliance
requirements based on the significance of trading activities to the
banking entity.\109\ Some commenters suggested that the use of trading
assets and liabilities alone as a metric to classify banking entities
for determining compliance obligations was inappropriate.\110\ The
agencies believe that a banking entity's trading assets and
liabilities, as calculated under the methodology described in the final
rule, is an appropriate metric to use in establishing compliance
requirements for banking entities. Imposing compliance obligations on a
banking entity based on the relative significance of trading activities
to the firm could have the result of imposing fewer compliance
obligations on a larger banking entity with identical trading
activities to a smaller counterpart, simply because of that entity's
larger size.
---------------------------------------------------------------------------

    \109\ See, e.g., ABA; Capital One et al.
    \110\ See, e.g., Data Boiler and John Hoffman.
---------------------------------------------------------------------------

    Several commenters recommended that the regulations exclude
particular types of trading assets and liabilities for purposes of
determining whether a banking entity has significant trading assets and
liabilities, moderate trading assets and liabilities, or limited
trading assets and liabilities. In particular, some commenters
encouraged the agencies to exclude all government obligations and other
assets and liabilities that are not subject to the prohibition on
proprietary trading under section 13 of the BHC Act and the
regulations.\111\ The final rule modifies the methodology for
calculating a firm's trading assets and liabilities to exclude all
financial instruments that are obligations of, or guaranteed by, the
United States, or that are obligations, participations, or other
instruments of or guaranteed by an agency of the United States or a
government-sponsored enterprise as described in the regulations.\112\
As commenters noted, banking entities are permitted to engage in
trading activities in these products under section 13 of the BHC Act
and the implementing regulations, and therefore the exclusion of such
instruments for the final rule will result in a more appropriately
tailored standard than under the proposal. The agencies also believe
that the calculation of trading assets and liabilities, subject to
these modifications, should continue to be relatively simple for
banking entities and the agencies, without requiring the imposition of
additional reporting requirements.
---------------------------------------------------------------------------

    \111\ See, e.g., BMO Financial Group (BMO); Capital One et al.;
and KeyCorp.
    \112\ See final rule Sec.  __.2(s)(2), (3); see also final rule
Sec.  __.6(a)(1), (2).
---------------------------------------------------------------------------

    A few commenters recommended that certain de minimis risk
portfolios, such as matched derivatives holdings and loan-related
swaps, be excluded from the calculation of trading assets and
liabilities.\113\ Another commenter recommended the calculation of
trading assets and liabilities should exclude insurance assets.\114\
Another commenter proposed that the trading assets and liabilities of
non-consolidated affiliates be excluded, because tracking the trading
assets and liabilities of such subsidiaries on an ongoing basis may
present significant practical burdens.\115\ As discussed herein, the
final rule makes several amendments to the methodology for calculating
trading assets and liabilities, for example by excluding securities
issued or guaranteed by certain government-sponsored enterprises, and
by calculating trading assets and liabilities for foreign banking
entities based only on the combined U.S. operations of such banking
entities.\116\ The agencies believe that the revisions in the final
rule should simplify the manner in which a banking entity calculates
its trading assets and liabilities. However, the final rule does not
adopt the changes recommended by a few commenters to exclude trading
assets and liabilities associated with particular business activities
or business lines, other than the express modifications noted above, or
to exclude the trading assets and liabilities of certain types of
subsidiaries. Rather, the final rule adopts an approach that is
intended to be straightforward and consistent and allow banking
entities greater ability to leverage regulatory reports that banking
entities are already required to prepare under existing law, such as
the Form Y9-C and the Call Report.\117\
---------------------------------------------------------------------------

    \113\ See, e.g., ABA; Arvest; and BOK Financial (BOK).
    \114\ See Insurance Coalition.
    \115\ See JBA.
    \116\ See final rule Sec.  __.2(s)(2)-(3), (ee)(2)-(3).
    \117\ Compliance obligations are determined on a consolidated
basis under the final rule. For that reason, where a banking entity
has an unconsolidated subsidiary, the banking entity would not need
to examine additional financial reports to determine its compliance
obligations.
---------------------------------------------------------------------------

    Some commenters noted that the regulations should clarify the
manner in which a banking entity should calculate trading assets and
liabilities, and make clear whether it would be appropriate to rely on
regulatory reporting forms such as the Board's Consolidated Financial
Statements for Holding Companies, Form FR Y-9C or call report
information, or other regulatory reporting forms.\118\ Other commenters
recommended that the agencies clarify whether the calculation of
``trading assets and liabilities'' should include only positions that
would be within the scope of the ``trading account'' definition, or
should otherwise exclude

[[Page 61983]]

certain types of instruments.\119\ The agencies support banking
entities relying on current regulatory reporting forms to the extent
possible to determine their compliance obligations under the final
rule. As discussed above, the calculation of significant trading assets
and liabilities, moderate trading assets and liabilities, and limited
trading assets and liabilities is based on a four-quarter average, and
therefore would not require daily or more frequent monitoring of
trading assets and liabilities.\120\
---------------------------------------------------------------------------

    \118\ See, e.g., Bank of Oklahoma; KeyCorp; BPI; and Capital One
et al Banks.
    \119\ See, e.g., BMO and Capital One et al.
    \120\ See final rule Sec.  __.2(s)(1)(i), (ee)(1)(i).
---------------------------------------------------------------------------

    A few commenters encouraged the agencies to include transition
periods for a banking entity that moves to a higher compliance tier, to
allow the banking entity time to comply with the different expectations
under the compliance tier.\121\ Some commenters said that the
regulations should permit a banking entity to breach a threshold for a
higher compliance category without needing to comply with the
heightened compliance requirements applicable to banking entities with
that level of trading assets and liabilities, provided the banking
entity's trading assets and liabilities drop below the relevant
threshold within a limited period of time.\122\ The final rule does not
adopt transition periods or cure periods as recommended by commenters.
The calculation of a banking entity's trading assets and liabilities is
calculated based on a 4-quarter average, which should provide banking
entities with ample notice to come into compliance with the
requirements of the final rule when crossing from having limited to
moderate trading assets and liabilities, or from moderate to
significant trading assets and liabilities.\123\
---------------------------------------------------------------------------

    \121\ See, e.g., ABA; BPI; Custody Banks; Capital One et al.;
and State Street.
    \122\ See State Street.
    \123\ A banking entity approaching a compliance threshold is
encouraged to contact its primary financial regulatory agency to
discuss the steps the banking entity should take to satisfy its
compliance obligations under the new threshold.
---------------------------------------------------------------------------

    One commenter recommended that the agencies provide for notice and
response procedures prior to exercising the reservation of authority to
require a banking entity to apply the requirements of a higher
compliance program tier, and, if a banking entity is determined to be
required to apply increased compliance program requirements, it should
be given a two-year conformance period to come into compliance with
such requirements.\124\ After considering this comment, the agencies
believe that the notice and response procedures provided in the
proposal for rebutting the presumption of compliance for banking
entities with limited trading assets and liabilities would also be
appropriate with respect to an agency exercising this reservation of
authority. However, the agencies believe that providing an automatic
two-year conformance period would be inappropriate, especially in
instances where the agency has concerns regarding evasion of the
requirements of the final rule. Therefore, the agencies are adopting
the reservation of authority with a modification to require that the
agencies exercise such authority in accordance with the notice and
response procedures in section __.20(i) of the final rule.\125\ To the
extent that an agency exercises this authority to require a banking
entity to apply increased compliance program requirements, an
appropriate conformance period shall be determined through the notice
and response procedures.
---------------------------------------------------------------------------

    \124\ See BPI.
    \125\ See final rule Sec.  __.20(i).
---------------------------------------------------------------------------

B. Subpart B--Proprietary Trading Restrictions

    Section 13(a)(1)(A) of the BHC Act prohibits a banking entity from
engaging in proprietary trading unless otherwise permitted in section
13. Section 13(h)(4) of the BHC Act defines proprietary trading, in
relevant part, as engaging as principal for the trading account of the
banking entity in any transaction to purchase or sell, or otherwise
acquire or dispose of, a security, derivative, contract of sale of a
commodity for future delivery, or other financial instrument that the
agencies include by rule. Section 13(h)(6) of the BHC Act defines
``trading account'' to mean any account used for acquiring or taking
positions in the securities and instruments described in section
13(h)(4) principally for the purpose of selling in the near term (or
otherwise with the intent to resell in order to profit from short-term
price movements), and any such other accounts as the agencies, by rule
determine.\126\ Section 3 of the implementing regulations defines
``proprietary trading,'' ``trading account,'' and several related
definitions.
---------------------------------------------------------------------------

    \126\ 12 U.S.C. 1851(h)(6).
---------------------------------------------------------------------------

1. Section __.3: Prohibition on Proprietary Trading and Related
Definitions
a. Trading Account
    The 2013 rule's definition of trading account includes three prongs
and a rebuttable presumption. The short-term intent prong includes
within the definition of trading account the purchase or sale of one or
more financial instruments principally for the purpose of (A) short-
term resale, (B) benefitting from actual or expected short-term price
movements, (C) realizing short-term arbitrage profits, or (D) hedging
one or more positions resulting from the purchases or sales of
financial instruments for the foregoing purposes.\127\ Under the 2013
rule's rebuttable presumption, the purchase (or sale) of a financial
instrument by a banking entity is presumed to be for the trading
account under the short-term intent prong if the banking entity holds
the financial instrument for fewer than sixty days or substantially
transfers the risk of the financial instrument within sixty days of the
purchase (or sale). A banking entity could rebut the presumption by
demonstrating, based on all relevant facts and circumstances, that the
banking entity did not purchase (or sell) the financial instrument
principally for any of the purposes described in the short-term intent
prong.\128\
---------------------------------------------------------------------------

    \127\ See 2013 rule Sec.  __.3(b)(1)(i).
    \128\ See 2013 rule Sec.  __.3(b)(2).
---------------------------------------------------------------------------

    The market risk capital rule prong (market risk capital prong)
includes within the definition of trading account the purchase or sale
of one or more financial instruments that are both covered positions
and trading positions under the market risk capital rule (or hedges of
other covered positions under the market risk capital rule), if the
banking entity, or any affiliate of the banking entity, is an insured
depository institution, bank holding company, or savings and loan
holding company, and calculates risk-based capital ratios under the
market risk capital rule.\129\
---------------------------------------------------------------------------

    \129\ See 2013 rule Sec.  __.3(b)(1)(ii).
---------------------------------------------------------------------------

    Finally, the dealer prong includes within the definition of trading
account any purchase or sale of one or more financial instruments for
any purpose if the banking entity (A) is licensed or registered, or is
required to be licensed or registered, to engage in the business of a
dealer, swap dealer, or security-based swap dealer, to the extent the
instrument is purchased or sold in connection with the activities that
require the banking entity to be licensed or registered as such; or (B)
is engaged in the business of a dealer, swap dealer, or security-based
swap dealer outside of the United States, to the extent the instrument
is purchased or sold in

[[Page 61984]]

connection with the activities of such business.\130\
---------------------------------------------------------------------------

    \130\ See 2013 rule Sec.  __.3(b)(1)(iii). An insured depository
institution may be registered as a swap dealer, but only the swap
dealing activities that require it to be so registered are covered
by the dealer trading account. If an insured depository institution
purchases or sells a financial instrument in connection with
activities of the insured depository institution that do not trigger
registration as a swap dealer, such as lending, deposit-taking, the
hedging of business risks, or other end-user activity, the financial
instrument is included in the trading account only if the instrument
falls within the definition of trading account under at least one of
the other prongs. See 79 FR at 5549.
---------------------------------------------------------------------------

    The proposal would have replaced the 2013 rule's short-term intent
prong with a new third prong based on the accounting treatment of a
position (the accounting prong). The proposal also would have added a
presumption of compliance with the proposed rule's prohibition on
proprietary trading for trading desks whose activities are not covered
by the market risk capital prong or the dealer prong if the activities
did not exceed a specified quantitative threshold. The proposal would
have retained a modified version of the market risk capital prong and
would have retained the dealer prong unchanged from the 2013 rule. As
described in detail below, the final rule retains the three-pronged
definition of trading account from the 2013 rule and does not adopt the
proposed accounting prong or presumption of compliance with the
proprietary trading prohibition. Rather, the final rule makes targeted
changes to the definition of trading account.
    Among other changes, the final rule eliminates the 2013 rule's
rebuttable presumption and replaces it with a rebuttable presumption
that financial instruments held for sixty days or more are not included
in the trading account under the short-term intent prong.\131\ The
agencies believe that the market risk capital prong, which expressly
includes certain short-term trading activities, is an appropriate
interpretation of the statutory definition of trading account for all
firms subject to the market risk capital rule.\132\ Therefore, the
final rule provides that banking entities that are subject to the
market risk capital prong are not subject to the short-term intent
prong.\133\ However, the final rule provides that banking entities that
are subject to the short-term intent prong may elect to apply the
market risk capital prong instead of the short-term intent prong.\134\
These changes are designed to simplify and tailor the trading account
definition in a manner that is consistent with section 13 of the BHC
Act and applicable safety and soundness standards.
---------------------------------------------------------------------------

    \131\ See final rule Sec.  __.3(b)(4).
    \132\ See 12 U.S.C. 1851(h)(6); see also Instructions for
Preparation of Consolidated Financial Statements for Holding
Companies, Trading Assets and Liabilities, Schedule HC-D, available
at https://www.federalreserve.gov/reportforms/forms/FR_Y-9C20190731_i.pdf, and Instructions for Preparation of Consolidated
Reports of Condition and Income, Schedule RC-D, available at https://www.ffiec.gov/pdf/FFIEC_forms/FFIEC031_FFIEC041_201803_i.pdf.
    \133\ See final rule Sec.  __.3(b)(2)(i).
    \134\ See final rule Sec.  __.3(b)(2)(ii).
---------------------------------------------------------------------------

i. Accounting Prong
    The proposed accounting prong would have provided that ``trading
account'' meant any account used by a banking entity to purchase or
sell one or more financial instruments that is recorded at fair value
on a recurring basis under applicable accounting standards.\135\ Such
instruments generally include, but are not limited to, derivatives,
trading securities, and available-for-sale securities. The proposed
inclusion of this prong in the definition of ``trading account'' was
intended to provide greater certainty and clarity to banking entities
than the short-term intent prong in the 2013 rule about which
transactions would be included in the trading account, because banking
entities could more readily determine which positions are recorded at
fair value on their balance sheets.\136\
---------------------------------------------------------------------------

    \135\ See proposed rule Sec.  __.3(b)(3); 83 FR at 33447-48.
    \136\ See 83 FR at 33447-48.
---------------------------------------------------------------------------

    Many commenters strongly opposed replacing the short-term intent
prong with the accounting prong.\137\ These commenters asserted that
the accounting prong could inappropriately scope in, among other
things: Over $400 billion in available-for-sale debt securities; \138\
certain long term investments; \139\ static hedging of long term
investments; \140\ traditional asset-liability management activities;
\141\ derivative transactions entered into for any purpose and
duration; \142\ long-term holdings of commercial mortgage-backed
securities; \143\ seed capital investments; \144\ investments that are
expressly permitted under the covered fund provisions; \145\
investments in connection with employee compensation; \146\ bank
holding company-permissible investments in enterprises engaging in
activities that are part of the business of banking or incidental
thereto, as well as other investments made pursuant to the BHC Act;
\147\ and financial holding company merchant banking investments.\148\
Some commenters argued that the accounting prong was inconsistent with
the statute; \149\ would lead to increased regulatory burden and
uncertainty; \150\ could encourage banking entities not to elect to
account for financial instruments at fair value, thereby reducing
transparency into banking entities' financial reporting and frustrating
risk management practices that are based on the fair value option;
\151\ could result in disparate treatment of the same activity between
two banking entities where one banking entity elects the fair value
option and the other does not; \152\ would have a disproportionately
negative impact on midsize and regional banks; \153\ could negatively
impact the securitization industry if liquidity for asset-backed
securities is impeded; \154\ could inappropriately scope in investment
advisers' use of seed capital to develop products, services, or
strategies for asset management clients; \155\ could lead to increased
burden for international banks by requiring them to apply both local
accounting standards and U.S. generally accepted accounting principles
(GAAP) to non-U.S. positions, one for regular accounting purposes and
one specifically for assessing compliance with the regulations
implementing section 13 of the BHC Act; \156\ that the exclusions and
exemptions from the prohibition on proprietary trading in the 2013 rule
are ill-suited with respect to positions captured by the accounting
prong; \157\ and that fair valuation of

[[Page 61985]]

assets and liabilities under applicable accounting standards is not
indicative of short-term trading intent.\158\
---------------------------------------------------------------------------

    \137\ See, e.g., BOK; New York Community Bank (NYCB); IAA; ABA;
KeyCorp; International Swaps and Derivatives Association (ISDA);
Mortgage Bankers Association (MBA); Commercial Real Estate Finance
Council (CREFC), Mortgage Bankers Association, and the Real Estate
Roundtable (Real Estate Associations); State Street; Chatham
Financial et al. (Chatham); Capital One et al.; BPI; FSF; Goldman
Sachs; SIFMA; Center for Capital Markets Competitiveness (CCMC);
IIB; Credit Suisse; EBF; and Arvest.
    \138\ See, e.g., BPI and SIFMA.
    \139\ See, e.g., Capital One et al.; BPI; SIFMA; and CCMR.
    \140\ See, e.g., BPI and ISDA.
    \141\ See, e.g., KeyCorp; BPI; Capital One et al.; FSF; and
Goldman Sachs.
    \142\ See e.g., ISDA and BPI.
    \143\ See MBA.
    \144\ See, e.g., ICI; Capital One et al.; Credit Suisse; FSF;
and SIFMA.
    \145\ See, e.g., Capital One et al. and BPI.
    \146\ See, e.g., Capital One et al. and BPI.
    \147\ See Capital One et al.
    \148\ See Capital One et al.
    \149\ See, e.g., Capital One et al.; CCMC; IAA; ABA; ISDA;
Credit Suisse; CREFC; BPI; FSF; Goldman Sachs; and SIFMA.
    \150\ See, e.g., CCMC; JBA; Structured Finance Industry Group
(SFIG); IIB; American Action Forum; ABA; BPI; ISDA; and SIFMA.
    \151\ See, e.g., BPI and IIB.
    \152\ See BPI.
    \153\ See, e.g., BOK; ABA; and NYCB.
    \154\ See SFIG.
    \155\ See IAA.
    \156\ See IIB.
    \157\ See, e.g., SIFMA; BPI; CCMR; FSF; and BB&T.
    \158\ See, e.g., Capital One et al.; ABA; BPI; FSF; SIFMA; and
Credit Suisse.
---------------------------------------------------------------------------

    Some commenters expressed a preference for the 2013 rule's short-
term intent prong over the accounting prong.\159\ Other commenters
suggested revisions to the accounting prong if adopted, such as
excluding from the definition of trading account any financial
instrument for which financial institutions record the change in value
in other comprehensive income; \160\ expressly excluding available-for-
sale portfolios from the accounting prong; \161\ and clarifying that
non-U.S. banking entities are permitted to use accounting standards
adopted by individual banking entities other than International
Financial Reporting Standards and GAAP.\162\ One commenter expressed
concern that a banking entity could circumvent the prohibition on
proprietary trading by recording financial instruments at amortized
cost instead of fair value.\163\
---------------------------------------------------------------------------

    \159\ See, e.g., Chatham; BPI; SIFMA; IIB; Credit Suisse; and
Arvest.
    \160\ See BOK.
    \161\ See BOK.
    \162\ See JBA.
    \163\ See Volcker Alliance.
---------------------------------------------------------------------------

    Some commenters supported adopting the accounting prong.\164\ One
commenter urged the agencies to retain the short-term intent prong and
to adopt the accounting prong as an additional test without any
presumption of compliance.\165\ Another commenter argued that the
accounting prong should be implemented as a new presumption within the
short-term trading prong.\166\ This commenter urged the agencies to
revise the accounting prong by codifying language from the applicable
accounting standards and coupling this with preamble language
indicating that the agencies intend to interpret the accounting prong
in a manner that is consistent with GAAP and international accounting
codifications and guidance, thereby allowing the agencies to
definitively interpret the text rather than accounting authorities, who
might not consider the regulations implementing section 13 of the BHC
Act when making further changes to accounting standards.\167\
---------------------------------------------------------------------------

    \164\ See, e.g., Public Citizen; CAP; Better Markets; and AFR.
    \165\ See CAP.
    \166\ See Better Markets.
    \167\ See Better Markets.
---------------------------------------------------------------------------

    After considering all comments received,\168\ the agencies are not
adopting the accounting prong in the final rule. The agencies agree
with commenters' concerns that the accounting prong would have
inappropriately scoped in many financial instruments and activities
that section 13 of the BHC Act was not intended to capture, including
some long-term investments. In addition, the accounting prong would
have inappropriately scoped in entire categories of financial
instruments, regardless of the banking entity's purpose for buying or
selling the instrument, such as all derivatives and equity securities
with a readily determinable fair value. Furthermore, the accounting
prong would have captured certain seeding activity that would otherwise
be permitted under subpart C of the regulations implementing section 13
of the BHC Act. As noted in the preamble to the proposed rule, the
impetus behind replacing the short-term intent prong with the
accounting prong was to address the uncertain application of the short-
term intent prong to certain trades.\169\ As discussed in detail below,
the agencies have modified the short-term intent prong to provide more
clarity. The agencies have also provided further clarity to the trading
account definition in the final rule by adding additional exclusions
from the ``proprietary trading'' definition. The agencies are adopting
these clarifying measures as a more tailored approach to address the
difficulties that have arisen under the existing short-term intent
prong.
---------------------------------------------------------------------------

    \168\ See, e.g., BOK; NYCB; IAA; ABA; KeyCorp; ISDA; MBA; Real
Estate Associations; State Street; Chatham; Capital One et al.; BPI;
FSF; Goldman Sachs; SIFMA; CCMC; IIB; Credit Suisse; EBF; CREFC; and
Arvest.
    \169\ See 83 FR at 33448.
---------------------------------------------------------------------------

ii. Presumption of Compliance With the Prohibition on Proprietary
Trading
    Under the accounting prong, the proposal would have added a
presumption of compliance with the proprietary trading prohibition
based on an objective, quantitative measure of a trading desk's
activities.\170\ Under this proposed presumption of compliance, the
activities of a trading desk of a banking entity that are not covered
by the market risk capital prong or the dealer prong-- i.e., the
activities that would be within the trading account under the proposed
accounting prong--would have been presumed to comply with the proposed
rule's prohibition on proprietary trading if the activities did not
exceed a specified quantitative threshold. The trading desk would have
remained subject to the prohibition on proprietary trading and, unless
the desk engaged in a material level of trading activity (or the
presumption of compliance was rebutted), the desk would not have been
required to comply with the more extensive requirements that would
otherwise apply under the proposal to demonstrate compliance. The
agencies proposed to use the absolute value of the trading desk's
profit and loss on a 90-calendar-day rolling basis as the relevant
quantitative measure for this threshold.
---------------------------------------------------------------------------

    \170\ See proposed rule Sec.  __.3(c); 83 FR at 33449-51.
---------------------------------------------------------------------------

    Two commenters supported adopting the presumption of compliance
with the prohibition on proprietary trading.\171\ Several commenters
opposed adopting this presumption of compliance.\172\ Some of these
commenters argued that the presumption of compliance could allow banks
to evade the restrictions on proprietary trading by splitting trades
over multiple trading desks.\173\ One of these commenters suggested
that the presumption of compliance for trading desk activities that
would have been within the trading account under the accounting prong
in the proposed rule could invite proprietary trading within the $25
million threshold.\174\ Another commenter had several concerns with
this proposal, including that not all businesses calculate daily
profits and losses, and that even businesses that do not sell a single
position within a 90-day period might exceed $25 million in unrealized
gains and losses.\175\ Two commenters asserted there is no statutory
basis to permit a de minimis amount of proprietary trading.\176\ Other
commenters asserted that the presumption could increase regulatory
burden.\177\ Several commenters argued that, if the presumption is
adopted, the threshold should be increased,\178\ or the method of
calculating profit and loss should be modified.\179\ Many commenters
stated that the proposed trading desk-level presumption of compliance
did not adequately address the overbreadth of the accounting
prong.\180\
---------------------------------------------------------------------------

    \171\ See, e.g., New England Council and CFA.
    \172\ See, e.g., Volcker Alliance; Public Citizen; CAP; Bean;
Feng; AFR; and Better Markets.
    \173\ See, e.g., Volcker Alliance; Public Citizen; CAP; and
Bean.
    \174\ See Public Citizen.
    \175\ See IIB.
    \176\ See, e.g., Bean and CAP.
    \177\ See, e.g., BOK; BPI; IIB; and JBA.
    \178\ See, e.g., BOK; BPI; IIB; and Capital One et al.
    \179\ See, e.g., CFA.
    \180\ See, e.g., Capital One et al.; BPI; FSF; and SIFMA.
---------------------------------------------------------------------------

    After considering the comments, the agencies have decided not to
adopt a trading desk-level presumption of compliance with the
prohibition on

[[Page 61986]]

proprietary trading. As discussed in the preamble to the proposal, this
presumption of compliance would have been available only for a trading
desk's activities that would have been within the trading account under
the proposed accounting prong, and not for a trading desk that is
subject to the market risk capital prong or the dealer prong of the
trading account definition. This presumption of compliance was intended
to address the potential impact of the accounting prong, which the
proposal recognized would have been a significant change from the 2013
rule. In particular, the proposal noted that the proposed trading desk-
level presumption of compliance with the prohibition on proprietary
trading was intended to allow banking entities to conduct ordinary
banking activities without having to assess every individual trade for
compliance with subpart B of the implementing regulations and the
proposed accounting prong.\181\ Since the agencies are not adopting the
accounting prong and are adopting additional clarifying revisions to
the short-term intent prong, the agencies have determined it is not
necessary to adopt the presumption of compliance.
---------------------------------------------------------------------------

    \181\ See 83 FR at 33449.
---------------------------------------------------------------------------

iii. Short-Term Intent Prong
    The 2013 rule's short-term intent prong included within the
definition of trading account the purchase or sale of one or more
financial instruments principally for the purpose of (A) short-term
resale, (B) benefitting from actual or expected short-term price
movements, (C) realizing short-term arbitrage profits, or (D) hedging
one or more positions resulting from the purchases or sales of
financial instruments for the foregoing purposes.\182\ Under the 2013
rule's rebuttable presumption, the purchase (or sale) of a financial
instrument by a banking entity was presumed to be for the trading
account under the short-term intent prong if the banking entity held
the financial instrument for fewer than sixty days or substantially
transferred the risk of the financial instrument within sixty days of
the purchase (or sale). A banking entity could rebut the presumption by
demonstrating, based on all relevant facts and circumstances, that the
banking entity did not purchase (or sell) the financial instrument
principally for any of the purposes described in the short-term intent
prong.\183\
---------------------------------------------------------------------------

    \182\ See 2013 rule Sec.  __.3(b)(1)(i).
    \183\ See 2013 rule Sec.  __.3(b(2).
---------------------------------------------------------------------------

    Several commenters stated that, for banking entities that are
subject to the market risk capital prong, the short-term intent prong
is redundant.\184\ In addition, several commenters stated that the
final rule should eliminate the short-term intent prong altogether, as
proposed.\185\ Other commenters stated that, consistent with the
statutory definition of trading account, the agencies should not
eliminate the short-term intent prong.\186\ One commenter suggested re-
adopting the short-term intent prong but defining the term ``short-
term'' differently based on asset class.\187\ Several commenters
supported retaining the short-term intent prong with modifications,
such as eliminating or reversing the rebuttable presumption or aligning
the short-term intent prong more closely with the market risk capital
prong.\188\ The agencies agree that there is substantial overlap
between the short-term intent prong and the market risk capital prong
and have revised the definition of trading account accordingly.
---------------------------------------------------------------------------

    \184\ See, e.g., Capital One et al.; BPI; FSF; KeyCorp; and
SIFMA.
    \185\ See, e.g., JBA; Credit Suisse; CREFC; and SIFMA.
    \186\ See AFR and Bean.
    \187\ See Occupy the SEC.
    \188\ See, e.g., SIFMA; BPI; State Street; Chatham; FSF; CCMR;
ABA; KeyCorp; Capital One et al.; Arvest; and IIB.
---------------------------------------------------------------------------

    Under the final rule, the definition of trading account includes
any account that is used by a banking entity to purchase or sell one or
more financial instruments principally for the purpose of short-term
resale, benefitting from actual or expected short-term price movements,
realizing short-term arbitrage profits, or hedging one or more of the
positions resulting from the purchases or sales of financial
instruments for the foregoing purposes.\189\ The agencies believe that
it is necessary to include a prong other than the market risk capital
prong or the dealer prong to define ``trading account'' for banking
entities that are subject to the final rule but are not subject to the
market risk capital prong. The agencies believe that requiring banking
entities that are not subject to the market risk capital rule to apply
the market risk capital prong in order to identify the scope of
positions subject to the Volcker Rule's proprietary trading provisions
could be unduly complex and burdensome for banking entities with
smaller and less active trading activities. The final rule allows a
banking entity not subject to the market risk capital prong to define
its trading account by reference to either the short-term intent prong
or the market risk capital prong because both tests are consistent with
the statutory definition of trading account; this flexible approach for
banking entities with less trading activities is appropriate for
various reasons, including because these banking entities are already
familiar with the short-term intent prong.\190\
---------------------------------------------------------------------------

    \189\ See final rule Sec.  __.3(b)(1)(i).
    \190\ See 12 U.S.C. 1851(h)(6).
---------------------------------------------------------------------------

    Under the final rule, the regulatory short-term intent prong
applies only to a banking entity that is not subject to the market risk
capital prong and that has not elected to apply the market risk capital
prong to determine the scope of the banking entity's trading
account.\191\ For purposes of the final rule, a banking entity is
subject to the market risk capital prong if it, or any affiliate with
which the banking entity is consolidated for regulatory reporting
purposes, calculates risk-based capital ratios under the market risk
capital rule.\192\ Applying the short-term intent prong only to banking
entities whose trading account is not covered by the market risk
capital prong will simplify application of the rule. No longer applying
the short-term intent prong to banking entities that are subject to the
market risk capital prong is appropriate because the scope of
activities captured by the short-term intent prong is substantially
similar to the scope of activities captured by the market risk capital
prong. Indeed, the preamble to the 2013 rule noted that the definition
of trading position in the market risk capital rule largely parallels
the statutory definition of trading account,\193\ which in turn mirrors
the language in the short-term intent prong. Accordingly, the agencies
believe that a banking entity should be subject either to the short-
term intent prong or to the market risk capital prong, but not
both.\194\
---------------------------------------------------------------------------

    \191\ See final rule Sec.  __.3(b)(2)(i), (ii).
    \192\ See 12 CFR part 3, subpart F; part 217, subpart F; part
324, subpart F.
    \193\ See 79 FR at 5548.
    \194\ A number of commenters suggested that, due to the overlap
between the market risk capital prong and the short-term intent
prong, banking entities that are subject to the market risk capital
prong should not also be subject to the short-term intent prong.
See, e.g., Capital One et al.; BPI; FSF; Goldman Sachs; CREFC; and
SIFMA.
---------------------------------------------------------------------------

    The final rule allows a banking entity that is not subject to the
market risk capital prong to elect to apply the market risk capital
prong in place of the short-term intent prong.\195\ The final rule
includes this option to provide parity between smaller banking entities
that are not subject to the market risk capital rule and larger banking
entities with active trading businesses that are

[[Page 61987]]

subject to the market risk capital prong.\196\ Under the final rule, a
banking entity that is not subject to the market risk capital rule may
choose to define its trading account as if the banking entity were
subject to the market risk capital prong. If a banking entity opts into
the market risk capital prong, the banking entity's trading account
would include all accounts used by the banking entity to purchase or
sell one or more financial instruments that would be covered positions
and trading positions under the market risk capital rule if the banking
entity were subject to the market risk capital rule. Banking entities
that do not make this election will continue to apply the short-term
intent prong.
---------------------------------------------------------------------------

    \195\ See final rule Sec.  __.3(b)(2)(ii).
    \196\ Several commenters recommended defining the trading
account solely by reference to the dealer prong and market risk
capital prong for banking entities subject to the market risk
capital rule. See, e.g., Capital One et al.; BPI; FSF; Goldman
Sachs; CREFC; and SIFMA. One commenter suggested that banking
entities that are not subject to the market risk capital rule and
subject to a third prong should be allowed to elect to be treated as
a banking entity subject to the market risk capital rule for
purposes of the regulations implementing section 13 of the BHC Act.
This approach would maintain parity between banking entities that
are subject to the market risk capital rule and those that are not.
See SIFMA.
---------------------------------------------------------------------------

    Under the final rule, an election to apply the market risk capital
prong must be consistent among a banking entity and all of its wholly
owned subsidiaries.\197\ This consistency requirement is intended to
facilitate banking entities' compliance with the proprietary trading
prohibition by subjecting wholly owned legal entities within a firm to
the same definition. Requiring a consistent definition of ``trading
account'' is particularly important to simplify compliance because a
trading desk may book trades into different legal entities within an
organization, and having a consistent definition of ``trading account''
among these entities should help ensure that each banking entity can
identify relevant trading activity and meet its compliance obligations
under the final rule. This requirement is also expected to facilitate
the agencies' supervision of compliance with the final rule. This
consistency requirement would apply only to a banking entity and its
wholly owned subsidiaries. In the case of minority-owned subsidiaries
or other subsidiaries that the banking entity does not functionally
control, it may be impractical for one banking entity within the
organization to ensure that all affiliates will make a consistent
election. However, the relevant primary financial regulatory agency may
subject a banking entity that is not a wholly owned subsidiary to the
consistency requirement if the agency determines it is necessary to
prevent evasion of the rule's requirements. When exercising this
authority, the relevant primary financial regulatory agency will follow
the same notice and response procedures used elsewhere in the final
rule.
---------------------------------------------------------------------------

    \197\ See final rule Sec.  __.3(b)(3).
---------------------------------------------------------------------------

iv. 60-Day Rebuttable Presumption
    The proposal would have eliminated the 2013 rule's 60-day
rebuttable presumption. Many commenters supported the proposed rule's
elimination of this rebuttable presumption.\198\ Some commenters urged
the agencies to establish a presumption that positions held for more
than 60 days are not proprietary trading.\199\ Some commenters
suggested that the agencies should presume, for banking entities not
subject to the market risk capital rule, that financial instruments
held for longer than 60 days, or that have an original maturity or
remaining maturity upon acquisition of fewer than 60 days to their
stated maturities, are not for the banking entity's trading
account.\200\ One commenter suggested that any third prong to the
definition of trading account that applies to banking entities that are
not subject to the market risk capital rule should have a rebuttable
presumption that any position held by the banking entity as principal
for 60 days or more is not for the trading account, as well as a
reasonable challenge procedure through which a banking entity would be
provided an opportunity to demonstrate to its primary financial
regulatory agency that positions held for fewer than 60 days do not
constitute proprietary trading.\201\ Several commenters asked that the
agencies--if they do not eliminate the presumption--provide guidance on
the rebuttal process,\202\ or make certain revisions to the
presumption, such as revising the ``substantial transfer of risk''
language; \203\ exempting financial instruments close to maturity;
\204\ and excluding hedging activity.\205\ Some commenters argued, in
contrast, that the 60-day rebuttable period was under-inclusive.\206\
One commenter argued that any position purchased or sold within 180
days should be automatically included within the definition of trading
account, or, in the alternative, that the presumption should be
extended from 60 to 180 days, and the agencies should mandate ongoing
monitoring and disclosure of all components, excluded or not, of the
banking entities' reported trading account assets.\207\ This commenter
also argued that there should not be a presumption that certain
positions are not within the trading account; that documentation
requirements for rebutting the presumption should be clearly specified
and the criteria more restrictive; that all arbitrage positions should
be presumed to be trading positions; and that the definition of
``short-term'' should vary by asset class. Another commenter generally
opposed eliminating the 60-day rebuttable presumption.\208\
---------------------------------------------------------------------------

    \198\ See, e.g., State Street; Chatham; BPI; FSF; CCMR; and CFA.
    \199\ See, e.g., ABA; KeyCorp; Capital One et al.; State Street;
and Arvest.
    \200\ See, e.g., ABA; Arvest; BPI; SIFMA; and IIB.
    \201\ See SIFMA.
    \202\ See, e.g., ABA; Arvest; BPI; SIFMA; State Street; and FSF.
    \203\ See, e.g., ABA and Arvest.
    \204\ Id.
    \205\ See Capital One et al.
    \206\ See AFR and Occupy the SEC.
    \207\ See Occupy the SEC.
    \208\ See Bean.
---------------------------------------------------------------------------

    After considering all comments received, the agencies are
eliminating the 60-day rebuttable presumption from the 2013 rule and
establishing a new rebuttable presumption that financial instruments
held for sixty days or more are not within the short-term intent prong.
Since the 2013 rule came into effect, the agencies have found that the
rebuttable presumption has captured many activities that should not be
included in the definition of proprietary trading,\209\ which, under
the statute, only covers buying and selling financial instruments
principally for the purpose of selling in the near term (or otherwise
with the intent to resell in order to profit from short-term price
movements).\210\ Several commenters supported eliminating the 2013
rule's rebuttable presumption for this reason or due to difficulties in
rebutting the presumption.\211\ Given the type of activities that have
triggered the 2013 rule's rebuttable presumption but that are not
undertaken principally for the purpose of selling in the near-
term,\212\

[[Page 61988]]

the agencies have concluded that it is not appropriate to continue to
presume short-term trading intent from holding a financial instrument
for fewer than 60 days.
---------------------------------------------------------------------------

    \209\ For example, asset-liability, liquidity management
activities, transactions to correct error trades and loan-related
swaps. See Part IV.B.2.b.i-iii.
    \210\ 12 U.S.C. 1851(h)(4) and (6).
    \211\ See, e.g., State Street; Chatham; BPI; FSF; CCMR; and CFA.
    \212\ Such activities include a foreign branch of a U.S. banking
entity purchasing a foreign sovereign debt obligation with remaining
maturity of fewer than 60 days in order to meet foreign regulatory
requirements. Similarly, error correcting trades and matched
derivative transactions, discussed infra may have triggered the 2013
rule's rebuttable presumption but are not undertaken 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).
---------------------------------------------------------------------------

    However, the agencies recognize the utility for both the agencies
and the subject banking entities of an objective time-based
standard.\213\ The final rule contains a new rebuttable presumption:
The purchase or sale of a financial instrument presumptively lacks
short-term trading intent if the banking entity holds the financial
instrument for 60 days or longer and does not transfer substantially
all of the risk of the financial instrument within 60 days of the
purchase (or sale).\214\ The agencies agree with commenters that a
banking entity subject to the short-term intent prong that holds an
instrument for at least 60 days should receive the benefit of a
presumption that the trade was not entered into 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. Replacing the 2013
rule's rebuttable presumption with a rebuttable presumption that
financial instruments held for sixty days or longer are not within the
short-term intent prong will provide clarity for banking entities with
respect to such positions, without imposing the burden associated with
the 2013 rule's rebuttable presumption.
---------------------------------------------------------------------------

    \213\ See 79 FR at 5550; see also ABA; KeyCorp; Capital One et
al.; State Street; Arvest; and SIFMA.
    \214\ See final rule Sec.  __.3(b)(4).
---------------------------------------------------------------------------

    In light of the revision to the 60-day rebuttable presumption, the
agencies do not believe it is necessary to provide a formal challenge
procedure with respect to financial instruments that are purchased or
sold within 60 days. Under the final rule, such activity is no longer
presumptively within a banking entity's trading account.
    As in the 2013 rule, the final rule's presumption only applies to
the short-term intent prong and does not apply to the market risk
capital or dealer prongs
v. Market Risk Capital Prong Modification
    The proposal would have revised the market risk capital prong to
apply to the activities of foreign banking organizations (FBOs) to take
into account the different market risk frameworks FBOs may have in
their home countries.\215\ Specifically, the proposal included within
the market risk capital prong an alternative definition that permitted
a banking entity that is not, and is not controlled directly or
indirectly by a banking entity that is, located in or organized under
the laws of the United States or any State, to include any account used
by the banking entity to purchase or sell one or more financial
instruments that are subject to risk-based capital requirements under a
market risk framework established by the home-country supervisor that
is consistent with the market risk framework published by the Basel
Committee on Banking Supervision (Basel Committee), as amended from
time to time.
---------------------------------------------------------------------------

    \215\ See proposed rule Sec.  __. 3(b)(1)(ii); 83 FR at 33447.
---------------------------------------------------------------------------

    One commenter asserted that, under some foreign regulatory market
risk capital frameworks, this expansion would capture positions that
are not held for short-term trading.\216\ This commenter advocated
adopting a flexible approach where foreign banking entities could
exclude a position subject to a foreign jurisdiction's market risk
capital framework from the trading account by demonstrating that the
position was not acquired for short-term purposes or otherwise should
not be treated as a trading account position.\217\
---------------------------------------------------------------------------

    \216\ See IIB.
    \217\ See id.
---------------------------------------------------------------------------

    After considering the comments on this issue,\218\ the agencies
have decided not to modify the market risk capital prong to incorporate
foreign market risk capital frameworks. The agencies believe that
relying on the short-term intent prong, market risk capital prong, and
dealer prong will ensure consistent treatment of U.S. and foreign
banking entities. Foreign banking entities that are not subject to the
market risk capital rule may continue to use the short-term intent
prong to define their trading accounts. However, a banking entity,
including a foreign banking entity, may elect to apply the market risk
capital prong in determining the scope of its trading account. As
discussed above, a banking entity that uses the market risk capital
prong to determine the scope of its trading account is not also subject
to the short-term intent prong. This approach will provide appropriate
parity between U.S. and foreign banking entities and will also maintain
consistency with the statutory trading account definition.\219\
---------------------------------------------------------------------------

    \218\ See IIB (noting that the scope of some foreign supervisory
market risk capital frameworks may capture positions that are not
held solely for short-term purposes and thus should be out of scope
for purposes of the final rule).
    \219\ In the course of developing the final rule, the agencies
have considered the prudential actions of foreign regulators in this
area and the resulting effects on U.S. and non-U.S. financial
institutions and the relevant markets in which they participate.
---------------------------------------------------------------------------

    Accordingly, the final rule retains a market risk capital prong
that is substantially similar to that in the 2013 rule. The final
rule's market risk capital prong includes within the definition of
trading account any account that is used by a banking entity to
purchase or sell one or more financial instruments that are both
covered positions and trading positions under the market risk capital
rule (or hedges of other covered positions under the market risk
capital rule), if the banking entity, or any affiliate that is
consolidated with the banking entity for regulatory reporting purposes,
calculates risk-based capital ratios under the market risk capital
rule.\220\
---------------------------------------------------------------------------

    \220\ See final rule Sec.  __.3(b)(1)(ii). The final rule's
market risk capital prong has, however, been modified as compared to
the 2013 rule to account for a banking entity that is not
consolidated with an affiliate (for regulatory reporting purposes)
that calculates risk-based capital ratios under the market risk
capital rule. For example, the trading positions of a broker-dealer
that is not consolidated with its parent bank holding company will
not be included in the holding company's trading positions in the
holding company's Form FR Y-9C. In such an instance, even though the
broker-dealer is affiliated with an entity that calculates risk-
based capital ratios under the market risk capital rule, it would
not be subject to the market capital risk prong due to the fact that
the broker-dealer is not consolidated with the affiliate for
regulatory reporting purposes. As a result, the broker-dealer would
be subject to the amended short-term intent prong and the dealer
prong (with respect to instruments purchased or sold in connection
with the activities that require the broker-dealer to be licensed or
registered as such). It may, however, be able to elect to use the
market risk capital prong (as an alternative to the short-term
intent prong) by following the procedures described above.
---------------------------------------------------------------------------

    In addition, the final rule includes a transition period for
banking entities as they become subject to the market risk capital
prong.\221\ Under the final rule, if a banking entity is subject to the
short-term intent prong and then becomes subject to the market risk
capital prong, the banking entity may continue to apply the short-term
intent prong instead of the market risk capital prong for one year from
the date on which it becomes, or becomes consolidated for regulatory
reporting purposes with, a banking entity that calculates risk-based
capital ratios under the market risk capital rule. The agencies are
adopting this transition period to provide banking entities a
reasonable period to update compliance programs.
---------------------------------------------------------------------------

    \221\ Unlike the Volcker Rule compliance program requirements,
which are based on average gross trading assets and liabilities over
the prior four quarters, the thresholds in the market risk capital
rule are based on the most recent quarter.
---------------------------------------------------------------------------

    The market risk capital rule includes a position that is reported
as a covered position for regulatory reporting purposes on applicable
reporting forms.\222\ Certain banking entities that may be subject to,
or elect to apply, the

[[Page 61989]]

market risk capital prong may not report positions on applicable
regulatory reporting forms as trading assets or trading liabilities.
Therefore, the final rule amends the definition of ``market risk
capital rule covered position and trading position'' to clarify that
this definition includes any position that meets the criteria to be a
covered position and a trading position, without regard to whether the
financial instrument is reported as a covered position or trading
position on any applicable regulatory reporting forms. The final rule
also modifies the definition of ``market risk capital rule'' to update
a cross-reference to the Board's capital rules and to clarify what the
applicable market risk capital rule would be for a firm electing to
apply the market risk capital prong.\223\
---------------------------------------------------------------------------

    \222\ See 12 CFR 3.202; 12 CFR 217.202; 12 CFR 324.202 (defining
``covered position'').
    \223\ See 12 CFR part 217.
---------------------------------------------------------------------------

vi. Dealer Prong
    The proposal did not propose revisions to the dealer prong.
However, several commenters requested that the agencies clarify that
not all purchases and sales of financial instruments by a dealer are
captured by the dealer prong.\224\ Specifically, these commenters
requested that the agencies clarify that the dealer prong does not
capture purchases or sales made by a dealer in a non-dealing capacity,
including financial instruments purchased for long-term investment
purposes.\225\ Among other things, those commenters noted that without
such modifications, the dealer prong may require a position-by-position
analysis to confirm whether a long-term investment is part of the
trading account. Another commenter requested that the agencies revise
the dealer prong to ensure that derivatives activities remain in the
trading account without regard to potential SEC and CFTC actions on the
de minimis thresholds or other registration requirements, and that such
derivatives activities do not benefit from any presumption of
compliance.\226\ The final rule retains the 2013 rule's dealer prong
without any substantive change.\227\
---------------------------------------------------------------------------

    \224\ See, e.g., BPI; FSF; and SIFMA.
    \225\ See e.g., BPI; FSF; and SIFMA.
    \226\ See Better Markets.
    \227\ In response to the commenter, the agencies clarify that
banking entities that are licensed or registered (or required to be
licensed or registered) as dealers, swap dealers, or security-based
swap dealers analyze the types of activities that would be captured
by the dealer prong without regard to the de minimis thresholds for
swap dealer or security-based swap dealer registration. However,
regardless of whether a banking entity is so licensed or registered,
the banking entity is also required to determine whether a purchase
or sale of a financial instrument would be captured by either the
short-term intent prong or the market risk capital prong, as
applicable.
---------------------------------------------------------------------------

    The final rule's dealer prong includes within the definition of
trading account any account that the banking entity uses to purchase or
sell one or more financial instruments for any purpose if the banking
entity (A) is licensed or registered, or is required to be licensed or
registered, to engage in the business of a dealer, swap dealer, or
security-based swap dealer, to the extent the instrument is purchased
or sold in connection with the activities that require the banking
entity to be licensed or registered as such; or (B) is engaged in the
business of a dealer, swap dealer, or security-based swap dealer
outside of the United States, to the extent the instrument is purchased
or sold in connection with the activities of such business.\228\ In
response to commenters and consistent with the 2013 rule, the agencies
reaffirm that a banking entity may be licensed or registered as a
dealer, but only the types of activities that require it to be so
licensed or registered are covered by the dealer prong. Thus, if a
banking entity purchases or sells a financial instrument in connection
with activities that are not the types of activities that would trigger
registration as a dealer, the purchase or sale of the financial
instrument is not covered by the dealer prong. However, it may be
included in the trading account under the short-term intent prong or
the market risk capital prong, as applicable.\229\ Moreover, in
response to commenters' concerns that the existing rule may require
dealers to conduct a position-by-position analysis of their trading
activities to determine whether a position is captured by the dealer
prong, the agencies believe that the changes being adopted today,
particularly the exclusions for financial instruments that are not
trading assets or liabilities,\230\ should help alleviate those
concerns by narrowing the range of transactions covered by the rule.
---------------------------------------------------------------------------

    \228\ See final rule Sec.  __.3(b)(1)(iii).
    \229\ See final rule Sec.  __.3(b)(1)(i), (ii).
    \230\ See infra section IV.B.1.b.v.
---------------------------------------------------------------------------

b. Proprietary Trading Exclusions
    Section __.3 of the 2013 rule generally prohibits a banking entity
from engaging in proprietary trading. In addition to defining the scope
of trading activity subject to the prohibition on proprietary trading,
the 2013 rule also provides several exclusions from the definition of
proprietary trading. Based on experience implementing the 2013 rule,
the agencies proposed modifying the exclusion for liquidity management
and adopting new exclusions for transactions made to correct errors and
for certain offsetting swap transactions. In addition, the agencies
requested comment regarding whether any additional exclusions should be
added, for example, to address certain derivatives entered into in
connection with a customer lending transaction. The agencies are
adopting the liquidity management exclusion as proposed, with a
modification to encompass non-deliverable cross-currency swaps, and
additional exclusions for the following activities: (i) Trading
activity to correct trades made in error, (ii) loan-related and other
customer accommodation swaps, (iii) matched derivative transactions,
(iv) hedges of mortgage servicing rights where trading in the
underlying mortgage servicing rights is not prohibited by the rule; and
(v) financial instruments that do not meet the definition of trading
assets or trading liabilities under applicable reporting forms.
i. Liquidity Management Exclusion Amendments
    The 2013 rule excludes from the definition of proprietary trading
the purchase or sale of securities for the purpose of liquidity
management in accordance with a documented liquidity management
plan.\231\ This exclusion contains several requirements. First, the
liquidity management exclusion is limited by its terms to securities
and requires that transactions be conducted pursuant to a liquidity
management plan that specifically contemplates and authorizes the
particular securities to be used for liquidity management purposes;
describes the amounts, types, and risks of securities that are
consistent with the banking entity's liquidity management plan; and the
liquidity circumstances in which the particular securities may or must
be used. Second, any purchase or sale of securities contemplated and
authorized by the plan must be principally for the purpose of managing
the liquidity of the banking entity, and not for the purpose of short-
term resale, benefitting from actual or expected short-term price
movements, realizing short-term arbitrage profits, or hedging a
position taken for such short-term purposes. Third, the plan must
require that any securities purchased or sold for liquidity management
purposes be highly liquid and limited to instruments the market,
credit, and other risks of which the banking entity does not reasonably
expect to give rise to appreciable profits or losses as a result of
short-term price movements. Fourth, the plan must limit any

[[Page 61990]]

securities purchased or sold for liquidity management purposes to an
amount that is consistent with the banking entity's near-term funding
needs, including deviations from normal operations of the banking
entity or any affiliate thereof, as estimated and documented pursuant
to methods specified in the plan. Fifth, the banking entity must
incorporate into its compliance program internal controls, analysis,
and independent testing designed to ensure that activities undertaken
for liquidity management purposes are conducted in accordance with the
requirements of the 2013 rule and the banking entity's liquidity
management plan. Finally, the plan must be consistent with the
supervisory requirements, guidance, and expectations regarding
liquidity management of the agency responsible for regulating the
banking entity. The 2013 rule established these requirements to provide
some safeguards to ensure that the liquidity management exclusion is
not misused for the purpose of impermissible proprietary trading.\232\
While some safeguards around a banking entity's liquidity management
are appropriate, the restrictions under the 2013 rule have limited the
ability of banking entities to engage in certain types of bona fide
liquidity management activities.
---------------------------------------------------------------------------

    \231\ See 2013 rule Sec.  __.3(d)(3).
    \232\ See 79 FR at 5555.
---------------------------------------------------------------------------

    The proposal would have amended the exclusion for liquidity
management activities to allow banking entities to use foreign exchange
forwards and foreign exchange swaps, each as defined in the Commodity
Exchange Act,\233\ and physically settled cross-currency swaps (i.e.,
cross-currency swaps that involve an actual exchange of the underlying
currencies) as part of their liquidity management activities.\234\
Foreign exchange forwards, foreign exchange swaps, and physically
settled cross-currency swaps are often used by trading desks of foreign
branches and subsidiaries of a U.S. banking entity to manage liquidity
in foreign jurisdictions.\235\ The proposal would have provided that a
banking entity could use foreign exchange forwards, foreign exchange
swaps, and physically settled cross-currency swaps for liquidity
management purposes provided that the use of such financial instruments
was in accordance with a documented liquidity management plan.\236\
---------------------------------------------------------------------------

    \233\ See 7 U.S.C. 1a(24) and 1a(25).
    \234\ See proposed rule Sec.  __.3(e)(3).
    \235\ See 83 FR at 33451-52
    \236\ See id.
---------------------------------------------------------------------------

    Many commenters supported the proposed expansion of activities
covered by the liquidity management exclusion.\237\ However, some
commenters expressed the view that the expansion did not go far enough
and should be expanded to include other types of financial
instruments.\238\ One commenter asserted that expanding the scope of
the liquidity management exclusion would streamline compliance for
banking entities without introducing additional safety and soundness
concerns or the risk of impermissible proprietary trading.\239\ Some
commenters said that non-deliverable currency derivatives should also
qualify for the exclusion, because there are some currencies for which
physically settled cross-currency swaps are not available.\240\
Additionally, other commenters argued that given the role of
derivatives in liquidity risk management, the agencies should expand
the exclusion further to cover all derivatives, including interest rate
swaps.\241\ Certain commenters suggested that the agencies should
further expand the liquidity management exclusion to include all
financial instruments that would be convenient and useful for managing
liquidity and asset-liability mismatch risks of the organization.\242\
---------------------------------------------------------------------------

    \237\ See, e.g., ISDA; Goldman Sachs; ABA; SIFMA; IIB; BPI;
GFMCA; CFA; New England Council, CCMC; Capital One et al., FSF; and
State Street.
    \238\ See, e.g., ISDA; ABA; FSF; New England Council; CCMC;
Capital One et al.; Goldman Sachs; SIFMA; IIB; Credit Suisse; and
State Street.
    \239\ See ISDA.
    \240\ See, e.g., Global Financial Markets Association (GFMA)
(noting that certain non-deliverable financial instruments are also
used for liquidity management purposes); SIFMA; State Street; JBA;
ABA; BPI; IIB; and Credit Suisse.
    \241\ See, e.g., FSF; Capital One et al.; IIB; and JBA.
    \242\ See, e.g., IIB and State Street.
---------------------------------------------------------------------------

    Several commenters claimed that the eligibility criteria of the
liquidity management exclusion are opaque and confusing, and suggested
modifying, clarifying, or eliminating some or all of the
requirements.\243\ For example, several commenters argued that the
requirement to maintain a documented liquidity management plan with
certain enumerated elements is unnecessarily prescriptive.\244\ Some
commenters stated that banking entities do not rely on the exclusion
due to the number and limiting nature of the requirements.\245\ Some
commenters argued that the agencies should be promoting, rather than
restricting, appropriate liquidity management and structural interest
rate risk management activities, and that the retention of these
requirements is not consistent with the removal of the prescriptive
requirements of Appendix B in the 2013 rule.\246\ Other commenters
argued that the agencies should eliminate the compliance-related
requirements and permit banking entities to design and manage their
liquidity management function according to their existing internal
compliance frameworks.\247\ In addition, a commenter recommended
clarifying whether treasury functions within banking entities may
manage global liquidity through the newly added financial
instruments.\248\
---------------------------------------------------------------------------

    \243\ See, e.g., Capital One et al.; BPI; JBA; SIFMA; CCMC; and
FSF.
    \244\ See, e.g., ISDA; KeyCorp; IIB; CCMC; SIFMA; and Goldman
Sachs.
    \245\ See, e.g., FSF and Credit Suisse.
    \246\ See, e.g., SIFMA and Goldman Sachs.
    \247\ See, e.g., BPI; IIB; and FSF.
    \248\ See ABA.
---------------------------------------------------------------------------

    In contrast, other commenters did not support the proposed
expansion of the liquidity management exclusion.\249\ One commenter
asserted that the proposed rule fails to demonstrate the need for
providing banks greater opportunity to use foreign currency
transactions to manage their liquidity needs when those needs are
already being met via the securities markets.\250\ Another commenter
argued that the proposed change would create concern for the currency
markets by making it easier for trading desks to trade these
instruments for speculative purposes under the guise of legitimate
liquidity management.\251\ One commenter argued that the proposal would
encourage banking entities to exclude impermissible trades as liquidity
management and engage in speculative currency trading. As a result, it
would increase banks' risk-taking and moral hazard, reducing the
effectiveness of regulatory oversight.\252\ In addition, some
commenters suggested that the agencies did not provide sufficient
justification to support the proposed changes to the exclusion.\253\
---------------------------------------------------------------------------

    \249\ See, e.g., Volcker Alliance; Data Boiler; NAFCU; Public
Citizen; CAP; Occupy the SEC; and Merkley.
    \250\ See Bean.
    \251\ See Volcker Alliance.
    \252\ See Data Boiler.
    \253\ See, e.g., Public Citizen and Bean.
---------------------------------------------------------------------------

    After reviewing the comments received, the agencies are adopting
the liquidity management exclusion substantially as proposed, but with
a modification to permit the use of non-deliverable cross-currency
swaps. The agencies recognize the various types of financial
instruments that can be used by a banking entity for liquidity
management as noted by commenters. However, the agencies continue to
believe, as stated in the proposal, that the purpose of the expansion
is to streamline compliance for banking entities operating in foreign

[[Page 61991]]

jurisdictions.\254\ Thus, the final rule expands the liquidity
management exclusion to permit the purchase or sale of foreign exchange
forwards (as that term is defined in section 1a(24) of the Commodity
Exchange Act (7 U.S.C. 1a(24)), foreign exchange swaps (as that term is
defined in section 1a(25) of the Commodity Exchange Act (7 U.S.C.
1a(25)), and cross-currency swaps \255\ entered into by a banking
entity for the purpose of liquidity management in accordance with a
documented liquidity management plan.\256\
---------------------------------------------------------------------------

    \254\ See 83 FR at 33451-52.
    \255\ As proposed, the final rule defines a cross-currency swap
as a swap in which one party exchanges with another party principal
and interest rate payments in one currency for principal and
interest rate payments in another currency, and the exchange of
principal occurs on the date the swap is entered into, with a
reversal of the exchange of principal at a later date that is agreed
upon for when the swap is entered. This definition is consistent
with regulations pertaining to margin and capital requirements for
covered swap entities, swap dealers, and major swap participants.
See 12 CFR 45__.2; 12 CFR 237.2; 12 CFR 349.2; 17 CFR 23.151.
    \256\ See final rule Sec.  __.3(d)(3).
---------------------------------------------------------------------------

    In response to commenters' concerns that physically settled cross-
currency swaps are not available for some currencies (e.g., due to
currency controls), the exclusion also encompasses non-deliverable
cross-currency swaps. For currencies where physically settled cross-
currency swaps are not available, a banking entity may have had to
engage in procedures such as using spot transactions or holding
currency at foreign custodians, which could be inefficient. Allowing
banking entities to use non-deliverable cross-currency swaps can
provide greater flexibility in conducting liquidity management in these
situations. Even though physically settled cross-currency swaps are
available in many currencies, the agencies believe it is appropriate to
allow non-deliverable cross-currency swaps to be used for liquidity
management in all currencies. Requiring physical settlement for some
cross-currency swaps but not others would make the exclusion more
difficult for banking entities to use and for the agencies to monitor,
particularly if currency controls change, causing the list of
currencies for which physical settlement is permitted to change. These
administrative hurdles would negate many of the benefits of allowing
the use of non-deliverable cross-currency swaps.
    Regarding the assertion that banking entities could meet their
liquidity needs in the securities markets, the agencies have found
that, to the contrary, foreign exchange forwards, foreign exchange
swaps, and cross-currency swaps are often used by trading desks to
manage liquidity both in the United States and in foreign
jurisdictions. As foreign branches and subsidiaries of U.S. banking
entities often have liquidity requirements mandated by foreign
jurisdictions, U.S. banking entities often use foreign exchange
products to address currency risk arising from holding this liquidity
in foreign currencies. Thus, these foreign exchange products are
important for liquidity management and should be included in the
expansion of the liquidity management exclusion.
    The agencies believe that adding foreign exchange forwards, foreign
exchange swaps, and cross-currency swaps to the exclusion addresses the
primary liquidity management needs for foreign entities, and therefore
are declining to expand the exclusion to other products as suggested by
some commenters. While some commenters asserted that further expanding
the liquidity management exclusion would streamline compliance without
introducing additional safety and soundness or proprietary trading
concerns, the agencies believe that the range of financial instruments
that will qualify for the exclusion under the final rule will be
sufficient for managing banking entities' liquidity risks.
    The final rule permits a banking entity to purchase or sell foreign
exchange forwards, foreign exchange swaps, and cross-currency swaps to
the same extent that a banking entity may purchase or sell securities
under the liquidity management exclusion in the 2013 rule, and the
conditions that apply for securities transactions also apply to
transactions in foreign exchange forwards, foreign exchange swaps, and
cross-currency swaps.\257\
---------------------------------------------------------------------------

    \257\ See Sec.  __.3(e)(3)(i)-(vi) of the final rule.
---------------------------------------------------------------------------

    The agencies acknowledge that, as stated in the proposal, cross-
currency swaps generally are more flexible in their terms, may have
longer durations, and may be used to achieve a greater variety of
potential outcomes, as compared to foreign exchange forwards and
foreign exchange swaps.\258\ However, the agencies believe that the
requirement to conduct liquidity management in accordance with a
documented liquidity management plan appropriately limits the use of
cross-currency swaps to activities conducted for liquidity management
purposes, and therefore banking entities' use of these swaps should not
adversely affect currency markets, as one commenter warned. Under the
plan, the purpose of the transactions must be liquidity management. The
timing of purchases and sales, the types and duration of positions
taken and the incentives provided to managers of these purchases and
sales must all indicate that managing liquidity, and not taking short-
term profits (or limiting short-term losses), is the purpose of these
activities. Thus, to be in compliance with the plan, cross-currency
swaps must be used principally for the purpose of managing the
liquidity of the banking entity, and not for the purpose of short-term
resale, benefitting from actual or expected short-term price movements,
realizing short-term arbitrage profits, or hedging a position taken for
such short-term purposes.\259\
---------------------------------------------------------------------------

    \258\ See 83 FR at 33452.
    \259\ See Sec.  __.3(d)(3)(ii) of the final rule.
---------------------------------------------------------------------------

    Regarding the assertion from some commenters that the compliance-
related requirements for the liquidity management exclusion are opaque
or unnecessarily prescriptive, the agencies believe it is important to
retain these requirements in order to provide clarity in administration
of the rule and to protect against potential misuse of the liquidity
management exclusion for proprietary trading. As noted above, the
documented liquidity management plan, required under the 2013 rule and
retained in the final rule,\260\ is a key element in assuring that
liquidity management is the purpose of the relevant transactions. The
agencies do not believe that the final rule will stand as an obstacle
to or otherwise impair the ability of banking entities to manage their
liquidity risks. Although other changes to the 2013 rule in the final
rule, such as the elimination of Appendix B, reflect efforts to tailor
compliance obligations, the agencies believe it is important to be
explicit in maintaining targeted compliance requirements for specific
provisions of the final rule, such as the liquidity management
exclusion.
---------------------------------------------------------------------------

    \260\ See Sec.  __.3(d)(3).
---------------------------------------------------------------------------

    The agencies believe that the six required elements of the
liquidity management plan help to mitigate commenters' concerns that
the proposal would have encouraged banking entities to exclude
impermissible trades as liquidity management or increase risk-taking.
Under the liquidity management plan required by the final rule, the
exclusion does not apply to activities undertaken with the stated
purpose or effect of hedging aggregate risks incurred by the banking
entity or its affiliates related to asset-liability mismatches or other
general market risks to which the entity or affiliates may be exposed.
Further, the exclusion does not apply to any trading activities

[[Page 61992]]

that expose banking entities to substantial risk from fluctuations in
market values, unrelated to the management of near-term funding needs,
regardless of the stated purpose of the activities.\261\
---------------------------------------------------------------------------

    \261\ See 79 FR at 5555.
---------------------------------------------------------------------------

    This final rule also includes a change to one of the liquidity
management exclusion's requirements. The 2013 rule requires that
activity conducted under the liquidity management exclusion be
consistent with applicable ``supervisory requirements, guidance, and
expectations.'' \262\ Consistent with changes elsewhere in the final
rule and with the Federal banking agencies' Interagency Statement
Clarifying the Role of Supervisory Guidance,\263\ the agencies are
removing references to guidance and expectations from the regulatory
text of the liquidity management exclusion. In addition, the final rule
includes conforming changes that reflect the addition of foreign
exchange forwards, foreign exchange swaps, and cross-currency swaps as
permissible contracts in conjunction with the other criteria under the
exclusion.\264\
---------------------------------------------------------------------------

    \262\ See 2013 rule Sec.  __.3(d)(3)(vi).
    \263\ Interagency Statement Clarifying the Role of Supervisory
Guidance (Sept. 11, 2018; https://www.occ.gov/news-issuances/news-releases/2018/nr-ia-2018-97a.pdf, https://www.fdic.gov/news/news/financial/2018/fil18049.html, https://www.federalreserve.gov/supervisionreg/srletters/sr1805.htm). The final rule similarly
removes references to ``guidance'' from subparts A and C.
    \264\ The term ``financial instruments'' is substituted for the
term ``securities'' when referring to what contracts are permitted
under the exclusion.
---------------------------------------------------------------------------

ii. Transactions To Correct Bona Fide Trade Errors
    The proposal included an exclusion from the definition of
proprietary trading for trading errors and subsequent correcting
transactions.\265\ As discussed in the proposal, the exclusion was
intended to address situations in which a banking entity erroneously
executes a purchase or sale of a financial instrument in the course of
conducting a permitted or excluded activity. For example, a trading
error may occur when a banking entity is acting solely in its capacity
as an agent, broker, or custodian pursuant to Sec.  __.3(d)(7) of the
2013 rule, such as by trading the wrong financial instrument, buying or
selling an incorrect amount of a financial instrument, or purchasing
rather than selling a financial instrument (or vice versa). To correct
such errors, a banking entity may need to engage in a subsequent
transaction as principal to fulfill its obligation to deliver the
customer's desired financial instrument position and to eliminate any
principal exposure that the banking entity acquired in the course of
its effort to deliver on the customer's original request. As the
proposal noted, banking entities have expressed concern that, however,
under the 2013 rule, the initial trading error and any corrective
transactions could, depending on the facts and circumstances involved,
fall within the proprietary trading definition if the transaction is
covered by any of the prongs of the trading account definition and is
not otherwise excluded pursuant to a different provision of the rule.
---------------------------------------------------------------------------

    \265\ See 83 FR at 33452-53.
---------------------------------------------------------------------------

    To address this concern, the agencies proposed a new exclusion from
the definition of proprietary trading for trading errors and subsequent
correcting transactions. The proposal noted that the availability of
this exclusion would depend on the facts and circumstances of the
transactions, such as whether the banking entity made reasonable
efforts to prevent errors from occurring, or identified and corrected
trading errors in a timely and appropriate manner. The proposed
exclusion required that banking entities, once they identified
purchases or sales made in error, transfer the financial instrument to
a separately managed trade error account for disposition. The proposal
would have required that this separately managed trade error account be
monitored and managed by personnel independent from the traders
responsible for the error, and that banking entities monitor and manage
trade error corrections and trade error accounts.
    The majority of commenters generally supported the proposed
exclusion for trade errors.\266\ Some commenters noted that, consistent
with operational risk management practices, bona fide trade error
activity is separately managed and classified as an operational loss
when there is a loss event or a ``near miss'' when error activity
results in a gain.\267\ Many commenters urged the agencies not to
mandate a separately managed trade error account, but to permit banking
entities to resolve trading errors in accordance with internal policies
and procedures to avoid duplicative resolution systems and unnecessary
regulatory costs.\268\ One commenter argued that error trades are
clearly outside the scope of activities meant to be prohibited by the
statute, so it should not be necessary to include any additional
documentation or administrative requirements related to them.\269\ One
comment letter requested that the agencies clarify that the exclusion
covers both pre-settlement trade errors (where the error is identified
and corrected prior to being settled in the client's account and is
settled in a separately managed trade error account) and post-
settlement trade errors (where the trade error is settled in and posted
directly to the client's account).\270\
---------------------------------------------------------------------------

    \266\ See, e.g., ABA; BB&T; Capital One et al.; BPI; FSF; CFA;
and JBA.
    \267\ See, e.g., ABA; BB&T; BPI; Capital One et al.; and FSF.
    \268\ See, e.g., ABA; Credit Suisse; FSF; JBA; and SIFMA.
    \269\ See SIFMA.
    \270\ See Capital One et al.
---------------------------------------------------------------------------

    One commenter supported providing an exclusion for bona fide error
trades, but suggested certain changes to the proposed exclusion.\271\
This commenter expressed concern that the proposed exclusion did not
provide sufficient protections to ensure that banking entities correct
errors in a timely and comprehensive manner and do not use the
exclusion to facilitate directional exposures. To this end, the
commenter recommended requiring banking entities to establish
reasonably designed controls, including periodic exception reports
containing certain specified fields. These reports, the commenter
argued, should be provided to independent personnel in the second line-
of-defense, including compliance and risk personnel, and escalated
internally in accordance with the banking entity's internal policies
and procedures. The commenter also recommended requiring periodic error
trade testing and audits conducted by the second line-of-defense.
---------------------------------------------------------------------------

    \271\ See Better Markets.
---------------------------------------------------------------------------

    One commenter argued against a blanket exclusion for error trades,
and urged the agencies to require any profit from error trades be
forfeited to the U.S. Treasury, thereby removing any incentive for a
banking entity to erroneously classify intentional financial positions
as error trades.\272\ Another commenter argued that the proposal did
not adequately explain or provide sufficient data to justify the
necessity of providing an exclusion for error trades, and that the
exclusion could be used to evade the prohibition on proprietary
trading.\273\
---------------------------------------------------------------------------

    \272\ See Public Citizen.
    \273\ See CAP.
---------------------------------------------------------------------------

    After weighing the comments received, the agencies are excluding
from the definition of ``proprietary trading'' any purchase or sale of
one or more financial instruments that was made in error by a banking
entity in the course of conducting a permitted or

[[Page 61993]]

excluded activity or is a subsequent transaction to correct such an
error.\274\ The agencies do not believe bona fide trading errors and
correcting transactions are proprietary trading. Under the 2013 rule,
trading errors and subsequent transactions to correct such errors could
trigger the short-term intent prong's 60-day rebuttable presumption and
thus could be considered to be presumptively within the trading
account. In addition, trading errors and correcting transactions could
be within the definition of proprietary trading under the market risk
prong or dealer prong. While the final rule eliminates the 2013 rule's
60-day rebuttable presumption,\275\ the agencies believe it is useful
and appropriate to clarify in the final rule that trading errors and
subsequent correcting transactions are not proprietary trading because
banking entities do not enter into these transactions 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).\276\
Rather, the principal purpose of a trading error correction is to
remedy a mistake made in the ordinary course of the banking entity's
permissible activities.\277\ Accordingly, the agencies are adopting
this exclusion to provide clarity regarding bona fide trading errors
and subsequent correcting transactions.
---------------------------------------------------------------------------

    \274\ Final rule Sec.  __.3(d)(10).
    \275\ See final rule Sec.  __.3(b)(4).
    \276\ See 12 U.S.C. 1851(h)(6).
    \277\ See, e.g., BPI and FSF.
---------------------------------------------------------------------------

    Consistent with feedback from several commenters,\278\ the
exclusion in the final rule does not require banking entities to
transfer erroneously purchased (or sold) financial instruments to a
separately managed trade error account for disposition. The agencies
agree that this requirement could have resulted in duplicative
resolution systems and imposed undue regulatory costs, which are not
appropriate in light of the narrow class of bona fide trading errors
that fall within the exclusion. As with all exclusions and permitted
trading activities, the agencies intend to monitor use of this
exclusion for evasion. For example, the magnitude or frequency of
errors could indicate that the trading activity is inconsistent with
this exclusion.
---------------------------------------------------------------------------

    \278\ See, e.g., ABA; Credit Suisse; FSF; JBA; and SIFMA.
---------------------------------------------------------------------------

    The agencies have considered comments suggesting that the agencies
should impose on banking entities certain reporting, auditing, and
testing requirements specifically related to trade error
transactions.\279\ As noted above, the agencies believe mandating
requirements such as these could lead to undue costs for banking
entities, which are not appropriate in light of the narrow class of
bona fide trading errors that fall within the exclusion. Such bona fide
trade errors and subsequent correcting transactions do not fall within
the statutory definition of ``proprietary trading'' because they lack
the requisite short-term intent. Accordingly, the agencies do not find
it necessary to impose additional requirements with respect to such
activities. Further, the agencies do not agree that any profits
resulting from trade error transactions should be remitted to the U.S.
Treasury.
---------------------------------------------------------------------------

    \279\ See Better Markets.
---------------------------------------------------------------------------

iii. Matched Derivative Transactions
    The proposal requested comment on the treatment of loan-related
swaps between a banking entity and customers that have received loans
from the banking entity.\280\ The proposal explained that, in a loan-
related swap transaction, a banking entity enters into a swap with a
customer in connection with the customer's loan and contemporaneously
offsets the swap with a third party. The swap with the customer is
directly related to the terms of the customer's loan.\281\ In one
typical type of loan-related swap, a banking entity seeks to make a
floating-rate loan to a customer that could have the benefit to the
banking entity of reducing the banking entity's interest rate risk, but
the customer would prefer to have the economics of a fixed-rate
loan.\282\ To achieve a result that addresses these divergent
preferences, the banking entity makes a floating-rate loan to the
customer and contemporaneously or nearly contemporaneously enters into
a floating rate to fixed rate interest rate swap with the same customer
and an offsetting swap with another counterparty.\283\ As a result, the
customer receives economic treatment similar to a fixed-rate loan.\284\
The banking entity has entered into the preferred floating rate loan,
provided the customer with the customer's preferred fixed rate
economics though the interest rate swap with the customer and offset
its market risk exposure from the customer-facing interest rate swap
through a swap with another counterparty.\285\
---------------------------------------------------------------------------

    \280\ See 83 FR at 33462-64.
    \281\ See id. at 33462.
    \282\ Id.
    \283\ Id.
    \284\ Id.
    \285\ Id. In this example, the banking entity retains the
counterparty risk from both swaps. However, depending on the type of
swap and the particular transaction, the banking entity may be able
to manage the counterparty risk, for example, by clearing the
transaction at a clearing agency or derivatives clearing
organization acting as a central counterparty, as applicable.
---------------------------------------------------------------------------

    Loan-related swaps have presented a compliance challenge
particularly for smaller non-dealer banking entities.\286\ These
banking entities may enter into loan-related swaps infrequently, and
the decision to do so tends to be situational and dependent on changes
in market conditions as well as on the interaction of a number of
factors specific to the banking entity, such as the nature of the
customer relationship.\287\
---------------------------------------------------------------------------

    \286\ Id.
    \287\ Id. at 33463.
---------------------------------------------------------------------------

    The proposal sought comment on whether loan-related swaps should be
excluded from the definition of proprietary trading, exempted from the
prohibition on proprietary trading, or permitted under the exemption
for market making-related activities.\288\ The proposal also asked
whether other types of swaps, such as end-user customer-driven swaps
that are used by a customer to hedge commercial risk should be treated
the same way as loan-related swaps.\289\ The proposal also requested
comment as to whether it is appropriate to permit loan-related swaps to
be conducted pursuant to the exemption for market making-related
activities where the frequency with which a banking entity executes
such swaps is minimal but the banking entity remains prepared to
execute such swaps when a customer makes an appropriate request.\290\
---------------------------------------------------------------------------

    \288\ Id.
    \289\ Id. at 33464.
    \290\ Id. at 33463.
---------------------------------------------------------------------------

    Most commenters supported allowing loan-related swaps, either by
adopting an exclusion from the definition of proprietary trading,\291\
creating a new exemption for loan-related swaps,\292\ or clarifying
that banking entities could enter into loan-related swaps under
existing exemptions.\293\ The majority of these commenters supported
explicitly excluding loan-related swaps from the definition of
proprietary trading.\294\ These commenters noted that loan-related swap
transactions generally do not fall within the statutory definition of
trading account and that these

[[Page 61994]]

transactions are important risk-mitigating activities.\295\ Commenters
stated that providing an exclusion or permitted activity exemption for
loan-related swaps would prevent section 13 of the BHC Act from having
an unintended chilling effect on an important and prudent lending-
related activity.\296\ Commenters also stated that these types of swap
transactions are important tools that facilitate bank customers'
ability to manage their risks.\297\ One commenter opposed providing an
exclusion for loan-related swaps, arguing that these activities instead
should be conducted under the risk-mitigating hedging exemption.\298\
---------------------------------------------------------------------------

    \291\ See, e.g., BOK; ABA; Covington & Burling LLP (Covington);
JBA; Chatham; Credit Suisse; BPI; SIFMA; IIB, Covington; Arvest;
IIB; KeyCorp; and Capital One et al.
    \292\ See, e.g., Covington and BPI.
    \293\ See, e.g., Covington; BPI; SIFMA; Credit Suisse; and BB&T.
    \294\ See, e.g., BOK; ABA; Covington; JBA; Chatham; Credit
Suisse; BPI; SIFMA; IIB, Covington; Arvest; IIB; KeyCorp; and
Capital One et al.
    \295\ See, e.g., BOK; ABA; Covington; JBA; Chatham; Arvest; and
IIB.
    \296\ See, e.g., Covington and Credit Suisse.
    \297\ See, e.g., Arvest and BOK.
    \298\ See Data Boiler.
---------------------------------------------------------------------------

    Two commenters requested that the agencies adopt a permitted
activity exemption for loan-related swaps or revise the existing
exemption for market making-related activities if the agencies do not
explicitly exclude loan-related swaps from the definition of
proprietary trading.\299\ In addition, two commenters suggested that
the exemption for riskless principal transactions in Sec.  __.6(c)(2)
of the 2013 rule could cover loan-related swaps.\300\ These commenters
and two others suggested that excluding loan-related swaps from the
definition of proprietary trading would be more effective than adopting
a new permitted activity exemption or relying on an existing permitted
activity exemption.\301\
---------------------------------------------------------------------------

    \299\ See, e.g., Covington and BPI.
    \300\ See, e.g., SIFMA and Credit Suisse.
    \301\ See, e.g., Covington; BPI; SIFMA; and Credit Suisse.
---------------------------------------------------------------------------

    Two commenters argued that banking entities should be allowed to
engage in loan-related swaps using the exemption for market making-
related activities.\302\ Several other commenters asserted that the
market-making exemption is a poor fit for loan-related swaps and that
the market-making exemption's requirements were unduly burdensome with
respect to this activity, particularly for smaller banking
entities.\303\
---------------------------------------------------------------------------

    \302\ See, e.g., BB&T and Credit Suisse (Credit Suisse noted,
however, that an exclusion would be preferable to using the market-
making exemption).
    \303\ See, e.g., IIB; Covington; SIFMA; Capital One et al.; BPI;
and B&F.
---------------------------------------------------------------------------

    Several commenters supported excluding additional derivatives
activities from the definition of proprietary trading, such as
customer-driven matched-book trades that enable customers to hedge
commercial risk regardless of whether the swaps are related to a
loan.\304\ Commenters noted that such customer-driven matched-book
trades do not expose banking entities to risk other than counterparty
credit risk.\305\ Moreover, these trades reduce risks to the bank's
customer and thus also reduce the risk of the banking entity's loans to
that customer.\306\
---------------------------------------------------------------------------

    \304\ See, e.g., BOK; JBA; ABA; Capital One et al.; and KeyCorp.
    \305\ See, e.g., BOK and ABA.
    \306\ See, e.g., BOK.
---------------------------------------------------------------------------

    Three commenters requested that the exclusion be expanded to cover
instances where a banking entity enters into a loan-related swap with a
customer but does not offset that swap with a third party.\307\
---------------------------------------------------------------------------

    \307\ See, e.g., ABA; Arvest; and IIB.
---------------------------------------------------------------------------

    One commenter urged the agencies to adopt a definition of loan-
related swaps that is substantially similar to the definition adopted
by the CFTC for swaps executed in connection with originating loans to
customers, and to include in the definition, the derivatives
transaction entered into with a dealer to offset the risk of the
customer-facing swap.\308\ Another commenter opposed using the CFTC's
definition, noting that the CFTC's definition would not address
commodity-based matched-book derivative transactions.\309\ One
commenter recommended defining ``customer-facing loan-related swap'' to
mean any swap with a customer or affiliate thereof in which the rate,
asset, liability, or other notional item underlying the swap with the
customer or affiliate thereof is, or is directly related to, a
financial term of a loan or other credit facility with the customer or
affiliate thereof (including, without limitation, the loan or other
credit facility's duration, rate of interest, currency or currencies,
or principal amount).\310\ The same commenter stated that the exclusion
should not include a timing requirement with respect to the offsetting
swap or, if a timing condition is included, the banking entity should
be required to enter into the offsetting swap ``contemporaneously or
substantially contemporaneously'' with the customer-facing loan-related
swap.\311\
---------------------------------------------------------------------------

    \308\ See Chatham.
    \309\ See BOK.
    \310\ See Covington.
    \311\ See id.
---------------------------------------------------------------------------

    After considering the comments received, the agencies are excluding
from the definition of ``proprietary trading'' entering into a
customer-driven swap or a customer-driven security-based swap and a
matched swap or security-based swap if: (i) The transactions are
entered into contemporaneously; (ii) the banking entity retains no more
than minimal price risk; \312\ and (iii) the banking entity is not a
registered dealer, swap dealer, or security-based swap dealer.\313\ The
agencies are adopting this exclusion to provide greater certainty for
non-dealer banking entities that engage in these customer-driven
matched-book swap transactions.
---------------------------------------------------------------------------

    \312\ Price risk is the risk of loss on a fair-value position
that could result from movements in market prices.
    \313\ Final rule Sec.  __.3(d)(11).
---------------------------------------------------------------------------

    Under the 2013 rule, these customer-driven matched swap
transactions could trigger the short-term intent prong's rebuttable
presumption and thus would be presumptively within the trading account.
Although the agencies are eliminating the 2013 rule's rebuttable
presumption,\314\ the agencies believe that it is nevertheless useful
and appropriate to clarify in the final rule that these customer-driven
matched swap transactions are not proprietary trading because banking
entities do not enter into these transactions 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).\315\ For
this reason, the agencies are providing an exclusion for these
activities from the proprietary trading definition rather than
requiring them to be conducted pursuant to the risk-mitigating hedging
exemption, as one commenter suggested.
---------------------------------------------------------------------------

    \314\ See final rule Sec.  __.3(b)(4).
    \315\ See 12 U.S.C. 1851(h)(6).
---------------------------------------------------------------------------

    The agencies believe that adopting this exclusion will reduce costs
for non-dealer banking entities and avoid disrupting a common and
traditional banking service provided to small and medium-sized
businesses. This exclusion will provide a greater degree of certainty
that these customer-driven matched swap transactions are outside the
scope of the final rule.
    Consistent with feedback received from commenters,\316\ the
exclusion in the final rule is not limited to loan-related swaps.\317\
Thus, the exclusion in the final rule could apply to a swap with a
customer in connection with the

[[Page 61995]]

customer's end-user activity (provided that all the terms of the
exclusion are met). For example, a corn farmer is a customer of a non-
dealer banking entity. To manage its risk with respect to the price of
corn, the corn farmer enters into a swap on corn prices with the
banking entity. The banking entity contemporaneously enters into a
corn-price swap with another counterparty to offset the price risk of
the swap with the corn farmer. The swap with the corn farmer and the
offsetting swap with the counterparty have matching terms such that the
banking entity retains no more than minimal price risk. The agencies
have determined that it is appropriate to exclude these types of
transactions from the definition of proprietary trading because, like
matched loan-related swaps discussed above, banking entities do not
enter into these customer-driven transactions 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).\318\
---------------------------------------------------------------------------

    \316\ See, e.g., BOK; JBA; ABA; Capital One et al.; and KeyCorp.
    \317\ As a result, the agencies are not adopting a definition of
``loan-related swap'' substantially similar to the definition
adopted by the CFTC for swaps executed in connection with
originating loans to customers, as requested by one customer. See
Chatham. The agencies also note that this exclusion does not impact
the ``insured depository institution swaps in connection with
originating loans to customers'' provisions in the CFTC's definition
of ``swap dealer.'' See 17 CFR 1.3, Swap dealer, paragraphs
(4)(i)(C) and (5). Additionally, this exclusion does not affect any
other aspects of the ``swap dealer'' definition in CFTC regulations,
or how that term is interpreted by the CFTC.
    \318\ See 12 U.S.C. 1851(h)(6).
---------------------------------------------------------------------------

    Several conditions must be met for the exclusion to apply.\319\ The
exclusion applies only to banking entities that are not registered
dealers, swap dealers, or security-based swap dealers. This approach is
consistent with feedback from commenters noting that primarily smaller
banking entities have faced compliance challenges with respect to
customer-driven swaps activities.\320\ Banking entities that are
registered dealers, swap dealers, or security-based swap dealers
generally engage in these activities on a more regular basis and
therefore have been able to conduct their derivatives activities
pursuant to the exemption for market making-related activities.
Although some commenters argued that the exemption for market making-
related activities is too burdensome to apply to this type of
activity,\321\ the agencies note that the final rule streamlines
certain requirements of that exemption.\322\
---------------------------------------------------------------------------

    \319\ If a transaction does not satisfy all of the conditions of
the exclusion but is not within the definition of trading account,
the transaction would not constitute proprietary trading.
    \320\ See, e.g., Chatham; ABA; and Covington.
    \321\ See, e.g., IIB; Covington; SIFMA; Capital One et al.; BPI;
and B&F.
    \322\ See final rule Sec.  __.4(b).
---------------------------------------------------------------------------

    The exclusion only applies to transactions where one of the two
matched swaps or security-based swaps is customer-driven, in that the
transaction is entered into for a customer's valid and independent
business purposes. In addition, the hedging swap or hedging security-
based swap must match the customer-driven swap or customer-driven
security-based swap. The banking entity may retain no more than minimal
price risk between the two swaps or security-based swaps.\323\ Finally,
the banking entity must enter into the customer-driven swap or customer
driven security-based swap contemporaneously with the matching swap or
matching security-based swap.\324\ These conditions carve out from the
exclusion activities whose principal purpose is resale in the near
term.\325\ For example, if a banking entity entered into a hedging swap
whose economic terms did not match the terms of the customer-driven
swap, the banking entity would be exposed to price risk and could be
speculating on short-term price movements. Similarly, if a banking
entity waited multiple days between entering into a customer-driven
swap and entering into the offsetting swap, the banking entity could be
speculating on short-term price movements during the unhedged period of
the swap transaction. In either case, the banking entity could be
engaged in proprietary trading.\326\ The requirements in the final
rule's exclusion are intended to limit the exclusion to activities that
the agencies have determined lack the requisite short-term trading
intent.
---------------------------------------------------------------------------

    \323\ The banking entity would retain minimal price risk if the
economic terms of the two swaps (e.g., index, amount, maturity, and
underlying reference asset or index) match.
    \324\ The exclusion only applies to transactions where the
customer-driven swap or customer-driven security-based swap is
offset by a matching swap or security-based swap on a one-for-one
basis. The exclusion does not apply to portfolio-hedged derivatives
transactions.
    \325\ See 12 U.S.C. 1851(h)(6).
    \326\ Whether the banking entity is actually engaged in
impermissible proprietary trading would depend on the facts and
circumstances of the particular transaction.
---------------------------------------------------------------------------

    The agencies have considered the comments requesting an exclusion
for unmatched loan-related swaps and determined that such an exclusion
is not necessary in the final rule.\327\ For example, if a bank
provides a loan to a customer and enters into a swap with the customer
related directly to the terms of that loan but does not offset that
customer-driven swap with a third-party, the exclusion does not apply.
Although the exclusion may not apply, the agencies believe that this
type of activity is unlikely to be within the trading account under the
final rule, particularly because the agencies are not adopting the
proposed accounting prong. Entering into such a loan-related swap would
be proprietary trading only if the purchase or sale of the swap is
principally for short term trading purposes or is otherwise within the
definition of trading account.\328\
---------------------------------------------------------------------------

    \327\ See ABA and Arvest.
    \328\ See final rule Sec.  __.3(b).
---------------------------------------------------------------------------

iv. Hedges of Mortgage Servicing Rights or Assets
    The final rule excludes from the definition of proprietary trading
any purchase or sale of one or more financial instruments that the
banking entity uses to hedge mortgage servicing rights or mortgage
servicing assets in accordance with a documented hedging strategy. The
agencies are adopting this exclusion to clarify the scope of the
prohibition on proprietary trading and to provide parity between
banking entities that are subject to the market risk capital prong and
banking entities that are subject to the short-term intent prong.
    Section 13 of the BHC Act defines ``trading account'' to mean ``any
account used for acquiring or taking positions in . . . securities and
instruments . . . principally for the purpose of selling in the near
term (or otherwise with the intent to resell in order to profit from
short-term price movements),'' and any such other accounts that the
agencies determine by rule. The purchase or sale of a financial
instrument as part of a bona fide mortgage servicing rights or mortgage
servicing asset hedging program is not within the statutory definition
of ``trading account'' under the short-term intent prong because the
principal purpose of such a purchase or sale is hedging rather than
short-term resale for profit.
    The agencies have determined to explicitly exclude this type of
hedging activity from the definition of ``proprietary trading'' to
provide greater clarity to banking entities that are subject to the
short-term intent prong in light of changes made elsewhere in the final
rule. Under the final rule, banking entities that are subject to the
market risk capital prong (or that elect to apply the market risk
capital prong) are not subject to the short-term intent prong. The
market risk capital rule explicitly excludes intangibles, including
servicing assets, from the definition of ``covered position.''
Financial instruments used to hedge mortgage servicing rights or assets
generally would not be captured under the market risk capital prong.
Therefore, absent an explicit exclusion, banking entities that are
subject to the market risk capital prong have more certainty than
banking entities that are subject to the short-term intent prong that
the purchase or sale of a financial instrument to hedge mortgage
servicing rights or mortgage servicing assets is not proprietary

[[Page 61996]]

trading. The agencies are explicitly excluding mortgage servicing
rights and mortgage servicing asset hedging activity to provide banking
entities that are not subject to the market risk capital prong (or that
elect to apply the market risk capital prong) the same degree of
certainty. As described in part IV.B.1.a.iii of this Supplementary
Information, the final rule seeks to provide parity between smaller
banking entities that are not subject to the market risk capital rule
and larger banking entities with active trading businesses that are
subject to the market risk capital prong. The agencies believe an
express exclusion for mortgage servicing rights and mortgage servicing
hedging activity is useful in light of the revision to the trading
account definition that applies the short-term intent prong only to
banking entities that are not subject to the market risk capital prong.
    This exclusion applies only to bona fide hedging activities,
conducted in accordance with a documented hedging strategy. This
requirement will assist the agencies in monitoring for evasion or
abuse. In addition, the agencies note that banking entities' mortgage
servicing activities and related hedging activities remain subject to
applicable law and regulation, including the Federal banking agencies'
safety and soundness standards.
v. Financial Instruments That Are Not Trading Assets or Trading
Liabilities
    The final rule excludes from the trading account any purchase or
sale of a financial instrument that does not meet the definition of
``trading asset'' or ``trading liability'' under the banking entity's
applicable reporting form. As with the exclusion for hedges of mortgage
servicing rights or assets, the agencies are adopting this exclusion to
clarify the scope of the prohibition on proprietary trading and to
provide parity between banking entities that are subject to the market
risk capital prong (or that elect to apply the market risk capital
prong) and banking entities that are subject to the short-term intent
prong.
    The agencies have determined to exclude the purchase or sale of
assets that would not meet the definition of trading asset or trading
liability from the definition of ``proprietary trading'' to provide
greater clarity to banking entities that are subject to the short-term
intent prong. As described above, under the final rule, banking
entities that are subject to the market risk capital prong (or that
elect to apply the market risk capital prong) are not subject to the
short-term intent prong.\329\ Under the market risk capital prong, a
purchase or sale of a financial instrument is within the trading
account if it would be both a covered position and trading position
under the market risk capital rule. In general, a position is a covered
position under the market risk capital prong if it is a trading asset
or trading liability (whether on- or off-balance sheet).\330\ Thus, the
exclusion for financial instruments that are not ``trading assets and
liabilities'' extends the same certainty to banking entities subject to
the short-term intent prong as is provided by operation of the market
risk capital prong.
---------------------------------------------------------------------------

    \329\ See final rule Sec.  __.3(b).
    \330\ See 12 CFR 3.202(b); 12 CFR 217.202(b); 12 CFR 324.202(b).
In addition, the market risk capital rule's ``covered position''
definition expressly includes and excludes additional classes of
instruments.
---------------------------------------------------------------------------

    One commenter recommended that the agencies modify the short-term
intent prong to include only financial instruments that meet the
definition of trading assets and liabilities and that are held for the
purpose of short-term trading.\331\ The agencies have determined that
including only financial instruments that meet the definition of
trading assets and liabilities (by excluding instruments that do not
meet this definition) is appropriate because the trading asset and
liability definitions used for regulatory reporting purposes
incorporate substantially the same short-term trading standard as the
short-term intent prong and section 13 of the BHC Act. The Call Report
and FR Y-9C provide that trading activities typically include, among
other activities, acquiring or taking positions in financial
instruments ``principally for the purpose of selling in the near term
or otherwise with the intent to resell in order to profit from short-
term price movements.'' \332\ This language is substantially identical
to the statutory definition of trading account, which applies to any
account used for acquiring or taking positions in financial instruments
``principally for the purpose of selling in the near term (or otherwise
with the intent to resell in order to profit from short-term price
movements) . . . .'' \333\ Therefore, excluding any purchase or sale of
a financial instrument that would not be classified as a trading asset
or trading liability on these applicable reporting forms is consistent
with the statutory definition of trading account in section 13 of the
BHC Act. This exclusion is expected to provide additional clarity to
banking entities subject to the short-term intent prong, while also
better aligning the compliance program requirements with the scope of
activities subject to section 13 of the BHC Act.
---------------------------------------------------------------------------

    \331\ See SIFMA.
    \332\ See, e.g., Instructions for Preparation of Consolidated
Reports of Condition and Income, FFIEC 031 and FFIEC 041, Schedule
RC-D; Instructions for Preparation of Consolidated Financial
Statements for Holding Companies, Reporting Form FR Y-9C, Schedule
HC-D.
    \333\ 12 U.S.C. 1851(h)(6).
---------------------------------------------------------------------------

    This exclusion applies to any purchase or sale of a financial
instrument that does not meet the definition of ``trading asset'' or
``trading liability'' under the applicable reporting form as of the
effective date of this final rule. The final rule references the
reporting forms in effect as of the final rule's effective date to
ensure the scope of the exclusion remains consistent with the statutory
trading account definition. Because the reporting forms are used for
many purposes and are generally based on generally accepted accounting
principles, future revisions to the reporting forms could define
``trading asset'' and ``trading liability'' inconsistently with the
``trading account'' definition in section 13 of the BHC Act. Further,
tying the exclusion to the reporting forms currently in effect will
provide greater certainty to banking entities. If the scope of the
exclusion were subject to change based on revisions to the applicable
reporting forms, it could require banking entities to make
corresponding changes to compliance systems to remain in compliance
with the rule, which could result in disruption both for banking
entities and the agencies. Accordingly, the final rule excludes any
purchase or sale of a financial instrument that does not meet the
definition of trading asset or trading liability under the applicable
reporting form as of the effective date of the final rule.
c. Trading Desk
    The 2013 rule applies certain requirements at the ``trading desk''-
level of organization.\334\ The 2013 rule defined ``trading desk'' to
mean the smallest discrete unit of organization of a banking entity
that purchases or sells financial instruments for the trading account
of the banking entity or an affiliate thereof.\335\
---------------------------------------------------------------------------

    \334\ See 2013 rule Sec. Sec.  __.4, __.5, App. A., App. B;
final rule Sec. Sec.  __.4, __.5, App. A.
    \335\ 2013 rule Sec.  __.3(e)(13).
---------------------------------------------------------------------------

    As noted in the proposal, some banking entities had indicated that,
in practice, the 2013 rule's definition of trading account had led to
uncertainty regarding the meaning of ``smallest discrete unit.'' \336\
In addition, banking

[[Page 61997]]

entities had communicated that this definition has caused confusion and
duplicative compliance and reporting efforts for banking entities that
also define trading desks for purposes unrelated to the 2013 rule,
including for internal risk management and reporting and calculating
regulatory capital requirements.\337\ In response to these concerns,
the proposal included a detailed request for comment on whether to
revise the trading desk definition to align with the trading desk
concept used for other purposes.\338\ Specifically, the proposal
requested comment on using a multi-factor trading desk definition based
on the same criteria typically used to establish trading desks for
other operational, management, and compliance purposes.\339\
---------------------------------------------------------------------------

    \336\ See 83 FR at 33453.
    \337\ See id.
    \338\ See id.
    \339\ See id.
---------------------------------------------------------------------------

    Commenters that addressed the definition of ``trading desk''
generally supported revising the definition along the lines
contemplated in the proposal.\340\ Commenters asserted that the 2013
rule's ``smallest discrete unit language'' was subjective, ambiguous,
and had been interpreted in different ways.\341\ Commenters said that
adopting a multi-factor definition would be preferable to the 2013
rule's definition because a multi-factor definition would align the
definition of trading desk with other operational and managerial
structures, whereas the 2013 rule's definition could be interpreted to
require banking entities to designate certain units of organization as
trading desks purely for purposes of the regulations implementing
section 13 of the BHC Act.\342\ One commenter supported the multi-
factor definition in the proposal but recommended that the agencies
should be required to approve the initial trading desk designations and
any changes in trading desk designations.\343\ One commenter said the
agencies should allow the unit of the trading desk to be determined at
the discretion of each financial institution \344\ and another said it
is not necessary to introduce complexity into how banking entities
organize their internal operations.\345\
---------------------------------------------------------------------------

    \340\ See, e.g., ABA; ISDA 1; CCMC; SIFMA 2; Goldman Sachs; FSF;
JBA; and AFR.
    \341\ See, e.g., ABA and CCMC.
    \342\ See, e.g., ABA; ISDA 1; CCMC; SIFMA 2; Goldman Sachs; FSF;
and JBA.
    \343\ See AFR.
    \344\ See JBA.
    \345\ See CCMC.
---------------------------------------------------------------------------

    The final rule adopts a multi-factor definition that is
substantially similar to the definition included in the request for
comment in the proposal, except that the first prong has been revised
and the reference to incentive compensation has been removed. This
multi-factor definition will align the criteria used to define trading
desk for purposes of the regulations implementing section 13 of the BHC
Act with the criteria used to establish trading desks for other
operational, management, and compliance purposes.
    The definition of trading desk includes a new second prong that
explicitly aligns the definition with the market risk capital
rule.\346\ The final rule provides that, for a banking entity that
calculates risk-based capital ratios under the market risk capital
rule, or a consolidated affiliate of a banking entity that calculates
risk-based ratios under market risk capital rule, ``trading desk''
means a unit of organization that purchases or sells financial
instruments for the trading account of the banking entity or an
affiliate thereof that is established by the banking entity or its
affiliate for purposes of capital requirements under the market risk
capital rule.\347\ This change specifies that, for a banking entity
that is subject to the market risk capital prong, the trading desk
established for purposes of the market risk capital rule must be the
same unit of organization that is established as a trading desk under
the regulations implementing section 13 of the BHC Act. This prong of
the trading desk definition is expected to simplify the supervisory
activities of the Federal banking agencies that also oversee compliance
with the market risk capital rule because the same unit of organization
can be assessed for purposes of both the market risk capital rule and
section 13 of the BHC Act, which will reduce complexity and cost for
banking entities, and improve the effectiveness of the final rule.
Together with providing firms with the flexibility to leverage existing
or planned compliance programs in order to satisfy the elements of
Sec.  __.20 as appropriate, the agencies expect aligning the definition
of trading desk will minimize compliance burden on banking entities
subject to both rules.
---------------------------------------------------------------------------

    \346\ Currently, the market risk capital rule does not include a
definition of ``trading desk.'' However, the federal banking
agencies expect to implement the Basel Committee's revised market
risk capital standards, which do. See Basel Committee on Banking
Supervision, ``Minimum Capital Requirements for Market Risk,'' MAR12
(Feb. 2019). The federal banking agencies expect their revised
market risk capital rule will include a definition of ``trading
desk'' that is consistent with the trading desk concept described in
the ``Minimum Capital Requirements for Market Risk,'' and the
multifactor approach in this final rule.
    \347\ See final rule Sec.  __.3(e)(13)(ii).
---------------------------------------------------------------------------

    To further align the final rule's trading desk concept with the
market risk capital rule, the final rule provides that a trading desk
must be ``structured by the banking entity to implement a well-defined
business strategy.'' \348\ This further aligns the trading desk
definition with the definition of ``trading desk'' in the Basel
Committee's minimum capital requirements for market risk.\349\ This
change will ensure that banking entities that are subject to the market
risk capital prong and banking entities that are not subject to the
market risk capital prong have comparable trading desk definitions. In
general, a well-defined business strategy typically includes a written
description of a desk's objectives, including the economics behind its
trading and hedging strategies, as well as the instruments and
activities the desk will use to accomplish its objectives. A desk's
well-defined business strategy may also include an annual budget and
staffing plan and management reports.
---------------------------------------------------------------------------

    \348\ Final rule Sec.  __.3(e)(13)(i)(A).
    \349\ See Basel Committee on Banking Supervision, Minimum
Capital Requirements for Market Risk (Feb. 2019).
---------------------------------------------------------------------------

    Like the proposal, the final rule states that a trading desk is
organized to ensure appropriate setting, monitoring, and management
review of the desk's trading and hedging limits, current and potential
future loss exposures, and strategies. The final rule also states that
a trading desk is characterized by a clearly-defined unit that: (i)
Engages in coordinated trading activity with a unified approach to its
key elements; (ii) operates subject to a common and calibrated set of
risk metrics, risk levels, and joint trading limits; (iii) submits
compliance reports and other information as a unit for monitoring by
management; and (iv) books its trades together. The agencies consider a
unit to be ``clearly-defined'' if it meets these four factors.
    The proposal included a multi-factor definition of trading desk
that referenced incentive compensation as one defining factor. However,
the banking agencies do not incorporate incentive compensation in
regulatory capital rules generally, and therefore omitting this
criterion would better align the trading desk definition between the
market risk capital rule and the Volcker Rule. Thus, the final rule
does not incorporate any reference to incentive compensation.\350\
---------------------------------------------------------------------------

    \350\ Compare 83 FR at 33453 with final rule Sec. 
__.3(e)(13)(i)(B).
---------------------------------------------------------------------------

    The final rule does not require the agencies to approve banking
entities'

[[Page 61998]]

initial trading desk designations and any changes in trading desk
designations, as one commenter had recommended.\351\ The agencies
believe such an approval process is unnecessary for purposes of the
final rule because the agencies intend to continue assessing banking
entities' trading desk designations as part of the agencies' ongoing
supervision of banking entities' compliance with the final rule as well
as other safety and soundness regulations, as applicable. At the same
time, the final rule does not allow the trading desk to be set
completely at the discretion of the banking entity, as one commenter
suggested.\352\ The adopted definition will provide flexibility to
allow banking entities to define their trading desks based on the same
criteria typically used for other operational, management, and
compliance purposes but would not be so broad as to hinder the
agencies' or banking entities' ability to detect prohibited proprietary
trading.
---------------------------------------------------------------------------

    \351\ See AFR.
    \352\ See JBA.
---------------------------------------------------------------------------

d. Reservation of Authority
    The proposal included a reservation of authority that would have
permitted an agency to determine, on a case-by-case basis, that any
purchase or sale of one or more financial instruments by a banking
entity for which it is the primary financial regulatory agency either
is or is not for the trading account as defined in section 13(h)(6) of
the BHC Act.\353\ The preamble requested comment on whether such a
reservation of authority would be necessary in connection with the
proposed trading account definition, which would have focused on
objective factors to define proprietary trading. The agencies explained
that this approach may have produced results that were over- or under-
inclusive with respect to the statutory trading account definition. The
agencies further explained that the reservation of authority could
provide appropriate balance by recognizing the subjective elements of
the statute in light of the bright-line approach of the proposed
accounting prong.
---------------------------------------------------------------------------

    \353\ See 83 FR at 33454.
---------------------------------------------------------------------------

    Two commenters supported adopting the reservation of
authority.\354\ Both of these commenters noted the importance of
coordination and consistent application of the reservation of
authority, particularly in instances where the primary financial
regulatory agency may vary by legal entity within a firm.\355\ One of
these commenters suggested that the agencies keep such authority in
reserve for use solely in those circumstances wherein poor management
is putting an institution at risk of failure.\356\
---------------------------------------------------------------------------

    \354\ See, e.g., BB&T and CFA.
    \355\ Id.
    \356\ See CFA.
---------------------------------------------------------------------------

    The final rule does not include the proposed reservation of
authority.\357\ The revised trading account definition in the final
rule retains a short-term intent standard that largely tracks the
statutory standard.\358\ Because the final trading account definition
does not include the proposed accounting prong and is aligned with the
statutory standard, the agencies do not find it necessary to retain a
reservation of authority.
---------------------------------------------------------------------------

    \357\ See proposed rule Sec.  __.3(g).
    \358\ Although banking entities that are subject to the market
risk capital prong are not subject to the short-term intent prong,
the market risk capital prong incorporates a substantially similar
short-term intent standard. As described above, the market risk
capital rule's definition of trading position largely parallels the
statutory definition of trading account, which in turn mirrors the
language in the short-term intent prong.
---------------------------------------------------------------------------

2. Section __.4: Permitted Underwriting and Market Making Related
Activities
a. Current Exemptions for Underwriting and Market Making--Related
Activities \359\
---------------------------------------------------------------------------

    \359\ In contrast to the proposal, the discussions of the
exemptions for underwriting and market making-related activity have
been combined in order to avoid any unnecessary redundancy as well
as any confusion that could arise to the extent there are
differences in the way that otherwise identical provisions of those
exemptions operate. However, the two exemptions remain separate and
distinct. Banking entities seeking to rely on one or both exemptions
are required to comply with the requirements and legal standards
contained in each applicable exemption, and will continue to be
required to do so following adoption of the final rule.
---------------------------------------------------------------------------

    Section 13(d)(1)(B) of the BHC Act contains an exemption from the
prohibition on proprietary trading for the purchase, sale, acquisition,
or disposition of securities, derivatives, contracts of sale of a
commodity for future delivery, and options on any of the foregoing in
connection with underwriting or 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 (RENTD).\360\ As the agencies noted when they adopted
the 2013 rule, client-oriented financial services, which include
underwriting, market making, and asset management services, are
important to the U.S. financial markets and the participants in those
markets.\361\
---------------------------------------------------------------------------

    \360\ 12 U.S.C. 1851(d)(1)(B).
    \361\ See 79 FR at 5615.
---------------------------------------------------------------------------

    In particular, underwriters play a key role in facilitating
issuers' access to funding, and are accordingly important to the
capital formation process and to economic growth.\362\ For example,
underwriters can help reduce issuers' costs of capital by mitigating
potential information asymmetries between issuers and their potential
investors.\363\ Similarly, market makers operate to help ensure that
securities, commodities, and derivatives markets in the United States
remain well-functioning by, among other things, providing important
intermediation and liquidity.\364\ At the same time, however, the
agencies also recognized that 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.\365\
---------------------------------------------------------------------------

    \362\ See 79 FR at 5561 (internal footnotes omitted).
    \363\ Id.
    \364\ See 79 FR at 5576.
    \365\ See 79 FR at 5541.
---------------------------------------------------------------------------

    Accordingly, the 2013 rule follows a comprehensive, multi-faceted
approach to implementing the statutory exemptions for underwriting and
market making-related activities. Specifically, section __.4(a) of the
2013 rule implements the statutory exemption for underwriting and sets
forth the requirements that banking entities must meet in order to rely
on the exemption. Among other things, the 2013 rule requires that:
     The banking entity act as an ``underwriter'' for a
``distribution'' of securities and the trading desk's underwriting
position be related to such distribution;
     The amount and types of securities in the trading desk's
underwriting position be designed not to exceed RENTD, and reasonable
efforts be made to sell or otherwise reduce the underwriting position
within a reasonable period, taking into account the liquidity,
maturity, and depth of the market for the relevant type of security;
     The banking entity has established and implements,
maintains, and enforces an internal compliance program that is
reasonably designed to ensure the banking entity's compliance with the
requirements of the underwriting exemption, including reasonably
designed written policies and procedures, internal controls, analysis,
and independent testing identifying and addressing:
    [cir] The products, instruments, or exposures each trading desk may
purchase, sell, or manage as part of its underwriting activities;
    [cir] Limits for each trading desk, based on the nature and amount
of the trading

[[Page 61999]]

desk's underwriting activities, including RENTD, on the (1) amount,
types, and risk of the trading desk's underwriting position, (2) level
of exposures to relevant risk factors arising from the trading desk's
underwriting position, and (3) period of time a security may be held;
    [cir] Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits; and
    [cir] Authorization procedures, including escalation procedures
that require review and approval of any trade that would exceed a
trading desk's limit(s), demonstrable analysis of the basis for any
temporary or permanent increase to a trading desk's limit(s), and
independent review of such demonstrable analysis and approval;
     The compensation arrangements of persons performing the
banking entity's underwriting activities are designed not to reward or
incentivize prohibited proprietary trading; and
     The banking entity is licensed or registered to engage in
the activity described in the underwriting exemption in accordance with
applicable law.
    Similarly, section __.4(b) of the 2013 rule implements the
statutory exemption for market making-related activities and sets forth
the requirements that all banking entities must meet in order to rely
on the exemption. Among other things, the 2013 rule requires that:
     The trading desk that establishes and manages the
financial exposure routinely stands ready to purchase and sell one or
more types of financial instruments related to its financial exposure
and is willing and available to quote, purchase and sell, or otherwise
enter into long and short positions in those types of financial
instruments for its own account, in commercially reasonable amounts and
throughout market cycles on a basis appropriate for the liquidity,
maturity, and depth of the market for the relevant types of financial
instruments;
     The amount, types, and risks of the financial instruments
in the trading desk's market-maker inventory are designed not to
exceed, on an ongoing basis, RENTD, as required by the statute and
based on certain factors and analysis specified in the rule;
     The banking entity has established and implements,
maintains, and enforces an internal compliance program that is
reasonably designed to ensure its compliance with the exemption for
market making-related activities, including reasonably designed written
policies and procedures, internal controls, analysis, and independent
testing identifying and assessing certain specified factors; \366\
---------------------------------------------------------------------------

    \366\ See 2013 rule Sec.  __.4(b)(2)(iii).
---------------------------------------------------------------------------

     To the extent that any required limit \367\ established by
the trading desk is exceeded, the trading desk takes action to bring
the trading desk into compliance with the limits as promptly as
possible after the limit is exceeded;
---------------------------------------------------------------------------

    \367\ See 79 FR at 5615.
---------------------------------------------------------------------------

     The compensation arrangements of persons performing market
making-related activities are designed not to reward or incentivize
prohibited proprietary trading; and
     The banking entity is licensed or registered to engage in
market making-related activities in accordance with applicable
law.\368\
---------------------------------------------------------------------------

    \368\ 2013 rule Sec.  __.4(b)(2). This provision was not
intended to expand the scope of licensing or registration
requirements under relevant U.S. or foreign law that are applicable
to a banking entity engaged in market-making activities, but rather
to recognize that compliance with applicable law is an essential
indicator that a banking entity is engaged in market-making
activities. See 79 FR at 5620.
---------------------------------------------------------------------------

    In the several years since the adoption of the 2013 rule, public
commenters have observed that the significant and costly compliance
requirements in the existing exemptions may unnecessarily constrain
underwriting and market making without a corresponding reduction in the
type of trading activities that the rule was designed to prohibit.\369\
As the agencies noted in the proposal, implementation of the 2013 rule
has indicated that the existing approach to give effect to the
statutory standard of RENTD may be overly broad and complex, and also
may inhibit otherwise permissible activity.\370\
---------------------------------------------------------------------------

    \369\ 83 FR at 33435, 33459.
    \370\ 83 FR at 33445-46.
---------------------------------------------------------------------------

    Accordingly, the proposal was intended to tailor, streamline, and
clarify the requirements that a banking entity must satisfy to avail
itself of either exemption for underwriting or market making-related
activities. In particular, the proposal intended to provide a clearer
way to determine if a trading desk's activities satisfy the statutory
requirement that underwriting or market making-related activity, as
applicable, be designed not to exceed RENTD. Specifically, the proposal
would have established a presumption, available to banking entities
both with and without significant trading assets and liabilities, that
trading within internally set limits satisfies the requirement that
permitted activities must be designed not to exceed RENTD.\371\ In
addition, the agencies also proposed to tailor the exemption for
underwriting and market making-related activities' compliance program
requirements to the size, complexity, and type of activity conducted by
the banking entity by making those requirements applicable only to
banking entities with significant trading assets and liabilities.\372\
---------------------------------------------------------------------------

    \371\ Proposed rules Sec.  __.4(a)(8) and Sec.  __.4(b)(6).
    \372\ 83 FR at 33438 and 33459.
---------------------------------------------------------------------------

b. Proposed Presumption of Compliance With the Statutory RENTD
Requirement
    As described above, the statutory exemptions for underwriting and
market making-related activities in section 13(d)(1)(B) of the BHC Act
requires that such activities be designed not to exceed RENTD.\373\
Consistent with the statute, for the purposes of the exemption for
underwriting activities, section __.4(a)(2)(ii) of the 2013 rule
requires that the amount and type of the securities in the trading
desk's underwriting position be designed not to exceed RENTD, and
reasonable efforts are made to sell or otherwise reduce the
underwriting position within a reasonable period, taking into account
the liquidity, maturity, and depth of the market for the relevant type
of security.\374\
---------------------------------------------------------------------------

    \373\ 12 U.S.C. 1851(d)(1)(B).
    \374\ 2013 rule Sec.  __.4(a)(2)(ii).
---------------------------------------------------------------------------

    Similarly, for the purposes of the exemption for market making-
related activities, section __.4(b)(2)(ii) of the 2013 rule requires
that the amount, types, and risks of the financial instruments in the
trading desk's market-maker inventory are designed not to exceed, on an
ongoing basis, RENTD, based on certain factors and analysis.\375\
Specifically, these factors are: (i) The liquidity, maturity, and depth
of the market for the relevant type of financial instrument(s), and
(ii) demonstrable analysis of historical customer demand, current
inventory of financial instruments, and market and other factors
regarding the amount, types, and risks of or associated with positions
in financial instruments in which the trading desk makes a market,
including through block trades.\376\ Under Sec.  __.4(b)(2)(iii)(C) of
the 2013 rule, a banking entity must account for these considerations
when establishing limits for each trading desk.\377\
---------------------------------------------------------------------------

    \375\ 2013 rule Sec.  __.4(b)(2)(ii).
    \376\ Id.
    \377\ 2013 rule Sec.  __.4(b)(2)(iii)(C).
---------------------------------------------------------------------------

    In the proposal, the agencies recognized that the prescriptive
standards for meeting the statutory RENTD requirements in the
exemptions for underwriting and market making-related activities were
complex, costly, and did not provide bright line conditions under which
trading activity

[[Page 62000]]

could be classified as permissible underwriting or market making-
related activity.\378\ Accordingly, the agencies sought comment on a
proposal to implement this key statutory factor--in connection with
both relevant exemptions--in a manner designed to provide banking
entities and the agencies with greater certainty and clarity about what
activity constitutes permissible underwriting or market making-related
activity pursuant to the applicable exemption.\379\
---------------------------------------------------------------------------

    \378\ See 83 FR at 33455, 33459.
    \379\ Id.
---------------------------------------------------------------------------

    Instead of the approach taken in the 2013 rule, the agencies
proposed to establish the articulation and use of internal limits as a
key mechanism for conducting trading activity in accordance with the
rule's exemptions for underwriting and market making-related
activities.\380\ Specifically, the proposal would have provided that
the purchase or sale of a financial instrument by a banking entity
would be presumed to be designed not to exceed RENTD if the banking
entity establishes internal limits for each trading desk, subject to
certain conditions, and implements, maintains, and enforces those
limits, such that the risk of the financial instruments held by the
trading desk does not exceed such limits.\381\ As stated in the
proposal, the agencies believe that this approach would provide banking
entities with more flexibility and certainty in conducting permissible
underwriting and market making-related activities.\382\
---------------------------------------------------------------------------

    \380\ As stated in the proposal, as a consequence of the changes
to focus on limits, many of the requirements of the 2013 rule
relating to limits associated with the exemptions for underwriting
and market making-related activities would be incorporated into this
requirement and modified or removed as appropriate in the proposal.
    \381\ See proposed rule Sec.  __.4(a)(8); proposed rule Sec. 
__.4(b)(6).
    \382\ 83 FR at 33438.
---------------------------------------------------------------------------

    Under the proposal, all banking entities, regardless of their
volume of trading assets and liabilities, would have been able to
voluntarily avail themselves of the presumption of compliance with the
RENTD requirement by establishing and complying with these internal
limits. With respect to the underwriting exemption, the proposal would
have provided that a banking entity would establish internal limits for
each trading desk that are designed not to exceed RENTD, based on the
nature and amount of the trading desk's underwriting activities, on
the:
    (1) Amount, types, and risk of its underwriting position;
    (2) Level of exposures to relevant risk factors arising from its
underwriting position; and
    (3) Period of time a security may be held.\383\
---------------------------------------------------------------------------

    \383\ Proposed rule Sec.  __.4(a)(8)(i).
---------------------------------------------------------------------------

    With respect to the exemption for market making-related activities,
the proposal would have provided that all banking entities, regardless
of their volume of trading assets and liabilities, would be able to
voluntarily avail themselves of the presumption of compliance with the
RENTD requirement by establishing and complying with internal limits.
Specifically, the proposal would have provided that a banking entity
would establish internal limits for each trading desk that are designed
not to exceed RENTD, based on the nature and amount of the trading
desk's market making-related activities, on the:
    (1) Amount, types, and risks of its market-maker positions;
    (2) Amount, types, and risks of the products, instruments, and
exposures the trading desk may use for risk management purposes;
    (3) Level of exposures to relevant risk factors arising from its
financial exposure; and
    (4) Period of time a financial instrument may be held.\384\
---------------------------------------------------------------------------

    \384\ Proposed rule Sec.  __.4(6)(i)(B).
---------------------------------------------------------------------------

    In the case of both exemptions, the proposal provided that banking
entities utilizing the applicable presumption of compliance with the
RENTD requirement would have been required to maintain internal
policies and procedures for setting and reviewing desk-level risk
limits.\385\ The proposed approach would not have required that a
banking entity's limits be based on any specific or mandated analysis,
as required with respect to RENTD analysis under the 2013 rule. Rather,
a banking entity would have established the limits according to its own
internal analyses and processes around conducting its underwriting
activities and market making-related activities in accordance with
section 13(d)(1)(B).\386\ In addition, the proposal would have
required, for both the exemption for underwriting and market making-
related activities, a banking entity to promptly report to the
appropriate agency when a trading desk exceeds or increases its
internal limits.\387\
---------------------------------------------------------------------------

    \385\ See 83 FR at 33456, 33460. Under the proposal, banking
entities with significant trading assets and liabilities would have
continued to be required to establish internal limits for each
trading desk as part of the underwriting compliance program
requirement in Sec.  __.4(a)(2)(iii)(B), the elements of which would
cross-reference directly to the requirement in proposed Sec. 
__.4(a)(8)(i). Similarly, banking entities with significant trading
assets and liabilities would have continued to be required to
establish internal limits for each trading desk as part of the
compliance program requirement for market making-related activity in
Sec.  __.4(b)(2)(iii)(C), the elements of which would cross-
reference directly to the requirement in proposed Sec. 
__.4(b)(6)(i). Banking entities without significant trading assets
and liabilities would have no longer been required to establish a
compliance program that is specific for the purposes of complying
with the either exemption, but would need to establish, implement,
maintain and enforce internal limits if they chose to utilize the
proposed presumption of compliance with respect to the statutory
RENTD requirement in section 13(d)(1)(B) of the BHC Act.
    \386\ See 83 FR at 33456, 34460. In the proposal, the agencies
indicated that they expected that the risk and position limits
metric that is required for certain banking entities under the 2013
rule (and would continue to be required under the Appendix to the
proposal) would help banking entities and the agencies to manage and
monitor the underwriting and market making-related activities of
banking entities subject to the metrics reporting and recordkeeping
requirements of the Appendix.
    \387\ Proposed rule Sec.  __.4(a)(8)(iii); proposed rule Sec. 
__.4(b)(6)(iii).
---------------------------------------------------------------------------

    The proposal also provided that internal limits established by a
banking entity for the presumption of compliance with the statutory
RENTD requirement under both the exemption for underwriting and market
making-related activities would have been subject to review and
oversight by the appropriate agency on an ongoing basis. Any review of
such limits would have assessed whether or not those limits are
established based on the statutory standard--i.e., the trading desk's
RENTD, based on the nature and amount of the trading desk's
underwriting or market making-related activities.\388\
---------------------------------------------------------------------------

    \388\ See 83 FR at 33456.
---------------------------------------------------------------------------

    Finally, under the proposal, the presumption of compliance with the
statutory RENTD requirement for permissible underwriting and market
making-related activities could have been rebutted by the appropriate
agency if the agency determines, based on all relevant facts and
circumstances, that a trading desk is engaging in activity that is not
based on the trading desk's RENTD on an ongoing basis. The agency would
have provided notice of any such determination to the banking entity in
writing.\389\
---------------------------------------------------------------------------

    \389\ See proposed rule Sec.  __.4(a)(8)(iv); proposed rule
Sec.  __.4(b)(6)(iv).
---------------------------------------------------------------------------

    The agencies requested comment on the proposed addition of a
presumption that conducting underwriting or market making-related
activities within internally set limits satisfies the requirement that
permitted such activities be designed not to exceed RENTD.

[[Page 62001]]

c. Commenters' Views
General Approach of a Presumption of Compliance With the Statutory
RENTD Requirement
    As discussed above, the agencies proposed to establish the
articulation and use of internal limits as a key mechanism for
conducting trading activity in accordance with the rule's exemptions
for underwriting and market making-related activities.\390\ A number of
commenters expressed support for the general approach of a presumption
of compliance to satisfy the RENTD standard.\391\ Claiming that the
2013 rule has chilled market making-related activities and is complex
and costly and does not provide bright line conditions under which
trading can clearly be classified as permissible market making-related
activities, one commenter asserted that the general approach would
significantly improve upon the approach of the 2013 rule.\392\
---------------------------------------------------------------------------

    \390\ See proposed rule Sec.  __.4(a)(8); proposed rule Sec. 
__.4(b)(6).
    \391\ See, e.g., Credit Suisse; SIFMA; State Street; Real Estate
Associations; and BOK.
    \392\ See SIFMA.
---------------------------------------------------------------------------

    One commenter supported the proposed approach on the basis that the
presumption would allow banking entities to estimate and manage
inventory limits in a more holistic manner to allow for greater and
more efficient liquidity and pricing for its clients.\393\ That
commenter argued that, in comparison to the 2013 rule, a presumption
will more effectively leverage existing industry practices and
reporting requirements related to managing market-making inventory,
such as maintaining daily VaR metrics by product and position limits
compared to relative levels of client activity.\394\ Another suggested
that because internally set limits are developed and applied by each
banking entity in light of capital requirements and risk management it
would be reasonable to provide a presumption of compliance tied to
internally set limits.\395\ Finally, one commenter said that the
approach would provide a more efficient use of compliance resources and
allow banking entities to tailor compliance requirements to its
specific underwriting and market making-related activities.\396\
---------------------------------------------------------------------------

    \393\ See State Street.
    \394\ Id.
    \395\ See JBA.
    \396\ See ABA.
---------------------------------------------------------------------------

    Several commenters, however, expressed concerns about the creation
of a presumption of compliance to satisfy the statutory RENTD
standard.\397\ For example, commenters argued that the proposed
presumption is not consistent with the statute,\398\ with one commenter
claiming that the statutory requirement was intended to constrain bank
activities, not bank risks.\399\ Commenters expressed concerns that the
proposed presumption of compliance is too deferential to banking
entities \400\ and would reward aggressive banking entities that set
their risk limits too high.\401\ One commenter argued that the limits
would not constrain proprietary trading because the proposed
presumption of compliance with RENTD allows banking entities to raise
their limits and does not distinguish between permissible and
impermissible proprietary trades within risk limits.\402\ Another
commenter disagreed with a presumption of compliance for underwriting
activity, asserting that this approach would undermine well-established
principles of safety and soundness, particularly given what the
commenter referred to as a general lack of scrutiny over bank-developed
risk limits.\403\
---------------------------------------------------------------------------

    \397\ See, e.g., Merkley; AFR; Bean; Better Markets; Center for
American Progress (CAP); Public Citizen; Volcker Alliance; and Data
Boiler.
    \398\ See, e.g., Bean; Better Markets; CAP; and Public Citizen.
    \399\ See AFR.
    \400\ See, e.g., AFR; Bean; CAP; Public Citizen; Volcker
Alliance; and Data Boiler.
    \401\ See, e.g., Bean and Volcker Alliance.
    \402\ See Better Markets.
    \403\ See NAFCU.
---------------------------------------------------------------------------

Required Analysis for Establishing Risk Limits
    As discussed above, the agencies recognized in the proposal that
the prescriptive standards in the 2013 rule for meeting the RENTD
requirements were complex, costly, and did not provide bright line
conditions under which trading can clearly be classified as permissible
proprietary trading.\404\ As a result, the proposal would not have
required that a banking entity's limits be based on any specific or
mandated analysis, as was required under the 2013 rule. Rather, under
the presumption of compliance with the RENTD requirement in the
proposal, a banking entity would have established limits according to
its own internal analyses and processes around conducting its
underwriting and market making-related activities in accordance with
section 13(d)(1)(B) of the BHC Act.\405\ Several commenters provided
their views on this element of the proposal.
---------------------------------------------------------------------------

    \404\ See 83 FR 33459.
    \405\ See 83 FR at 33460. In the proposal, the agencies noted
that they expect that the risk and position limits metric that is
already required for certain banking entities under the 2013 rule
(and would continue to be required under the Appendix to the
proposal) would help banking entities and the agencies to manage and
monitor the market making-related activities of banking entities
subject to the metrics reporting and recordkeeping requirements of
the Appendix.
---------------------------------------------------------------------------

    Two commenters supported the agencies' contention in the proposal
that the prescriptive standards in the 2013 rule were complex, costly,
and did not provide bright line conditions under which trading can
clearly be classified as permissible proprietary trading.\406\ Some
commenters said that removing certain conditions, such as the
demonstrable analysis of historical customer demand in Sec. 
__.4(b)(2)(ii)(B) of the 2013 rule, would increase flexibility and
provide certainty for banking entities to engage in market making-
related activities since current or reasonably forecasted market demand
may be different than historical data may suggest.\407\
---------------------------------------------------------------------------

    \406\ See, e.g., Capital One et al. and SIFMA.
    \407\ See FSF; State Street and SIFMA.
---------------------------------------------------------------------------

    Several commenters, however, expressed concerns about the proposed
removal of the demonstrable analysis requirement. Some commenters
argued that the removal of this requirement will make it harder to for
the agencies to rebut the presumption or determine when banking
entities have not properly set their RENTD limits.\408\ One commenter
argued that by not requiring a demonstrable analysis, the proposed rule
will allow banking entities to engage in trading activities only
superficially tied to customer demand.\409\ One commenter expressed a
belief that the demonstrable analysis cannot be effectively replaced by
other metrics in the proposal, such as the risk and position limits and
usage metric in the Appendix because this metric does not provide
information on customer demand relative to trading inventories.\410\
---------------------------------------------------------------------------

    \408\ See Merkley; Volcker Alliance; and Data Boiler.
    \409\ See Better Markets.
    \410\ See AFR.
---------------------------------------------------------------------------

    To increase flexibility and certainty for banking entities engaged
in permitted activities, several of the commenters that supported the
general approach of the presumption of compliance with the RENTD
requirement requested that this proposed requirement be modified in
certain ways. One commenter suggested that the presumption should be
available to trading desks that establish internal limits appropriate
for their risk appetite, risk capacity, and business strategy and hold
themselves out as a

[[Page 62002]]

market maker.\411\ A commenter requested that the agencies revise the
presumption to make it available to a banking entity that sets, in a
manner agreed to with its onsite prudential examiner and consistent
with the intent and purposes of section 13 of the BHC, internal RENTD
limits based on factors relevant to the reasonable near-term demand of
clients, customers and counterparties, which are calibrated with the
intention of not exceeding RENTD.\412\ One commenter suggested that,
instead of adhering to the more prescriptive aspects of the proposed
RENTD presumption, the trading desks of moderate and limited trading
assets and liabilities banking entities should be given discretion to
adopt internal risk limits appropriate to the activities of the desk
subject to other existing bank regulations, supervisory review, and
oversight by the appropriate agency and still be able to utilize the
presumption of compliance.\413\
---------------------------------------------------------------------------

    \411\ See JBA.
    \412\ See SIFMA (recommended that such factors might include,
for example, anticipated market volatility and current client
inquiries and other indications of client interest, among many
others); FSF.
    \413\ See Capital One et al.
---------------------------------------------------------------------------

    Some commenters requested that the agencies clarify aspects of the
proposal's RENTD presumption. Commenters asked the agencies to clarify
that supervisors and examiners will not impose a one-size fits all
approach given the differences in business models among banking
entities.\414\ While opposed to the general approach of a presumption
of compliance with the statutory RENTD requirement, one commenter
suggested that, if the agencies adopt the presumption of compliance,
additional guidance should be given to banking entities regarding the
factors to consider when setting the limits required to establish the
presumption of compliance, as the factors in the proposal were too
broad and malleable.\415\ Another commenter suggested that the agencies
clarify that the presumption of compliance should include activity-
based limits as a part of its risk-limit structure, such as financial
instrument holding periods, notional size and inventory turnover,
because activity-based limits are reflective of client demand and an
appropriate statutory substitute compared to risk-based limits, which
can be hedged.\416\
---------------------------------------------------------------------------

    \414\ See CCMR and JBA (In particular, this commenter argued
that the agencies should not compare banking entities as it would be
an impediment to banking entities that are not the most conservative
in its internal risk controls).
    \415\ See Better Markets.
    \416\ See BB&T.
---------------------------------------------------------------------------

    Specific to the underwriting exemption, one commenter asserted that
underwriting activity can be sporadic due to client demand or market
factors, which may result in low limit utilization and a rebuttal of
the presumption of compliance even when the underwriting position
itself is identifiable as part of a primary or follow-on offering of
securities.\417\ The commenter suggested that the agencies consider
corporate actions, such as a debt offering, as an appropriate
identifier of permissible underwriting.\418\ Another commenter
suggested that the agencies permit banking entities to set limits based
on the absolute value of profits and losses in the case of an
underwriting desk.\419\
---------------------------------------------------------------------------

    \417\ Id.
    \418\ Id.
    \419\ See JBA.
---------------------------------------------------------------------------

Prompt Notifications
    As discussed above, the proposal would have required a banking
entity to promptly report to the appropriate agency when a trading desk
exceeds or increases the internal limits it sets to avail itself of the
RENTD presumption with respect to the exemptions for underwriting and
market making-related activities.\420\ With two exceptions,\421\
commenters strongly opposed the proposal's requirement that banking
entities promptly report limit breaches.\422\ For example, many of
these commenters stated that the notifications would be impractical and
burdensome to banking entities \423\ and would not enhance the
oversight capabilities of the agencies because the information is
already otherwise available through ordinary supervisory
processes,\424\ including the internal limits and usage metric.\425\
Two commenters asserted that the notices would provide little insight
into how risk is managed.\426\ Some commenters expressed concern that
complying with the requirement would be particularly challenging for
banking entities with parents that are FBOs because these banking
entities lack on-site examiners to receive notifications.\427\ A few
commenters claimed that the prompt notification requirement provides
incentives for banking entities to set their limits so high that they
have fewer breaches and changes to limits.\428\ Commenters also noted
that, when risk limits are appropriately calibrated, breaches are not
uncommon, and notifying the agencies of each breach could overwhelm the
agencies.\429\ Another commenter argued that the prompt notification
may chill traders' willingness to request changes to limits where it
would otherwise be appropriate to accommodate legitimate customer
demand.\430\
---------------------------------------------------------------------------

    \420\ See proposed rule Sec.  __.4(a)(8)(iii); proposed rule
Sec.  __.4(b)(6)(iii).
    \421\ See, e.g., CFA at 7 (stating that, some small and mid-
sized institutions may not have strong internal controls and may be
susceptible to the activities of a rogue trader, so the prompt
notice requirements allow regulators to impose stricter controls if
necessary); Data Boiler at 36 (representing that the prompt
reporting requirement would decrease opportunities for evasion of
the rule's requirements).
    \422\ See, e.g., CCMC; BOK; ISDA; Real Estate Associations;
Goldman Sachs; GFMA; CREFC; ABA; SIFMA; IIB; BB&T; JBA; FSF; Credit
Suisse; and Capital One et al.
    \423\ See, e.g., CCMR; Credit Suisse; GFMA; FSF; and JBA.
    \424\ See, e.g., Credit Suisse; ABA; GFMA; IIB; BOK; and SIFMA.
    \425\ See, e.g., FSF; JBA; ABA; Goldman Sachs; CREFC; and CCMC.
    \426\ See, e.g., BOK (stating that limit excesses do not, of
themselves, show that an institution has changed it strategy or risk
tolerance and that reporting by financial institutions might detract
from a focus on risk management and shift to a ``number of times
exceeded'' view which provides very little insight into how risk is
managed); MBA (stating that prompt reporting would encourage the
agencies to view events in isolation without consideration to facts
and circumstances and that it would be more appropriate to review
limit-events in the ordinary course of established supervisory
process).
    \427\ See, e.g., JBA (stating that it would be operationally
difficult and costly for foreign headquarters to collect and report
data to US regulators); IIB (stating that foreign trading desks
would not have on-site examiners to receive reports and that the
requirement could intrude into local supervisory matters).
    \428\ See, e.g., Better Markets; Capital One et al.; and State
Street.
    \429\ See, e.g., GFMA and BOK (stating that limits that are
never exceeded ``may not be very useful limits.'').
    \430\ See CCMC.
---------------------------------------------------------------------------

    As an alternative to the prompt notification requirement, many
commenters suggested that the agencies require banking entities to make
detailed records of limit changes and breaches.\431\ Other commenters
suggested that the agencies rely on existing supervisory processes to
monitor limit breaches and increases,\432\ including the internal
limits and usage metric.\433\
---------------------------------------------------------------------------

    \431\ See, e.g., CCMR and BB&T.
    \432\ See, e.g., FSF; GFMA; and Real Estate Associations.
    \433\ See, e.g., FSF; JBA; and ABA.
---------------------------------------------------------------------------

Rebutting the Presumption
    As discussed above, under the proposal, the RENTD presumption could
have been rebutted by the appropriate agency if the agency determined,
based on all relevant facts and circumstances, that a trading desk is
engaging in activity that is not based

[[Page 62003]]

on the trading desk's RENTD on an ongoing basis.\434\
---------------------------------------------------------------------------

    \434\ See proposed rule Sec.  __.4(a)(8)(iv); proposed rule
Sec.  __.4(b)(6)(iv).
---------------------------------------------------------------------------

    A few commenters discussed the rebuttal process. For example, one
commenter requested that the agencies specify the procedures for an
agency to rebut the presumption of compliance.\435\ Another commenter
recommended that the agencies adopt a consistent procedure for
challenging the presumptions in the rule.\436\ Another commenter stated
that the proposal would only allow the agencies to challenge the risk
limit approval and exception process, not the nexus between RENTD and
the limits themselves.\437\
---------------------------------------------------------------------------

    \435\ See MBA.
    \436\ See IIB.
    \437\ See Better Markets.
---------------------------------------------------------------------------

d. Final Presumption of Compliance With the Statutory RENTD Requirement
    The agencies are adopting the presumption of compliance with the
RENTD requirement for both the exemptions for underwriting and market
making-related activities largely as proposed, but with modifications
intended to be responsive to commenters' concerns.\438\
---------------------------------------------------------------------------

    \438\ In addition to the changes described in this section, the
presumption of compliance has been moved into a new paragraph (c) in
Sec.  __.4, as opposed to including separate provisions under each
of the two relevant exemptions. That change was intended solely for
clarity and to avoid any unnecessary duplication in light of the
fact that the process for complying with the presumption of
compliance is identical for both exemptions. New paragraph (c) does,
however, recognize that the limits banking entities will be required
to implement, maintain, and enforce will differ as between the
exemptions for underwriting and market making-related activities.
See final rule Sec. Sec.  __.4(c)(2)(A) and __.4(c)(2)(B).
---------------------------------------------------------------------------

    The agencies are mindful of the concerns raised by commenters
regarding the general approach of relying on a banking entity's
internal limits to satisfy the statutory RENTD requirement.\439\ With
respect to the comments described above that the presumption would not
be consistent with the statute, the agencies note that the statute
permits underwriting and market making-related activities to the extent
that such activities are designed not to exceed RENTD. Accordingly,
under the final rule the presumption will be available to each trading
desk that establishes, implements, maintains, and enforces internal
limits that are designed not to exceed RENTD.\440\ In addition, with
respect to the commenter who expressed concern that the presumption
would undermine safety and soundness due to a perceived lack of general
scrutiny over banking entity-developed limits, the agencies note that
these internal limits will be subject to supervisory review and
oversight, which constrains banking entities' ability to set their
limits too high. Further, the agencies may review such limits to assess
whether or not those limits are consistent with the statutory RENTD
standard. This allows the supervisors and examiners to look to the
articulation and use of limits to distinguish between permissible and
impermissible proprietary trading. The agencies believe that the
presumption of compliance, along with the other requirements of the
final rule's exemptions for underwriting and market making-related
activities, create a framework that will allow banking entities and the
agencies to determine whether a trading activity has been designed not
to exceed RENTD.
---------------------------------------------------------------------------

    \439\ As noted above, this includes commenters who argue that
such amendments will undermine the operation of the 2013 rule, lead
to increased risk taking among banking entities, and conflict with
the statutory requirements in section 13(d)(1)(B) of the BHC Act.
See supra notes 28, 36-41 and accompanying text.
    \440\ For consistency with the final rule's RENTD requirement,
the sub-heading for Sec.  __.4(c)(1) has been changed from ``risk
limits'' to ``limits.''
---------------------------------------------------------------------------

    Further, the agencies are concerned that compliance with the 2013
rule's exemptions for underwriting and market making-related activities
may be unnecessarily complex and costly to achieve the intended goal of
compliance with these exemptions. For example, as noted in the
proposal, a number of banking entities have indicated that even after
conducting a number of complex and intensive analyses to meet the
``demonstrable analysis'' requirements for the exemption for market
making-related activities, they still may be unable to gain comfort
that their bona fide market making-related activity meets the
factors.\441\ Further, the absence of clear, bright-line standards for
assessing compliance with the statutory RENTD standard may be
unnecessarily constraining underwriting and market making, two critical
functions to the health and well-being of financial markets in the
United States.
---------------------------------------------------------------------------

    \441\ 83 FR at 33459.
---------------------------------------------------------------------------

    The agencies note commenters' concerns regarding the removal of
``demonstrable analysis'' requirement will make it harder for agencies
to rebut the presumption of compliance with the RENTD requirement or
determine when banking entities have not properly set their RENTD
limits. The agencies believe, however, that requiring a banking
entity's internal limits to be based on RENTD as a requirement for
utilizing the presumption of compliance should help to simplify
compliance with, and oversight of, that statutory standard by placing
the focus on how those limits are established, maintained, implemented,
and enforced.
    Accordingly, under the rule, a banking entity will be presumed to
meet the RENTD requirements in Sec.  __.4 (a)(2)(ii)(A) or Sec. 
__.4(b)(2)(ii) with respect to the purchase or sale of a financial
instrument if the banking entity has established and implements,
maintains, and enforces the limits for the relevant trading desk as
described in the final rule.\442\ With respect to underwriting
activities, the presumption will be available to each trading desk that
establishes, implements, maintains, and enforces internal limits that
are designed not to exceed RENTD, based on the nature and amount of the
trading desk's underwriting activities, on the:
---------------------------------------------------------------------------

    \442\ See final rule, Sec.  __.4(c)(1)(i).
---------------------------------------------------------------------------

    (1) Amount, types, and risk of its underwriting position;
    (2) Level of exposures to relevant risk factors arising from its
underwriting position; and
    (3) Period of time a security may be held.\443\
---------------------------------------------------------------------------

    \443\ See final rule Sec.  __.4(c)(1)(ii)(A). The language in
this paragraph of the rule has been modified slightly from the
proposal to clarify that such limits should take into account the
liquidity, maturity, and depth of the market for the relevant types
of financial instruments. As this language comes directly from the
RENTD requirement in Sec.  __.4 (a)(2)(ii)(A), the agencies do not
view this as a substantive change. Rather, the agencies believe that
it is important to emphasize in the rule text that the limit used to
satisfy the presumption of compliance for one type of financial
instrument will not necessarily be the same for other types of
financial instruments and that the particular characteristics of the
relevant market should be taken into account throughout the process
of setting these limits.
---------------------------------------------------------------------------

    With respect to market making-related activities, the presumption
will be available to each trading desk that establishes, implements,
maintains, and enforces risk and position limits that are designed not
to exceed RENTD, based on the nature and amount of the trading desk's
market making-related activities, that address the:
    (1) Amount, types, and risks of its market-maker positions;
    (2) Amount, types, and risks of the products, instruments, and
exposures the trading desk may use for risk management purposes;
    (3) Level of exposures to relevant risk factors arising from its
financial exposure; and
    (4) Period of time a financial instrument may be held.\444\
---------------------------------------------------------------------------

    \444\ See final rule Sec.  __.4(c)(1)(ii)(B). For the reasons
described in connection with the limits required as satisfy the
presumption of compliance in connection with the underwriting
exemption, the language in this paragraph has been modified slightly
from the proposal to clarify that such limits must take into account
the liquidity, maturity, and depth of the market for the relevant
types of financial instruments. See id.

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[[Page 62004]]

    Some commenters also noted that the agencies should not take a
``one-size-fits-all'' approach to the limits that must be established
to satisfy the presumption of compliance with RENTD on the basis that
not all of the proposed limits may be applicable to every type of
financial instrument, particularly derivatives.\445\ In response to
these commenters, the agencies have modified the rule text to clarify
that the limits required to be established by a banking entity in order
to satisfy the presumption of compliance must address certain items.
The agencies recognize that certain of the enumerated items, which are
unchanged from the proposal, may be more easily applied for desks that
engage in market-making in securities rather than derivatives, and
emphasize that section __.4(b), both as currently in effect and as
amended, is intended to provide banking entities with the flexibility
to determine appropriate limits for market making-related activities
that are designed not to exceed RENTD, taking into account the
liquidity, maturity, and depth of the market for the relevant types of
financial instruments.
---------------------------------------------------------------------------

    \445\ See e.g., FSF, SIFMA.
---------------------------------------------------------------------------

    With respect to derivatives, certain of the enumerated items may
not be effective for designing market making-related activities not to
exceed RENTD, which is ultimately the primary purpose of adopting a
presumption of compliance based on the establishment and use of
internal limits.\446\ Under those circumstances, the agencies
acknowledge that it may be appropriate for banking entities to
establish limits based on specific conditions that would need to be
satisfied in order to utilize the presumption of compliance, rather
than a fixed number of market-maker positions.\447\
---------------------------------------------------------------------------

    \446\ As previously noted, the final rule also replaces the
existing definition of ``market maker-inventory'' with a definition
of ``market-maker positions.'' This change was intended to reflect
the fact that requiring banking entities seeking to rely on the
presumption of compliance with the RENTD requirement to have limits
on market maker-inventory is generally unworkable in the context of
derivatives. See infra note 458 and accompanying text.
    \447\ The agencies note that this discussion does not encompass
or impact the CFTC's or SEC's treatment of market-making in
derivatives for purposes other than section 13 of the BHC Act and
the rule.
---------------------------------------------------------------------------

    For example, for a desk that engages in market making-related
activities only with respect to derivatives (or derivatives and non-
financial instruments), the requirement to establish, implement,
maintain, and enforce limits designed not to exceed RENTD could be
satisfied to the extent the banking entity establishes limits on the
market making desk's level of exposures to relevant risk factors
arising from its financial exposure and such limits are designed not to
exceed RENTD (including derivatives positions related to a request from
a client, customer, or counterparty), based on the nature and amount of
the trading desk's market making-related activities. Such limits would
be consistent with the underlying purpose of the exemption for market
making-related activities, which is to implement the restriction on a
banking entity's proprietary trading activities while still allowing
market makers to provide intermediation and liquidity services
necessary to the functioning of our financial markets.
    Consistent with the proposal, the limits used to satisfy the
presumption of compliance under the final rule will be subject to
supervisory review and oversight by the applicable agency on an ongoing
basis.\448\ Moreover, the final rule provides that the presumption of
compliance may be rebutted by the applicable agency if such agency
determines, taking into account the liquidity, maturity, and depth of
the market for the relevant types of financial instruments and based on
all relevant facts and circumstances, that a trading desk is engaging
in activity that is not designed not to exceed RENTD.\449\ In a
modification from the proposed rule, the final rule contains additional
language that specifies that the agencies will take into account the
liquidity, maturity, and depth of the market for the relevant types of
financial instruments when determining whether to rebut the presumption
of compliance. This change is intended to provide additional clarity
regarding the factors the agencies will consider when making this
determination. In response to commenters' concerns about the rebuttal
process, the final rule specifies that any such rebuttal of the
presumption must be made in accordance with the notice and response
procedures in subpart D of the rule.\450\
---------------------------------------------------------------------------

    \448\ See final rule Sec.  __.4(c)(2). The supervisory review
provision in the proposed rule stated that ``any review of such
limits will include assessment of whether the limits are designed
not to exceed the reasonably expected near term demands of clients,
customers, or counterparties.'' Sections___.4(c)(1)(i)-(ii) of the
final rule clearly stipulate that such limits must be designed not
to exceed the reasonably expected near term demand of clients,
customers, or counterparties. To avoid redundancy, this language has
been omitted from Sec.  __.4(c)(2) in the final rule.
    \449\ See final rule Sec.  __.4(c)(4).
    \450\ See infra notes 655-58 and accompanying text (discussion
of the notice and response procedures in Sec.  __.20(i)).
---------------------------------------------------------------------------

    The agencies are, however, persuaded by the arguments raised by
some commenters with respect to the proposed requirement that a banking
entity promptly report to the appropriate agency when a trading desk
exceeds or increases its internal limits to avail itself of the RENTD
presumption with respect to the exemptions for underwriting and market
making-related activity.\451\ The agencies recognize that limits that
are set so high as to never be breached are not necessarily meaningful
limits. Thus, breaches of appropriately set limits may occur with a
frequency that does not justify notifying the agencies for every single
breach. The agencies recognize that the burdens associated with
preparing and reporting such information may not be justified in light
of the potential benefits of such requirement.
---------------------------------------------------------------------------

    \451\ See proposed rule Sec. Sec.  __.4(a)(8)(iii) and
__.4(b)(6)(iii). See also supra note 387 and accompanying text.
---------------------------------------------------------------------------

    Accordingly, the final rule instead requires banking entities to
maintain and make available to the applicable agency, upon request,
records regarding (1) any limit that is exceeded and (2) any temporary
or permanent increase to any limit(s), in each case in the form and
manner as directed by the agency.\452\ Moreover, when a limit is
breached or increased, the presumption of compliance with RENTD will
continue to be available so long as the banking entity: (1) Takes
action as promptly as possible after a breach to bring the trading desk
into compliance; and
---------------------------------------------------------------------------

    \452\ See final rule Sec. __.4(c)(3)(i).
---------------------------------------------------------------------------

    (2) follows established written authorization procedures, including
escalation procedures that require review and approval of any trade
that exceeds a trading desk's limit(s), demonstrable analysis of the
basis for any temporary or permanent increase to a trading desk's
limit(s), and independent review of such demonstrable analysis and
approval.\453\ The agencies believe that this requirement will provide
the agencies with sufficient information to determine whether a banking
entity's existing limits are appropriately calibrated to comply with
the RENTD requirement for that particular financial instrument.\454\
---------------------------------------------------------------------------

    \453\ See final rule Sec.  __.4(c)(3)(i).
    \454\ The agencies note that the final rule requires that
banking entities with significant trading assets and liabilities
must record and report the quantitative measurements contained in
the Appendix to the final rule. See infra Subpart E-- Metrics:
Appendix to Part []--Reporting and Recordkeeping
Requirements. The agencies believe that the risk and position limits
metric will also help banking entities and the agencies monitor the
underwriting and market making-related activities of banking
entities with significant trading assets and liabilities.

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

[[Page 62005]]

e. Additional Changes to the Final Rule's Underwriting and Market
Making-Related Activities Exemptions
    In addition to the changes described above, the final rule's
exemptions for underwriting and market making-related activities
contain several other conforming and clarifying changes. Consistent
with the proposed rule, the structure of Sec.  __.4(a)(ii) in the final
rule has been modified to clarify that the applicable paragraph
contains two separate and distinct requirements.\455\ In addition,
several definitions used in the final rule's exemptions for
underwriting and market making-related activities have also been
modified. Specifically, the phrase ``paragraph (b)'' has been replaced
with ``this section'' in the definition of ``underwriting position''
because the defined term is used in several places.\456\ The definition
of ``financial exposure'' has been similarly modified.\457\ Finally,
the final rule, however, replaces the existing definition of ``market
maker-inventory'' with a definition for ``market-maker positions'' to
correspond with the language in Sec.  __.4(c)(ii)(B)(1), which is the
only place such definition is used.\458\
---------------------------------------------------------------------------

    \455\ Unlike the 2013 rule, Sec.  __.4(a)(ii) in the final rule
contains subparagraphs (A) and (B).
    \456\ See Sec.  __.4(a)(6).
    \457\ See Sec.  __.4(b)(4).
    \458\ See Sec.  __.4(c)(ii)(B)(1). With respect to the exemption
for market making-related activities, the rebuttable presumption of
compliance for the RENTD requirement in the final rule requires,
among other things, that a trading desk establish, implement, and
enforce limits on the amounts, types, and risks of its market-maker
positions.
---------------------------------------------------------------------------

f. Compliance Program and Other Requirements for Underwriting and
Market Making-Related Activities
2013 Rule Compliance Program Requirements
    The underwriting exemption in Sec.  __.4(a) of the 2013 rule
requires a banking entity to establish, implement, maintain, and
enforce an internal compliance program, as required by subpart D, that
is reasonably designed to ensure compliance with the requirements of
the exemption. Such compliance program is required to include
reasonably designed written policies and procedures, internal controls,
analysis and independent testing identifying and addressing: (i) The
products, instruments, or exposures each trading desk may purchase,
sell, or manage as part of its underwriting activities; (ii) certain
limits for each trading desk, based on the nature and amount of the
trading desk's underwriting activities, including the reasonably
expected near term demands of clients, customers, or counterparties;
\459\ (iii) internal controls and ongoing monitoring and analysis of
each trading desk's compliance with its limits; and (iv) authorization
procedures, including escalation procedures that require review and
approval of any trade that would exceed one or more of a trading desk's
limits, demonstrable analysis of the basis for any temporary or
permanent increase to one or more of a trading desk's limits, and
independent review (i.e., by risk managers and compliance officers at
the appropriate level independent of the trading desk) of such
demonstrable analysis and approval.
---------------------------------------------------------------------------

    \459\ These factors include the: (1) Amount, types, and risk of
its underwriting position; (2) level of exposures to relevant risk
factors arising from its underwriting position; and (3) period of
time a security may be held.
---------------------------------------------------------------------------

    The exemption for market making-related activities in the 2013 rule
contains similar requirements. Specifically, Sec.  __.4(b) of the 2013
rule requires that a banking entity establish, implement, maintain, and
enforce an internal compliance program, as required by subpart D, that
is reasonably designed to ensure compliance with the requirements of
the exemption. Such a compliance program is required to include
reasonably designed written policies and procedures, internal controls,
analysis, and independent testing identifying and addressing: (i) The
financial instruments each trading desk stands ready to purchase and
sell in accordance with the exemption for market making-related
activities; (ii) the actions the trading desk will take to demonstrably
reduce or otherwise significantly mitigate the risks of its financial
exposure consistent with the limits required under paragraph
(b)(2)(iii)(C), and the products, instruments, and exposures each
trading desk may use for risk management purposes; the techniques and
strategies each trading desk may use to manage the risks of its market
making-related activities and inventory; and the process, strategies,
and personnel responsible for ensuring that the actions taken by the
trading desk to mitigate these risks are and continue to be effective;
(iii) the limits for each trading desk, based on the nature and amount
of the trading desk's market making-related activities, including the
reasonably expected near term demands of clients, customers, or
counterparties; \460\ (iv) internal controls and ongoing monitoring and
analysis of each trading desk's compliance with its limits; and (v)
authorization procedures, including escalation procedures that require
review and approval of any trade that would exceed one or more of a
trading desk's limits, demonstrable analysis of the basis for any
temporary or permanent increase to one or more of a trading desk's
limits, and independent review (i.e., by risk managers and compliance
officers at the appropriate level independent of the trading desk) of
such demonstrable analysis and approval.
---------------------------------------------------------------------------

    \460\ Specifically, such limits include the: (1) Amount, types,
and risks of its market-maker inventory; (2) amount, types, and
risks of the products, instruments, and exposures the trading desk
may use for risk management purposes; (3) the level of exposures to
relevant risk factors arising from its financial exposure; and (4)
period of time a financial instrument may be held.
---------------------------------------------------------------------------

Proposed Compliance Program Requirement
    Feedback from market participants and agency oversight have
indicated that the compliance program requirements of the existing
exemptions for underwriting and market making-related activities may be
unduly complex and burdensome for banking entities with smaller and
less active trading activities. In the proposed rule, the agencies
proposed a tiered approach to such compliance program requirements, to
make these requirements commensurate with the size, scope, and
complexity of the relevant banking entity's trading activities and
business structure. Under the proposed rule, a banking entity with
significant trading assets and liabilities would continue to be
required to establish, implement, maintain, and enforce a comprehensive
internal compliance program as a condition for relying on the
exemptions for underwriting and market making-related activities.
However, the agencies proposed to eliminate such compliance program
requirements for banking entities that have moderate or limited trading
assets and liabilities.\461\
---------------------------------------------------------------------------

    \461\ Under the 2013 rule, the compliance program requirement in
Sec.  __.4(a)(2)(iii) is part of the compliance program required by
subpart D but is specifically used for purposes of complying with
the exemption for underwriting activity.
---------------------------------------------------------------------------

Comments on the Proposed Compliance Program Requirement
    Some commenters did not support the removal of the underwriting or
market making-specific compliance program

[[Page 62006]]

requirements for banking entities with limited and moderate trading
assets and liabilities under the proposal. For example, one commenter
urged the agencies to require all banking entities to establish,
implement, maintain, and enforce such compliance program, independent
of any presumption of compliance.\462\ This commenter indicated that
there are ``exceedingly low incremental costs'' associated with most
elements of the RENTD compliance and controls framework for the
exemptions for underwriting and market making-related activities, even
for those banking entities with limited or moderate trading assets and
liabilities.\463\ In the commenter's view, minimal incremental costs
support the retention of such requirements, which are further justified
by the increased stability of financial institutions and financial
markets as a result of the 2013 rule.\464\
---------------------------------------------------------------------------

    \462\ See Better Markets.
    \463\ Id.
    \464\ Id.
---------------------------------------------------------------------------

    Further, that same commenter asserted that the compliance
requirements under the 2013 rule permit too much discretion for banking
entities to implement policies, procedures, and controls, noting that
judgments on the effectiveness of implemented controls depend on the
methodologies used by banking entities' testing functions, and argued
that the agencies should consider additional capital and activities-
based requirements specifically tied to the reported inventory of
trading assets, taking into account the total size of those trading
assets, the overall capital position of the financial institution, and
the average holding period or aging of trading assets, which may
indicate that inventories are unrelated to underwriting and market
making activities.\465\ Similarly, another commenter indicated that a
tiered compliance approach would not be appropriate because it
considered the proposed categorization of entities in terms of trading
assets and liabilities to be flawed.\466\
---------------------------------------------------------------------------

    \465\ Id.
    \466\ See Data Boiler.
---------------------------------------------------------------------------

    Other commenters supported the revisions under the proposed rule to
apply the market making-related activities' compliance program
requirements only to those banking entities with significant trading
assets and liabilities. For example, one commenter expressed concern
that the market making-related activities' compliance program
requirements under the 2013 rule have contributed to decreased market
making activities with, and increased costs for, banking entities'
commercial end-user counterparties.\467\ This commenter indicated that
applying the market making-related activities' compliance program
requirements only to banking entities with significant trading assets
and liabilities would allow banking entities to develop more efficient
compliance and liquidity risk management programs, which would
ultimately reduce transaction costs for commercial end users.\468\
---------------------------------------------------------------------------

    \467\ See Coalition of Derivatives End Users.
    \468\ Id.
---------------------------------------------------------------------------

    Another commenter expressed the view that the proposed approach of
applying the compliance program requirements under the exemptions for
underwriting and market making-related activities only to those banking
entities with significant trading assets and liabilities was an
appropriate means of reducing the regulatory burdens on banks with
limited or moderate trading and underwriting exposures.\469\ That
commenter noted that such approach would continue to allow for the
appropriate monitoring of these activities to ensure compliance with
the provisions of the 2013 rule.\470\
---------------------------------------------------------------------------

    \469\ See CFA.
    \470\ Id.
---------------------------------------------------------------------------

Final Compliance Program Requirement
    The agencies believe that the compliance program requirements that
apply specifically to the exemptions for underwriting and market
making-related activities play an important role in facilitating and
monitoring a banking entity's compliance with the requirements of those
exemptions. However, the agencies also believe that those requirements
can be appropriately tailored to the nature of the underwriting and
market making activities conducted by each banking entity. It also is
important to recognize that the removal of such compliance program
requirements for banking entities that do not have significant trading
assets and liabilities would not relieve those banking entities of the
obligation to comply with the other requirements of the exemptions for
underwriting and market making-related activities, including RENTD
requirements, under the final rule.
    Accordingly, and after consideration of the comments, the agencies
continue to believe that removing the Sec.  __.4 compliance program
requirements for banking entities that do not have significant trading
assets and liabilities as a condition to engaging in permitted
underwriting and market making-related activities should provide these
banking entities with additional flexibility to tailor their compliance
programs in a way that takes into account the risk profile and relevant
trading activities of each particular trading desk.
    The agencies recognize that banking entities that do not have
significant trading assets and liabilities may incur costs to
establish, implement, maintain, and enforce the compliance program
requirements applicable to permitted underwriting activities under the
2013 rule. As the trading activities of banking entities that do not
have significant trading activities comprise approximately seven
percent of the total U.S. trading activity subject to the Volcker Rule,
the agencies believe the costs of the compliance program requirement
would be disproportionate to the banking entity's trading activity and
the risk posed to U.S. financial stability. Accordingly, eliminating
the Sec.  __.4 compliance program requirements for permitted
underwriting and market making-related activities conducted by banking
entities that do not have significant trading assets and liabilities
may reduce compliance costs without materially impacting conformance
with the objectives set forth in section 13 of the BHC Act. Applying
these specific compliance requirements only to banking entities with
significant trading assets and liabilities also is consistent with the
modifications to the general compliance program requirements for these
banking entities under Sec.  __.20 of the final rule, as discussed
below.
    Accordingly, Sec.  __.4(a)(2)(iii) of the final rule will require
banking entities with significant trading assets and liabilities, as a
condition to complying with the underwriting exemption, to establish
and implement, maintain, and enforce an internal compliance program
required by subpart D that is reasonably designed to ensure the banking
entity's compliance with the requirements of the exemption, including
reasonably designed written policies and procedures, internal controls,
analysis and independent testing identifying and addressing:
    (A) The products, instruments or exposures each trading desk may
purchase, sell, or manage as part of its underwriting activities;
    (B) Limits for each trading desk, in accordance with Sec. 
__.4(a)(2)(ii)(A); \471\
---------------------------------------------------------------------------

    \471\ Final rule Sec.  __.4(a)(2)(ii)(A) requires that the
amount and type of the securities in the trading desk's underwriting
position are designed not to exceed RENTD, taking into account the
liquidity, maturity, and depth of the market for the relevant type
of security; and (B) that reasonable efforts are made to sell or
otherwise reduce the underwriting position within a reasonable
period, taking into account the liquidity, maturity, and depth of
the market for the relevant type of security.

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

[[Page 62007]]

    (C) Written authorization procedures, including escalation
procedures that require review and approval of any trade that would
exceed a trading desk's limit(s), demonstrable analysis of the basis
for any temporary or permanent increase to a trading desk's limit(s),
and independent review of such demonstrable analysis and approval; and
    (D) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits.
    With respect to the exemption for market making-related activities,
Sec.  __.4(a)(b)(iii) of the final rule will require banking entities
with significant trading assets and liabilities to establish and
implement, maintain, and enforce an internal compliance program
required by subpart D that is reasonably designed to ensure the banking
entity's compliance with the requirements of the exemption, including
reasonably designed written policies and procedures, internal controls,
analysis and independent testing identifying and addressing:
    (A) The financial instruments each trading desk stands ready to
purchase and sell in accordance with Sec.  __.4(b)(2)(i); \472\
---------------------------------------------------------------------------

    \472\ Final rule Sec.  __.4(b)(2)(i) requires that the trading
desk that establishes and manages the financial exposure routinely
stands ready to purchase and sell one or more types of financial
instruments related to its financial exposure and is willing and
available to quote, purchase and sell, or otherwise enter into long
and short positions in those types of financial instruments for its
own account, in commercially reasonable amounts and throughout
market cycles on a basis appropriate for the liquidity, maturity,
and depth of the market for the relevant types of financial
instruments.
---------------------------------------------------------------------------

    (B) The actions the trading desk will take to demonstrably reduce
or otherwise significantly mitigate promptly the risks of its financial
exposure consistent with the limits required under Sec.  __.4
(b)(2)(iii)(C); the products, instruments, and exposures each trading
desk may use for risk management purposes; the techniques and
strategies each trading desk may use to manage the risks of its market
making-related activities and positions; and the process, strategies,
and personnel responsible for ensuring that the actions taken by the
trading desk to mitigate these risks are and continue to be effective;
    (C) Limits for each trading desk, in accordance with Sec. 
__.4(b)(2)(ii); \473\
---------------------------------------------------------------------------

    \473\ Final rule Sec.  __.4(b)(2)(ii) requires that the trading
desk's market making-related activities are designed not to exceed,
on an ongoing basis, RENTD, taking into account the liquidity,
maturity, and depth of the market for the relevant type of security.
---------------------------------------------------------------------------

    (D) Written authorization procedures, including escalation
procedures that require review and approval of any trade that would
exceed a trading desk's limit(s), demonstrable analysis of the basis
for any temporary or permanent increase to a trading desk's limit(s),
and independent review of such demonstrable analysis and approval; and
    (E) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits.
    The agencies are clarifying in the final rule that the
authorization procedures for banking entities with significant trading
assets and liabilities of proposed Sec.  __.4(a)(2)(iii)(D) and Sec. 
__.4(b)(2)(iii)(E) are to be in writing pursuant to Sec. 
__.4(a)(2)(iii)(C) and Sec.  __.4(b)(2)(iii)(D). Requiring that these
authorization procedures are written provides a basis for which banking
entities and supervisors can review for compliance with the
underwriting and market making exemption compliance requirements.
    Sections __.4(a)(2)(iii) (which sets forth the compliance program
requirements for the underwriting exemption) and Sec.  __.4(b)(2)(iii)
(which sets forth the compliance program requirements for the
exemptions for market making-related activities) further provide that a
banking entity with significant trading assets and liabilities may
satisfy the requirements pertaining to limits and written authorization
procedures by complying with the requirements pursuant to the
presumption of compliance with the statutory RENTD requirement in Sec. 
__.4(c).\474\ As such, Sec.  __.4(c)(1) provides for a rebuttable
presumption that a banking entity's purchase or sale of a financial
instrument complies with the RENTD requirements in Sec. 
__.4(a)(2)(ii)(A) and Sec.  __.4(b)(2)(ii) if the relevant trading desk
establishes, implements, maintains, and enforces internal limits that
are designed not to exceed the reasonably expected near term demands of
clients, customers, or counterparties, taking into account the
liquidity, maturity, and depth of the market for the relevant type of
security. In taking this approach, the agencies recognize that
requiring a banking entity to establish separate limits in accordance
with the statutory RENTD requirement would be unnecessary and may
reduce the benefit of relying on internal limits set pursuant to Sec. 
__.4(c)(1).
---------------------------------------------------------------------------

    \474\ See supra section IV.B.2.d (discussing the requirements in
the final rule associated with the presumption of compliance with
the statutory RENTD requirement).
---------------------------------------------------------------------------

    Additionally, in the case of a banking entity with significant
trading assets and liabilities, the relevant exemption compliance
requirements pertaining to written authorization procedures in Sec. 
__.4(a)(2)(iii)(C) are not required if the criteria in Sec.  __.4(c)
are satisfied. Without the requirement to establish limits pursuant to
Sec.  __.4(a)(iii)(B), such a requirement for written authorization
procedures would be unnecessary. Further, because Sec. 
__.4(c)(3)(ii)(2) contains written authorization procedures, also
requiring written authorization procedures in Sec.  __.4(a)(2)(iii)(C)
would be duplicative.
    These revisions clarify that banking entities with significant
trading assets and liabilities that establish limits and written
authorization procedures pursuant to the rebuttable presumption of
compliance do not have to establish a second set of limits and written
authorization procedures pursuant to the compliance program
requirements of the underwriting or market making exemptions.
Regardless of whether a banking entity with significant trading assets
and liabilities relies on the presumption of compliance in Sec. 
__.4(c), every banking entity with significant trading assets and
liabilities is required to maintain limits and written authorization
procedures for purposes of complying with the exemption for permitted
underwriting or market making-related activities under Sec.  __.4.
    The agencies are removing the proposed rule's requirement for a
banking entity with significant trading assets and liabilities that, to
the extent that any limit identified pursuant to Sec. 
__.4(b)(2)(iii)(C) of the proposed rule is exceeded, the trading desk
takes action to bring the trading desk into compliance with the limits
as promptly as possible after the limit is exceeded. Instead, this
requirement is being moved to Sec.  __.4(c), the rebuttable presumption
of compliance for banking entities that establish internal limits
pursuant to Sec.  __.4(c)(1). Such requirements would be redundant for
a banking entity with significant trading assets and liabilities that
is required, on an ongoing basis, to ensure that its trading desk's
market making activities are designed not to exceed RENTD while also
establishing limits designed not to exceed RENTD.\475\ In addition, the
written authorization procedures \476\

[[Page 62008]]

require internal compliance processes to handle such limit breaches.
---------------------------------------------------------------------------

    \475\ See final rule Sec.  __.4(b)(2)(iii)(C).
    \476\ See final rule Sec.  __.4(b)(2)(iii)(D).
---------------------------------------------------------------------------

g. Other Comments
    Finally, some commenters recommended changes to certain aspects of
the existing exemptions for underwriting and market making-related
activities in the 2013 rule that were not specifically proposed. For
example, one commenter suggested that the agencies eliminate the
limitations on treating banking entities with greater than $50 billion
in trading assets and liabilities as clients, customers, or
counterparties.\477\ As stated in the 2013 rule, the agencies believe
that removing this limitation could make it difficult to meaningfully
distinguish between permitted market making-related activity and
impermissible proprietary trading, and allow a trading desk to maintain
an outsized inventory and to justify such inventory levels as being
tangentially related to expected market-wide demand.\478\ The agencies
also believe that banking entities engaged in substantial trading
activity do not typically act as customers to other market makers.\479\
As a result, the agencies have retained the 2013 rule's definition of
client, customer, or counterparty. Another commenter suggested
broadening the scope of the exemption for underwriting activities to
encompass any activity that assists persons or entities in accessing
the capital markets or raising capital.\480\ The agencies believe the
final rule's changes provide additional clarity while maintaining
consistency with statutory objectives. Accordingly, after consideration
of these comments, the agencies have decided not to make any changes to
the exemptions for underwriting or market making-related activities
other than those discussed above.
---------------------------------------------------------------------------

    \477\ See CCMC.
    \478\ See 79 FR 5607.
    \479\ See 79 FR 5606-5607.
    \480\ See ISDA.
---------------------------------------------------------------------------

h. Market Making Hedging
    As noted in the proposal, during implementation of the 2013 rule,
the agencies received a number of inquiries regarding the circumstances
under which banking entities could elect to comply with the market
making risk management provisions permitted in Sec.  __.4(b) or
alternatively the risk-mitigating hedging requirements under Sec. 
__.5. These inquiries generally related to whether a trading desk could
treat an affiliated trading desk as a client, customer, or counterparty
for purposes of the exemption market making-related activities' RENTD
requirement; and whether, and under what circumstances, one trading
desk could undertake market making risk management activities for one
or more other trading desks.\481\
---------------------------------------------------------------------------

    \481\ 83 FR at 33464.
---------------------------------------------------------------------------

    Each trading desk engaging in a transaction with an affiliated
trading desk that meets the definition of proprietary trading must rely
on an exemption or exclusion in order for the transaction to be
permissible. As noted in the proposal, in one example presented to the
agencies, one trading desk of a banking entity may make a market in a
certain financial instrument (e.g., interest rate swaps), and then
transfer some of the risk of that instrument (e.g., foreign exchange
(FX) risk) to a second trading desk (e.g., an FX swaps desk) that may
or may not separately engage in market making-related activity. In the
proposal, the agencies requested comment as to whether, in such a
scenario, the desk taking the risk (in the preceding example, the FX
swaps desk) and the market making desk (in the preceding example, the
interest rate desk) should be permitted to treat each other as a
client, customer, or counterparty for purposes of establishing internal
limits or RENTD levels under the exemption for market making-related
activities.\482\
---------------------------------------------------------------------------

    \482\ Id.
---------------------------------------------------------------------------

    The agencies also requested comment as to whether each desk should
be permitted to treat swaps executed between the desks as permitted
market making-related activities of one or both desks if the swap does
not cause the relevant desk to exceed its applicable limits and if the
swap is entered into and maintained in accordance with the compliance
requirements applicable to the desk, without treating the affiliated
desk as a client, customer, or counterparty for purposes of
establishing or increasing its limits. This approach was intended to
maintain appropriate limits on proprietary trading by not permitting an
expansion of a trading desk's market making limits based on internal
transactions. At the same time, this approach was intended to permit
efficient internal risk management strategies within the limits
established for each desk.\483\
---------------------------------------------------------------------------

    \483\ Id.
---------------------------------------------------------------------------

    The agencies also requested comment on the circumstances in which
an organizational unit of an affiliate (affiliated unit) of a trading
desk engaged in market making-related activities in compliance with
Sec.  __.4(b) (market making desk) would be permitted to enter into a
transaction with the market making desk in reliance on the market
making desk's risk management policies and procedures. In this
scenario, to effect such reliance the market making desk would direct
the affiliated unit to execute a risk-mitigating transaction on the
market making desk's behalf. If the affiliated unit did not
independently satisfy the requirements of the exemption for market
making-related activities with respect to the transaction, it would be
permitted to rely on the exemption for market making-related activities
available to the market making desk for the transaction if: (i) The
affiliated unit acts in accordance with the market making desk's risk
management policies and procedures; and (ii) the resulting risk-
mitigating position is attributed to the market making desk's financial
exposure (and not the affiliated unit's financial exposure) and is
included in the market making desk's daily profit and loss calculation.
If the affiliated unit establishes a risk-mitigating position for the
market making desk on its own accord (i.e., not at the direction of the
market making desk) or if the risk-mitigating position is included in
the affiliated unit's financial exposure or daily profit and loss
calculation, then the affiliated unit may still be able to comply with
the requirements of the risk-mitigating hedging exemption pursuant to
Sec.  __.5 for such activity.\484\
---------------------------------------------------------------------------

    \484\ Id.
---------------------------------------------------------------------------

    The commenters were generally in favor of permitting affiliated
trading desks to treat each other as a client, customer, or
counterparty for the purposes of establishing risk limits or RENTD
levels under the exemption for market making-related activities,\485\
particularly for banking entities that service customers in different
jurisdictions. One commenter, however, did not support this approach,
and expressed that it would be difficult to validate banking entities'
RENTD limits if affiliates could be considered as a client, customer,
or counterparty.\486\
---------------------------------------------------------------------------

    \485\ See, e.g., HSBC; JBA; and IIB.
    \486\ See Data Boiler.
---------------------------------------------------------------------------

    One commenter argued that affiliated trading desks with different
mandates should be able to treat each other as a client, customer, or
counterparty as long as each desk stays within its limits, because such
an approach would allow banking entities to take an enterprise-wide
view of risk management.\487\
---------------------------------------------------------------------------

    \487\ See IIB.
---------------------------------------------------------------------------

    Two commenters explained that, to increase efficiencies, certain
internationally active banking entities employ a ``hub-and-spoke''
model, where trading desks at local entities

[[Page 62009]]

(spoke) enter into transactions with major affiliates (hub) that manage
the risks of, and source trading positions for, the local
entities.\488\ One of these commenters expressed that these trading
desks have trouble demonstrating they are indeed market making desks
without intra-entity and inter-affiliate transactions being treated as
transactions with a client, customer, or counterparty.\489\ The other
commenter expressed that, under the hub-and-spoke model, treating the
``spoke'' trading desk as a client, customer, or counterparty, would
allow the hub desk to look through to the customer of the local entity
since the hub is acting as the ultimate market maker.\490\
---------------------------------------------------------------------------

    \488\ See HSBC and JBA.
    \489\ See JBA.
    \490\ See HSBC.
---------------------------------------------------------------------------

    After consideration of comments, the agencies continue to recognize
that, under certain circumstances, a trading desk may undertake market
making risk management activities for one or more affiliated trading
desks \491\ and trading desks may rely on the exemption for market
making-related activities for its transactions with affiliated trading
desks. The agencies, however, are declining to permit banking entities
to treat affiliated trading desks as ``clients, customers, or
counterparties'' \492\ for the purposes of determining a trading desk's
RENTD pursuant to Sec.  __.4(b)(2)(ii) of the exemption for market
making-related activities.
---------------------------------------------------------------------------

    \491\ See 79 FR at 5594.
    \492\ Sec.  __.4(b)(3).
---------------------------------------------------------------------------

    The agencies believe that, under the exemption for market making-
related activities, each trading desk must be able to independently tie
its activities to the RENTD of external customers that the trading desk
services. Allowing a desk to treat affiliated trading desks as
customers for purposes of RENTD would allow the desk to accumulate
financial instruments if it has a reason to believe that other internal
desks will be interested in acquiring the positions in the near term.
Those other desks could then acquire the positions from the first desk
at a later time when they have a reasonable expectation of near term
demand from external customers. The agencies also believe that
generally allowing a desk to treat other internal desks as customers
for purposes of RENTD could impede monitoring of market making-related
activity and detection of impermissible proprietary trading since a
banking entity could aggregate in a single trading desk the RENTD of
trading desks that engage in multiple different trading strategies and
aggregate a larger volume of trading activities.\493\
---------------------------------------------------------------------------

    \493\ See 79 FR at 5590.
---------------------------------------------------------------------------

    With respect to the arguments raised by these commenters that
permitting this treatment would facilitate efficient risk
management,\494\ the agencies believe that the amendments to the risk-
mitigating hedging exemption in the final rule \495\ and the amendments
to the liquidity management exemption in the final rule \496\ will
provide banking entities with additional flexibility to manage risks
more efficiently than the 2013 rule.
---------------------------------------------------------------------------

    \494\ See HSBC; JBA; and IIB.
    \495\ The agencies are streamlining several aspects of the risk-
mitigating hedging exemption for banking entities with and without
significant trading assets and liabilities. See final rule Sec. 
__.5; See also section IV.B.3, infra.
    \496\ The agencies have expanded the types of financial
instruments eligible for the exclusion to include for exchange
forwards and foreign exchange swaps. See final rule Sec.  __.3(e);
See also section IV.B.1.b.i, supra.
---------------------------------------------------------------------------

    Further, the agencies note that while affiliated trading desks may
not consider each other clients, customers, or counterparties,
transactions between affiliated trading desks may be permitted under
the exemption for market making-related activities in certain
circumstances that do not require the expansion of a trading desk's
market making limits based on internal transactions. Returning to the
example from the proposal and described above \497\ concerning an
interest rate swaps desk transferring some of the risk of a financial
instrument to an affiliated FX swaps desk, if the FX swaps desk acts as
a market maker in FX swaps, the FX swaps desk may be able to rely on
the exemption for market making-related activities for its transactions
with the interest rate swaps desk if those transactions are consistent
with the requirements of the exemption for market making-related
activities, including the FX swaps desk's RENTD.\498\ Further, if the
FX swaps desk does not independently satisfy the requirements of the
exemption for market making-related activities with respect to the
transaction, it would be permitted to rely on the exemption for market
making-related activities available to the market making desk for the
transaction under certain conditions. If the banking entity has
significant trading assets and liabilities, the FX swaps desk would be
permitted to rely on the exemption for market making-related activities
if: (i) The FX swaps desk acts in accordance with the interest rate
swaps desk's risk management policies and procedures established in
accordance with Sec.  __.4(b)(2)(iii) and (ii) the resulting risk-
mitigating position is attributed to the interest rate swaps desk's
financial exposure (and not the FX swaps desk's financial exposure) and
is included in the interest rate swaps desk's daily profit and loss
calculation. If the banking entity does not have significant trading
assets and liabilities, the FX swaps desk would be permitted to rely on
the exemption for market making-related activities if the resulting
risk-mitigating position is attributed to the interest rate swaps
desk's financial exposure (and not the FX swaps desk's financial
exposure) and is included in the interest rate swaps desk's daily
profit and loss calculation. If the FX swaps desk cannot independently
satisfy the requirements of the exemption for market making-related
activities with respect to its transactions with the interest rate
swaps desk, the risk-mitigating hedging exemption would be available,
provided the conditions of that exemption are met.
---------------------------------------------------------------------------

    \497\ See Part IV.B.2.h, supra; see also 83 FR 33463.
    \498\ The interest rate market making desk can rely on the
exemption for market making-related activities for the FX swap it
enters into with the FX swaps desk provided the interest rate market
making desk enters into the FX swap to hedge its market making-
related position and otherwise complies with the requirements of the
exemption for market making-related activities.
---------------------------------------------------------------------------

3. Section __.5: Permitted Risk-Mitigating Hedging Activities
a. Section __.5 of the 2013 Rule
    Section 13(d)(1)(C) of the BHC Act provides an exemption from the
prohibition on proprietary trading for risk-mitigating hedging
activities that are designed to reduce the specific risks to a banking
entity in connection with and related to individual or aggregated
positions, contracts, or other holdings. Section __.5 of the 2013 rule
implements section 13(d)(1)(C).
    Section __.5 of the 2013 rule provides a multi-faceted approach to
implementing the hedging exemption to ensure that hedging activity is
designed to be risk-reducing and does not mask prohibited proprietary
trading. Under the 2013 rule, risk-mitigating hedging activities must
comply with certain conditions for those activities to qualify for the
exemption. Generally, a banking entity relying on the hedging exemption
must have in place an appropriate internal compliance program that
meets specific requirements, including the requirement to conduct
certain correlation analysis, to support its compliance with the terms
of the exemption, and the compensation arrangements of persons
performing risk-mitigating hedging activities must be designed not to
reward or incentivize

[[Page 62010]]

prohibited proprietary trading.\499\ In addition, the hedging activity
itself must meet specified conditions. For example, at inception, the
hedge must be designed to reduce or otherwise significantly mitigate,
and must demonstrably reduce or otherwise significantly mitigate, one
or more specific, identifiable risks arising in connection with and
related to identified positions, contracts, or other holdings of the
banking entity, and the activity must not give rise to any significant
new or additional risk that is not itself contemporaneously
hedged.\500\ Finally, Sec.  __.5 establishes certain documentation
requirements with respect to the purchase or sale of financial
instruments made in reliance of the risk-mitigating exemption under
certain circumstances.\501\
---------------------------------------------------------------------------

    \499\ See 2013 rule Sec.  __.5(b)(1) and (3).
    \500\ See 2013 rule Sec.  __.5(b)(2).
    \501\ See 2013 rule Sec.  __.5(c).
---------------------------------------------------------------------------

b. Proposed Amendments to Section __.5
i. Correlation Analysis for Section __.5(b)(1)(iii)
    The agencies proposed to remove the specific requirement to conduct
a correlation analysis for risk-mitigating hedging activities.\502\ In
particular, the agencies proposed to remove the words ``including
correlation analysis'' from the requirement that the banking entity
seeking to engage in risk-mitigating hedging activities conduct
``analysis, including correlation analysis, and independent testing''
designed to ensure that hedging activities may reasonably be expected
to reduce or mitigate the risks being hedged. Thus, the requirement to
conduct an analysis would have remained, but the banking entity would
have had flexibility to apply a type of analysis that was appropriate
to the facts and circumstances of the hedge and the underlying risks
targeted.\503\
---------------------------------------------------------------------------

    \502\ See 83 FR at 33465.
    \503\ See 83 FR at 33465.
---------------------------------------------------------------------------

    The agencies noted that they have become aware of practical
difficulties with the correlation analysis requirement, which according
to banking entities can add delays, costs, and uncertainty to permitted
risk-mitigating hedging.\504\ The agencies anticipated that removing
the correlation analysis requirement would reduce uncertainties in
meeting the analysis requirement without significantly impacting the
conditions that risk-mitigating hedging activities must meet in order
to qualify for the exemption.\505\
---------------------------------------------------------------------------

    \504\ See id.
    \505\ See id.
---------------------------------------------------------------------------

    The agencies also noted that section 13 of the BHC Act does not
specifically require this correlation analysis.\506\ Instead, the
statute only provides that a hedging position, technique, or strategy
is permitted so long as it is ``. . . designed to reduce the specific
risks to the banking entity . . . .'' \507\ The 2013 rule added the
correlation analysis requirement as a measure intended to ensure
compliance with this exemption.
---------------------------------------------------------------------------

    \506\ See 83 FR at 33465.
    \507\ 12 U.S.C. 1851(d)(1)(C).
---------------------------------------------------------------------------

ii. Hedge Demonstrably Reduces or Otherwise Significantly Mitigates
Specific Risks for Sections __.5(b)(1)(iii), __.5(b)(2)(ii), and
__.5(b)(2)(iv)(B)
    The agencies stated in the proposal that the requirements in Sec. 
__.5(b)(1)(iii), Sec.  __.5(b)(2)(ii), and Sec.  __.5(b)(2)(iv)(B),
that a risk-mitigating hedging activity demonstrably reduces or
otherwise significantly mitigates specific risks, is not directly
required by section 13(d)(1)(C) of the BHC Act.\508\ The statute
instead requires that the hedge be designed to reduce or otherwise
significantly mitigate specific risks.\509\ Thus, the agencies proposed
to remove the ``demonstrably reduces or otherwise significantly
mitigates'' specific risk requirement from Sec.  __.5(b)(2)(ii) and
Sec.  __.5(b)(2)(iv)(B). This change would retain the requirement that
the hedging activity be designed to reduce or otherwise significantly
mitigate one or more specific, identifiable risks, while providing
banking entities with the flexibility to apply a type of analysis that
was appropriate to the facts and circumstances of the hedge and the
underlying risks targeted.
---------------------------------------------------------------------------

    \508\ See 83 FR at 33465.
    \509\ See id.
---------------------------------------------------------------------------

    The agencies also proposed to remove parallel provisions in Sec. 
__.5(b)(1)(iii). In particular, the agencies proposed to delete the
word ``demonstrably'' from the requirement that ``the positions,
techniques and strategies that may be used for hedging may reasonably
be expected to demonstrably reduce or otherwise significantly mitigate
the specific, identifiable risk(s) being hedged'' in Sec. 
__.5(b)(1)(iii). This change would have meant that the banking entity's
analysis and testing would have had to show that the hedging may be
expected to reduce or mitigate the risks being hedged, but without the
specific requirement that such reduction or mitigation be demonstrable.
The agencies also proposed to delete the requirement in Sec. 
__.5(b)(1)(iii) that ``such correlation analysis demonstrates that the
hedging activity demonstrably reduces or otherwise significantly
mitigates the specific, identifiable risk(s) being hedged'' because
this requirement was not necessary if the ``correlation analysis'' and
``demonstrable'' requirements were deleted.
    The agencies noted that, in practice, it appears that the
requirement to show that hedging activity demonstrably reduces or
otherwise significantly mitigates a specific, identifiable risk that
develops over time can be complex and could potentially reduce bona
fide risk-mitigating hedging activity. For example, in some
circumstances it would be very difficult, if not impossible, for a
banking entity to comply with the continuous requirement to
demonstrably reduce or significantly mitigate the identifiable risks,
and therefore the firm would not enter into what would otherwise be
effective hedges of foreseeable risks.\510\
---------------------------------------------------------------------------

    \510\ See id.
---------------------------------------------------------------------------

iii. Reduced Compliance Requirements for Banking Entities That Do Not
Have Significant Trading Assets and Liabilities for Section __.5(b) and
(c)
    For banking entities that do not have significant trading assets
and liabilities, the agencies proposed to eliminate the requirements
for a separate internal compliance program for risk-mitigating hedging
under Sec.  __.5(b)(1); certain of the specific requirements of Sec. 
__.5(b)(2); the limits on compensation arrangements for persons
performing risk-mitigating activities in Sec.  __.5(b)(3); and the
documentation requirements for certain hedging activities in Sec. 
__.5(c).\511\ In place of those requirements, the agencies proposed a
new Sec.  __.5(b)(2) that would require that the risk-mitigating
hedging activities be: (i) At the inception of the hedging activity
(including any adjustments), designed to reduce or otherwise
significantly mitigate one or more specific, identifiable risks,
including the risks specifically enumerated in the proposal; and (ii)
subject to ongoing recalibration, as appropriate, to ensure that the
hedge remains designed to reduce or otherwise significantly mitigate
one or more specific, identifiable risks.\512\ The proposal also
included conforming changes to Sec.  __.5(b)(1) and Sec.  __.5(c) of
the 2013 rule to make the requirements of those sections

[[Page 62011]]

applicable only to banking entities that have significant trading
assets and liabilities.\513\
---------------------------------------------------------------------------

    \511\ See 83 FR at 33466.
    \512\ Id.
    \513\ Id.
---------------------------------------------------------------------------

    The agencies explained that these requirements are overly
burdensome and complex for banking entities that do not have
significant trading assets and liabilities, which are generally less
likely to engage in the types of trading activities and hedging
strategies that would necessitate these additional compliance
requirements. Given these considerations, the agencies believed that
removing the requirements for banking entities that do not have
significant trading assets and liabilities would be unlikely to
materially increase risks to the safety and soundness of the banking
entity or U.S. financial stability. The agencies also believed that the
proposed requirements for banking entities without significant trading
assets and liabilities would effectively implement the statutory
requirement that the hedging transactions be designed to reduce
specific risks the banking entity incurs.\514\
---------------------------------------------------------------------------

    \514\ Id.
---------------------------------------------------------------------------

iv. Reduced Documentation Requirements for Banking Entities That Have
Significant Trading Assets and Liabilities for Section __.5(c)
    For banking entities that have significant trading assets and
liabilities, the agencies proposed to retain the enhanced documentation
requirements for the hedging transactions identified in Sec. 
__.5(c)(1) to permit evaluation of the activity.\515\ However, the
agencies proposed a new paragraph (c)(4) in Sec.  __.5 that would
eliminate the enhanced documentation requirement for hedging activities
that meets certain conditions.\516\ Under new paragraph (c)(4) in Sec. 
__.5, compliance with the enhanced documentation requirement would not
apply to purchases and sales of financial instruments for hedging
activities that are identified on a written list of financial
instruments pre-approved by the banking entity that are commonly used
by the trading desk for the specific types of hedging activity for
which the financial instrument is being purchased or sold.\517\ In
addition, at the time of the purchase or sale of the financial
instruments, the related hedging activity would need to comply with
written, pre-approved hedging limits for the trading desk purchasing or
selling the financial instrument, which would be required to be
appropriate for the size, types, and risks of the hedging activities
commonly undertaken by the trading desk; the financial instruments
purchased and sold by the trading desk for hedging activities; and the
levels and duration of the risk exposures being hedged.\518\
---------------------------------------------------------------------------

    \515\ Id.
    \516\ Id.
    \517\ Id.
    \518\ Id.
---------------------------------------------------------------------------

    The agencies explained that certain of the regulatory purposes of
these documentation requirements, such as facilitating subsequent
evaluation of the hedging activity and prevention of evasion, are less
relevant in circumstances where common hedging strategies are used
repetitively. Therefore the agencies believed that the enhanced
documentation requirements were not necessary in such instances and
that reducing them would make beneficial risk-mitigating activity more
efficient and effective. The agencies intended that the conditions on
the pre-approved limits would provide clarity regarding the limits
needed to comply with requirements.\519\
---------------------------------------------------------------------------

    \519\ See 83 FR at 33466-67.
---------------------------------------------------------------------------

c. Commenters' Views
    One commenter argued that the requirements associated with the 2013
rule's risk-mitigating hedging exemption have been overly prescriptive,
cumbersome, and unnecessary for sound and efficient risk
management.\520\ Many commenters supported the agencies' efforts to
reduce costs and uncertainty and improve the utility of the risk-
mitigating hedging exemption.\521\ More specifically, commenters agreed
with the recommendations to remove the correlation analysis
requirement, remove the requirement that a hedge demonstrably reduce or
otherwise significantly mitigate one or more specific risks, and reduce
the enhanced documentation requirements.\522\
---------------------------------------------------------------------------

    \520\ See SIFMA.
    \521\ See, e.g., State Street; FSF; ABA; BPI; and SIFMA.
    \522\ See, e.g., State Street; FSF; ABA; BPI; and SIFMA.
---------------------------------------------------------------------------

    Although some commenters supported the agencies' effort to reduce
the compliance burden in the risk-mitigating hedging exemption, others
argued that the agencies did not go far enough. Several commenters
argued that the agencies should reduce the enhanced documentation
requirements and go further to remove these requirements for all
banking entities.\523\ Another commenter urged the agencies to
eliminate the enhanced documentation requirements altogether in light
of the proposed rule's robust compliance framework.\524\ In addition, a
commenter suggested targeted modifications to the provision, including
permitting certain types of hedging in line with internal risk limits,
allowing aggregate assessment of hedging, and clarifying how firms can
comply with the provision.\525\
---------------------------------------------------------------------------

    \523\ See, e.g., SIFMA; JBA; ABA; BPI; FSF; and CREFC.
    \524\ See BPI.
    \525\ See Credit Suisse.
---------------------------------------------------------------------------

    In contrast, other commenters did not support the agencies'
proposed changes to the compliance obligations associated with the
risk-mitigating hedging exemption.\526\ One commenter argued that
eliminating the correlation analysis requirement would eliminate the
primary means used by most banks today to ensure a hedging activity is,
in fact, offsetting risk.\527\ Moreover, the same commenter argued that
eliminating the existing regulatory requirement that banks show a hedge
``demonstrably reduces'' or ``significantly mitigates'' the risks
targeted by the hedge would be a direct repudiation of the statute,
because that type of demonstration is required by the statute.\528\
Another commenter argued that the various changes proposed by the
agencies would lead to uncontrollable speculations.\529\
---------------------------------------------------------------------------

    \526\ See, e.g., Volcker Alliance; Bean; Data Boiler; CFA; AFR;
NAFCU; Merkley; Better Markets; CAP; Systemic Risk Council; and
Public Citizen.
    \527\ See Bean.
    \528\ See Bean.
    \529\ See Data Boiler.
---------------------------------------------------------------------------

d. Final Rule
i. Correlation Analysis for Section __.5(b)(1)(i)(C)
    The agencies are adopting Sec.  __.5(b)(1)(iii) as proposed, but
renumbered as Sec.  __.5(b)(1)(i)(C). Based on the agencies'
implementation experience of the 2013 rule and commenters' feedback on
the proposed changes, the agencies are removing the requirement that a
correlation analysis be the type of analysis used to assess risk-
mitigating hedging activities. The agencies continue to believe, as
stated in the proposal, that allowing banking entities to use the type
of analysis that is appropriate to the hedging activities in question
will avoid the uncertainties discussed in the proposal without
substantially impacting the conditions that risk-mitigating hedging
activities must meet in order to qualify for the exemption.\530\
---------------------------------------------------------------------------

    \530\ See 83 FR at 33465.
---------------------------------------------------------------------------

    Furthermore, section 13 of the BHC Act does not require that the
analysis used by the banking entity be a correlation analysis. Instead,
the statute only provides that a hedging position,

[[Page 62012]]

technique, or strategy is permitted so long as it is ``. . . designed
to reduce the specific risks to the banking entity . . . .'' \531\ The
agencies believe the continuing requirement that the banking entity
conduct ``analysis and independent testing designed to ensure that the
positions, techniques and strategies that may be used for hedging may
reasonably be expected to reduce or otherwise significantly mitigate
the specific, identifiable risk(s) being hedged'' will effectively
implement the statute.
---------------------------------------------------------------------------

    \531\ 12 U.S.C. 1851(d)(1)(C).
---------------------------------------------------------------------------

    The agencies anticipate that the banking entity's flexibility to
apply the type of analysis that is appropriate to assess the particular
hedging activity at issue will facilitate the appropriate use of risk-
mitigating hedging under the exemption. Regarding the comment asserting
that correlation analysis is the primary means used by banking entities
to test whether a hedging activity is offsetting risk, the agencies
note that if this is the case it would be reasonable to expect that the
banking entity would use correlation analysis to satisfy the regulatory
requirements with respect to that hedging activity. However, if another
type of analysis is more appropriate, the banking entity would have the
flexibility to use that form of analysis instead.
ii. Hedge Demonstrably Reduces or Otherwise Significantly Mitigates
Specific Risks for Sections __.5(b)(1)(i)(C), __.5(b)(1)(ii)(B) and
__.5(b)(1)(ii)(D)(2)
    The agencies are adopting Sec.  __.5(b)(1)(iii), Sec. 
__.5(b)(2)(ii), and Sec.  __.5(b)(2)(iv)(B) as proposed, but renumbered
as Sec.  __.5(b)(1)(i)(C), Sec.  __.5(b)(1)(ii)(B) and Sec. 
__.5(b)(1)(ii)(D)(2). As stated in the proposal, the requirement that
the reduction or mitigation of specific risks resulting from a risk-
mitigating hedging activity be demonstrable is not directly required by
section 13(d)(1)(C) of the BHC Act.\532\ In practice, it appears that
the requirement to show that hedging activity demonstrably reduces or
otherwise significantly mitigates a specific, identifiable risk that
develops over time can be complex and could potentially reduce bona
fide risk-mitigating hedging activity. The agencies continue to believe
that in some circumstances, it may be difficult for banking entities to
know with sufficient certainty that a potential hedging activity that a
banking entity seeks to commence will continuously demonstrably reduce
or significantly mitigate an identifiable risk after it is implemented,
even if the banking entity is able to enter into a hedge reasonably
designed to reduce or significantly mitigate such a risk. As stated in
the proposal, unforeseeable changes in market conditions, event risk,
sovereign risk, and other factors that cannot be known with certainty
in advance of undertaking a hedging transaction could reduce or
eliminate the otherwise intended hedging benefits.\533\ In these
events, the requirement that a hedge ``demonstrably reduce'' or
``significantly mitigate'' the identifiable risks could create
uncertainty with respect to the hedge's continued eligibility for the
exemption. In such cases, a banking entity may determine not to enter
into what would otherwise be a reasonably designed hedge of foreseeable
risks out of concern that the banking entity may not be able to
effectively comply with the requirement that such a hedge demonstrably
reduces such risks due to the possibility of unforeseen risks occur.
Therefore, the final rule removes the ``demonstrably reduces or
otherwise significantly mitigates'' specific risk requirement from
Sec.  __.5(b)(1)(i)(C), Sec.  __.5(b)(1)(ii)(B) and Sec. 
__.5(b)(1)(ii)(D)(2).
---------------------------------------------------------------------------

    \532\ See 83 FR at 33465.
    \533\ See id.
---------------------------------------------------------------------------

    The agencies do not agree with a commenter's assertion that the
requirement that banking entities show that a hedge ``demonstrably''
reduces or significantly mitigates the risks is a core requirement
under section 13 of the BHC Act. Instead, the statute expressly permits
hedging activities that are ``designed to reduce the specific risks of
the banking entity.'' \534\ The final rule maintains the requirement
that hedging activity undertaken pursuant to Sec.  __.5 be designed to
reduce or otherwise mitigate specific, identifiable risks. Hedging
activity must also be subject to ongoing recalibration by the banking
entity to ensure that the hedging activity satisfies the requirement
that the activity is designed to reduce or otherwise significantly
mitigate one or more specific, identifiable risks even after changes in
market conditions or other factors. In light of these requirements, the
agencies do not find it necessary to require that the hedge
``demonstrably reduce'' risk to the banking entity on an ongoing basis.
---------------------------------------------------------------------------

    \534\ 12 U.S.C. 1851(d)(1)(C).
---------------------------------------------------------------------------

iii. Reduced Compliance Requirements for Banking Entities That Do Not
Have Significant Trading Assets and Liabilities for Section __.5(b)(2)
and Section __.5(c)
    The agencies are adopting Sec. Sec.  __.5(b)(2) and __.5(c) as
proposed. Consistent with the changes in the final rule relating to the
scope of the requirements for banking entities that do not have
significant trading assets and liabilities, the agencies are also
revising the requirements in Sec. Sec.  __.5(b)(2) and __.5(c) for
banking entities that do not have significant trading assets and
liabilities. For these firms, the agencies are eliminating the
requirements for a separate internal compliance program for risk-
mitigating hedging under Sec.  __.5(b)(1); certain of the specific
requirements of Sec.  __.5(b)(2); the limits on compensation
arrangements for persons performing risk-mitigating activities in Sec. 
__.5(b)(1)(iii); and the documentation requirements for those
activities in Sec.  __.5(c). Based on comments received, the agencies
have determined that these requirements are overly burdensome and
complex for banking entities with moderate trading assets and
liabilities, in light of the reduced scale of their trading and hedging
activities.
    In place of those requirements, new Sec.  __.5(b)(2) requires that
risk-mitigating hedging activities for those banking entities be: (i)
At the inception of the hedging activity (including any adjustments),
designed to reduce or otherwise significantly mitigate one or more
specific, identifiable risks, including the risks specifically
enumerated in the proposal; and (ii) subject to ongoing recalibration,
as appropriate, to ensure that the hedge remains designed to reduce or
otherwise significantly mitigate one or more specific, identifiable
risks. The agencies continue to believe that these tailored
requirements for banking entities without significant trading assets
and liabilities effectively implement the statutory requirement that
the hedging transactions be designed to reduce specific risks the
banking entity incurs. The agencies believe that the remaining
requirements for a firm with moderate trading assets and liabilities
would be effective in ensuring such banking entities engage only in
permissible risk-mitigating hedging activities. The agencies also note
that reducing these compliance requirements for banking entities that
do not have significant trading assets and liabilities is unlikely to
materially increase risks to the safety and soundness of the banking
entity or

[[Page 62013]]

U.S. financial stability. Therefore, the agencies are eliminating and
modifying these requirements for banking entities that do not have
significant trading assets and liabilities. In connection with these
changes, the final rule also includes conforming changes to Sec. Sec. 
__.5(b)(1) and __.5(c) of the 2013 rule to make the requirements of
those sections applicable only to banking entities that have
significant trading assets and liabilities.
iv. Reduced Documentation Requirements for Banking Entities That Have
Significant Trading Assets and Liabilities for Section __.5(c)
    The agencies are adopting Sec.  __.5(c) as proposed. The final rule
retains the enhanced documentation requirements for banking entities
that have significant trading assets and liabilities for hedging
transactions identified in Sec.  __.5(c)(1) to permit evaluation of the
activity. Although this documentation requirement results in more
extensive compliance efforts, the agencies continue to believe it
serves an important role to prevent evasion of the requirements of
section 13 of the BHC Act and the final rule.
    The hedging transactions identified in Sec.  __.5(c)(1) include
hedging activity that is not established by the specific trading desk
that creates or is responsible for the underlying positions, contracts,
or other holdings the risks of which the hedging activity is designed
to reduce; is effected through a financial instrument, exposure,
technique, or strategy that is not specifically identified in the
trading desk's written policies and procedures as a product,
instrument, exposure, technique, or strategy such trading desk may use
for hedging; or established to hedge aggregated positions across two or
more trading desks. The agencies believe that hedging transactions
established at a different trading desk, or which are not identified in
the relevant policies, may present or reflect heightened potential for
prohibited proprietary trading. In other words, the further removed
hedging activities are from the specific positions, contracts, or other
holdings the banking entity intends to hedge, the greater the danger
that such activity is not limited to hedging specific risks of
individual or aggregated positions, contracts, or other holdings of the
banking entity. For this reason, the agencies do not agree with
commenters who argued that the enhanced documentation requirements
should be removed for all banking entities.
    However, based on the agencies' experience during the first several
years of implementation of the 2013 rule, it appears that many hedges
established by one trading desk for other affiliated desks are often
part of common hedging strategies that are used regularly and that do
not raise the concerns of those trades prohibited by the rule. In those
instances, the documentation requirements of Sec.  __.5(c) of the 2013
rule are less necessary for purposes of evaluating the hedging activity
and preventing evasion. In weighing the significantly reduced
regulatory and supervisory utility of additional documentation of
common hedging trades against the complexity of complying with the
enhanced documentation requirements, the agencies have determined that
the documentation requirements are not necessary in those instances.
Reducing the documentation requirement for common hedging activity
undertaken in the normal course of business for the benefit of one or
more other trading desks would also make beneficial risk-mitigating
activity more efficient and potentially improve the timeliness of
important risk-mitigating hedging activity, the effectiveness of which
can be time sensitive.
    Therefore, Sec.  __.5(c)(4) of the final rule eliminates the
enhanced documentation requirement for hedging activities that meet
certain conditions. In excluding a trading desk's common hedging
instruments from the enhanced documentation requirements in Sec. 
__.5(c), the final rule seeks to distinguish between those financial
instruments that are commonly used for a trading desk's ordinary
hedging activities and those that are not. The final rule requires the
banking entity to have in place appropriate limits so that less common
or more unusual levels of hedging activity would still be subject to
the enhanced documentation requirements. The final rule provides that
the enhanced documentation requirement does not apply to purchases and
sales of financial instruments for hedging activities that are
identified on a written list of financial instruments pre-approved by
the banking entity that are commonly used by the trading desk for the
specific types of hedging activity for which the financial instrument
is being purchased or sold. In addition, at the time of the purchase or
sale of the financial instruments, the related hedging activity would
need to comply with written, pre-approved hedging limits for the
trading desk purchasing or selling the financial instrument. These
hedging limits must be appropriate for the size, types, and risks of
the hedging activities commonly undertaken by the trading desk; the
financial instruments purchased and sold by the trading desk for
hedging activities; and the levels and duration of the risk exposures
being hedged. These conditions on the pre-approved limits are intended
to provide clarity as to the types and characteristics of the limits
needed to comply with the final rule. The pre-approved limits should be
reasonable and set to correspond to the type of hedging activity
commonly undertaken and at levels consistent with the hedging activity
undertaken by the trading desk in the normal course.
    The agencies considered comments that suggested additional targeted
modifications to the risk-mitigating hedging requirements, but believe
that the suggested modifications would add additional complexity and
administrative burden without significantly changing the efficiency and
effectiveness of the final rule. Additionally, the agencies believe
that because the final rule maintains significant requirements for
hedging activities to qualify for the exemption, it should not lead to
uncontrollable speculation, as one commenter warned.
4. Section __.6(e): Permitted Trading Activities of a Foreign Banking
Entity
    Section 13(d)(1)(H) of the BHC Act \535\ permits certain foreign
banking entities to engage in proprietary trading that occurs solely
outside of the United States (the foreign trading exemption); \536\
however, the statute does not define when a foreign banking entity's
trading occurs ``solely outside of the United States.'' The 2013 rule
includes several conditions on the availability of the foreign trading
exemption. Specifically, in addition to limiting the exemption to
foreign banking entities where the purchase or sale is made pursuant to
paragraph (9)

[[Page 62014]]

or (13) of Sec.  __.4(c) of the BHC Act,\537\ the 2013 rule provides
that the foreign trading exemption is available only if: \538\
---------------------------------------------------------------------------

    \535\ Section 13(d)(1)(H) of the BHC Act permits trading
conducted by a foreign banking entity pursuant to paragraph (9) or
(13) of section 4(c) of the BHC Act (12 U.S.C. 1843(c)), if the
trading occurs solely outside of the United States, and the banking
entity is not directly or indirectly controlled by a banking entity
that is organized under the laws of the United States or of one or
more States. See 12 U.S.C. 1851(d)(1)(H).
    \536\ This section's discussion of the concept of ``solely
outside of the United States'' is provided solely for purposes of
the rule's implementation of section 13(d)(1)(H) of the BHC Act and
does not affect a banking entity's obligation to comply with
additional or different requirements under applicable securities,
banking, or other laws. Among other differences, section 13 of the
BHC Act does not necessarily include the customer protection,
transparency, anti-fraud, anti-manipulation, and market orderliness
goals of other statutes administered by the agencies. These other
goals or other aspects of those statutory provisions may require
different approaches to the concept of ``solely outside of the
United States'' in other contexts.
    \537\ 12 U.S.C. 1843(c)(9), (13). See 2013 rule Sec. 
__.6(e)(1)(i) and (ii).
    \538\ See 2013 rule Sec.  __.6(e).
---------------------------------------------------------------------------

    (i) The banking entity engaging as principal in the purchase or
sale (including any personnel of the banking entity or its affiliate
that arrange, negotiate, or execute such purchase or sale) is not
located in the United States or organized under the laws of the United
States or of any State.
    (ii) The banking entity (including relevant personnel) that makes
the decision to purchase or sell as principal is not located in the
United States or organized under the laws of the United States or of
any State.
    (iii) The purchase or sale, including any transaction arising from
risk-mitigating hedging related to the instruments purchased or sold,
is not accounted for as principal directly or on a consolidated basis
by any branch or affiliate that is located in the United States or
organized under the laws of the United States or of any State.
    (iv) No financing for the banking entity's purchase or sale is
provided, directly or indirectly, by any branch or affiliate that is
located in the United States or organized under the laws of the United
States or of any State (the financing prong).
    (v) The purchase or sale is not conducted with or through any U.S.
entity,\539\ except if the purchase or sale is conducted:
---------------------------------------------------------------------------

    \539\ ``U.S. entity'' is defined for purposes of this provision
as any entity that is, or is controlled by, or is acting on behalf
of, or at the direction of, any other entity that is, located in the
United States or organized under the laws of the United States or of
any State. See 2013 rule Sec.  __.6(e)(4).
---------------------------------------------------------------------------

    (A) With the foreign operations of a U.S. entity, if no personnel
of such U.S. entity that are located in the United States are involved
in the arrangement, negotiation or execution of such purchase or sale
(the counterparty prong); \540\
---------------------------------------------------------------------------

    \540\ A foreign banking entity wishing to engage in trading
activities with a U.S. entity's foreign affiliate generally must
rely on the counterparty prong.
---------------------------------------------------------------------------

    (B) with an unaffiliated market intermediary acting as principal,
provided the transaction is promptly cleared and settled through a
clearing agency or derivatives clearing organization acting as a
central counterparty; or
    (C) through an unaffiliated market intermediary, provided the
transaction is conducted anonymously (i.e., each party to the
transaction is unaware of the identity of the other party(ies)) on an
exchange or similar trading facility and promptly cleared and settled
through a clearing agency or derivatives clearing organization acting
as a central counterparty.
    Since the adoption of the 2013 rule, foreign banking entities have
asserted that certain of these criteria limit their ability to make use
of the statutory exemption for trading activity that occurs outside of
the United States, which has adversely impacted their foreign trading
operations. Additionally, many foreign banking entities have suggested
that the full set of eligibility criteria to rely on the exemption for
foreign trading activity are unnecessary to accomplish the policy
objectives of section 13 of the BHC Act. This information has raised
concerns that the current requirements for the exemption may be overly
restrictive and not effective in permitting foreign banks to engage in
foreign trading activities consistent with the policy objective of the
statute.
    The proposal would have modified the requirements for the foreign
trading exemption so that it would be more usable by foreign banking
entities. Specifically, the proposal would have retained the first
three requirements of the 2013 rule, with a modification to the first
requirement, and would have removed the last two requirements of Sec. 
__.6(e)(3). As a result, Sec.  __.6(e)(3), as modified by the proposal,
would have required that for a foreign banking entity to be eligible
for this exemption:
    (i) The banking entity engaging as principal in the purchase or
sale (including relevant personnel) is not located in the United States
or organized under the laws of the United States or of any State;
    (ii) The banking entity (including relevant personnel) that makes
the decision to purchase or sell as principal is not located in the
United States or organized under the laws of the United States or of
any State; and
    (iii) The purchase or sale, including any transaction arising from
risk-mitigating hedging related to the instruments purchased or sold,
is not accounted for as principal directly or on a consolidated basis
by any branch or affiliate that is located in the United States or
organized under the laws of the United States or of any State.
    The proposal would have maintained these three requirements in
order to ensure that the banking entity (including any relevant
personnel) that engages in the purchase or sale as principal or makes
the decision to purchase or sell as principal is not located in the
United States or organized under the laws of the United States or any
State. Furthermore, the proposal would have retained the 2013 rule's
requirement that the purchase or sale, including any transaction
arising from a related risk-mitigating hedging transaction, may not be
accounted for as principal by the U.S. operations of the foreign
banking entity. However, the proposal would have replaced the first
requirement that any personnel of the banking entity that arrange,
negotiate, or execute such purchase or sale are not located in the
United States with one that would restrict only the relevant personnel
engaged in the banking entity's decision in the purchase or sale are
not located in the United States.
    Under the proposed approach, the requirements for the foreign
trading exemption focused on whether the banking entity that engages in
or that decides to engage in the purchase or sale as principal
(including any relevant personnel) is located in the United States. The
proposed modifications recognized that some limited involvement by U.S.
personnel (e.g., arranging or negotiating) would be consistent with
this exemption so long as the principal risk and actions of the
purchase or sale do not take place in the United States for purposes of
section 13 of the BHC Act and the implementing regulations.
    The proposal also would have eliminated the financing prong and the
counterparty prong. Under the proposal, these changes would have
focused the key requirements of the foreign trading exemption on the
principal actions and risk of the transaction. In addition, the
proposal would have removed the financing prong to address concerns
that the fungibility of financing has made this requirement in certain
circumstances difficult to apply in practice to determine whether a
particular financing is tied to a particular trade. Market participants
have raised a number of questions about the financing prong and have
indicated that identifying whether financing has been provided by a
U.S. affiliate or branch can be exceedingly complex, in particular with
respect to demonstrating that financing has not been provided by a U.S.
affiliate or branch with respect to a particular transaction. To
address the concerns raised by foreign banking entities and other
market participants, the proposal would have amended the exemption to
focus on the principal risk of a transaction and the location of the
actions as principal and trading decisions, so that a foreign banking
entity would be able to make use of the exemption so long as the risk
of the transaction is booked outside of the United States. While the
agencies

[[Page 62015]]

recognize that a U.S. branch or affiliate that extends financing could
bear some risks, the agencies note that the proposed modifications to
the foreign trading exemption were designed to require that the
principal risks of the transaction occur and remain solely outside of
the United States.
    Similarly, foreign banking entities have communicated to the
agencies that the counterparty prong has been overly difficult and
costly for banking entities to monitor, track, and comply with in
practice. As a result, the agencies proposed to remove the requirement
that any transaction with a U.S. counterparty be executed solely with
the foreign operations of the U.S. counterparty (including the
requirement that no personnel of the counterparty involved in the
arrangement, negotiation, or execution may be located in the United
States) or through an unaffiliated intermediary and an anonymous
exchange. These changes were intended to materially reduce the reported
inefficiencies associated with rule compliance. In addition, market
participants have indicated that this requirement has in practice led
foreign banking entities to overly restrict the range of counterparties
with which transactions can be conducted, as well as disproportionately
burdened compliance resources associated with those transactions,
including with respect to counterparties seeking to do business with
the foreign banking entity in foreign jurisdictions.
    The proposal would have removed the counterparty prong and focused
the requirements of the foreign trading exemption on the location of a
foreign banking entity's decision to trade, action as principal, and
principal risk of the purchase or sale. This proposed focus on the
location of actions and risk as principal in the United States was
intended to align with the statute's definition of ``proprietary
trading'' as ``engaging as principal for the trading account of the
banking entity.'' \541\ The proposal would have scaled back those
requirements that were not critical for this determination and thus
would not be needed in the final rule. Therefore, the proposal would
have removed the requirements of Sec.  __.6(e)(3) since they are less
directly relevant to these considerations.
---------------------------------------------------------------------------

    \541\ See 12 U.S.C. 1851(h)(4) (emphasis added).
---------------------------------------------------------------------------

    Consistent with the 2013 rule, the exemption under the proposal
would not have exempted the U.S. or foreign operations of U.S. banking
entities from having to comply with the restrictions and limitations of
section 13 of the BHC Act. Thus, for example, the U.S. and foreign
operations of a U.S. banking entity that is engaged in permissible
market making-related activities or other permitted activities may
engage in those transactions with a foreign banking entity that is
engaged in proprietary trading in accordance with the exemption under
Sec.  __.6(e) of the 2013 rule, so long as the U.S. banking entity
complies with the requirements of Sec.  __.4(b), in the case of market
making-related activities, or other relevant exemption applicable to
the U.S. banking entity. The proposal, like the 2013 rule, would not
have imposed a duty on the foreign banking entity or the U.S. banking
entity to ensure that its counterparty is conducting its activity in
conformance with section 13 and the implementing regulations. Rather,
that obligation would have been on each party subject to section 13 to
ensure that it is conducting its activities in accordance with section
13 and the implementing regulations.
    The proposal's exemption for trading of foreign banking entities
outside the United States potentially could have given foreign banking
entities a competitive advantage over U.S. banking entities with
respect to permitted activities of U.S. banking entities because
foreign banking entities could trade directly with U.S. counterparties
without being subject to the limitations associated with the market
making-related activities exemption or other exemptions under the rule.
This competitive disparity in turn could create a significant potential
for regulatory arbitrage. In this respect, the agencies sought to
mitigate this concern through other changes in the proposal; for
example, U.S. banking entities would have continued to be able to
engage in all of the activities permitted under the 2013 rule and the
proposal, including the simplified and streamlined requirements for
market making and risk-mitigating hedging and other types of trading
activities.
    In general, commenters supported the proposed changes.\542\
However, a number of commenters requested further modifications to the
foreign trading exemption. For example, some commenters requested that
the agencies clarify the definition of ``relevant personnel'' to mean
employees that conduct risk management, and not the traders or others
associated with executing the transaction.\543\ One commenter requested
clarification that the proposed changes not constrain foreign banking
entities from delegating investment authority to non-affiliated U.S.
investment advisers.\544\ Another commenter supported eliminating the
conduct restriction.\545\ One commenter proposed several additional
modifications, including further simplifying the exemption to only
focus on where the transaction is booked, clarifying certain terms
(e.g., sub-servicing, dark pools, engaging in), and including inter-
affiliate or intra-bank transactions in the exemption.\546\ This
commenter also requested that the agencies include execution as one of
the examples of limited involvement.\547\
---------------------------------------------------------------------------

    \542\ See, e.g., ISDA; IIB; ABA; New England Council; BVI; HSBC;
EBF; Credit Suisse; JBA FSF; and EFAMA.
    \543\ See, e.g., HSBC and JBA.
    \544\ See EFAMA.
    \545\ See HSBC.
    \546\ See JBA.
    \547\ See JBA.
---------------------------------------------------------------------------

    A few commenters opposed the proposed changes to eliminate the
financing and counterparty requirements.\548\ These commenters argued
that the proposed changes might provide foreign entities with a
competitive advantage over domestic entities.\549\ One commenter
asserted that the proposed changes would increase uncertainty and could
increase the exposure of U.S. institutions to foreign proprietary
trading losses.\550\ This commenter also argued that the agencies did
not provide factual data to support the change and that the proposal
was contrary to law.\551\
---------------------------------------------------------------------------

    \548\ See, e.g., Bean; Data Boiler; and Better Markets.
    \549\ See, e.g., Better Markets and FSF.
    \550\ See Bean.
    \551\ See Bean.
---------------------------------------------------------------------------

    After consideration of these comments, the agencies are adopting
the changes to the foreign trading exemption as proposed. The
proposal's modifications in general sought to balance concerns
regarding competitive impact while mitigating the concern that an
overly narrow approach to the foreign trading exemption may cause
market bifurcations, reduce the efficiency and liquidity of markets,
make the exemption overly restrictive to foreign banking entities, and
harm U.S. market participants. The agencies believe that this approach
appropriately balances one of the key objectives of section 13 of the
BHC Act by limiting the risks that proprietary trading poses to the
U.S. financial system, while also modifying the application of section
13 as it applies to foreign banking entities, as required by section
13(d)(1)(H).
    As noted in the preamble to the proposal, the statute contains an
exemption that allows foreign banking entities to engage in trading
activity that is, only for purposes of the prohibitions of the statute,
solely outside the United

[[Page 62016]]

States. The statute also contains a prohibition on proprietary trading
for U.S. banking entities regardless of where their activity is
conducted. The statute generally prohibits U.S. banking entities from
engaging in proprietary trading because of the perceived risks of those
activities to U.S. banking entities and the U.S. financial system. The
modified foreign trading exemption excludes from the statutory
prohibitions transactions where the principal risk is booked outside of
the United States and the actions and decisions as principal occur
outside of the United States by foreign operations of foreign banking
entities. The agencies also are confirming that the foreign trading
exemption does not preclude a foreign banking entity from engaging a
non-affiliated U.S. investment adviser as long as the actions and
decisions of the banking entity as principal occur outside of the
United States. By continuing to limit the risks of foreign banking
entities' proprietary trading activities to the U.S. financial system,
the agencies believe that the rule continues to protect and promote the
safety and soundness of banking entities and the financial stability of
the United States, while also allowing U.S. markets to continue to
operate efficiently in conjunction with foreign markets.

C. Subpart C--Covered Fund Activities and Investments

1. Overview of Agencies' Approach to the Covered Fund Provisions
    The proposal included several proposed revisions to subpart C (the
covered fund provisions). The proposal also sought comments on other
aspects of the covered fund provisions beyond those changes for which
specific rule text was proposed. As described further below, the
agencies have determined to adopt, as proposed, the changes to subpart
C for which specific rule text was proposed. The agencies continue to
consider other aspects of the covered fund provisions on which the
agencies sought comment in the proposal and intend to issue a separate
proposed rulemaking that specifically addresses those areas.
    The proposal sought comment on the 2013 rule's general approach to
defining the term ``covered fund,'' as well as the existing exclusions
from the covered fund definition and potential new exclusions from this
definition. The agencies received numerous comments on these aspects of
the covered fund provisions. Some commenters encouraged the agencies to
make significant revisions to these provisions, such as narrowing the
covered fund ``base definition'' \552\ or providing additional
exclusions from this definition.\553\ Other commenters argued that the
agencies should not narrow the covered fund definition or should retain
the definition in section 13 of the BHC Act.\554\ Some commenters
raised concerns about the agencies' ability to finalize changes to the
covered fund provisions for which the proposal did not provide specific
rule text.\555\ In light of the number and complexity of issues under
consideration, the agencies intend to address these and other comments
received on the covered fund provisions in a subsequent proposed
rulemaking.
---------------------------------------------------------------------------

    \552\ See, e.g., ABA; AIC; Center for American Entrepreneurship;
Goldman Sachs; and JBA.
    \553\ See, e.g., Capital One et al.; Credit Suisse; and SIFMA.
    \554\ See, e.g., AFR and Occupy the SEC.
    \555\ See, e.g., AFR; Bean; and Volcker Alliance.
---------------------------------------------------------------------------

    In this final rule, the agencies are adopting only those changes to
the covered fund provisions for which specific rule text was
proposed.\556\ Those changes are being adopted as final without change
from the proposal for the reasons described below. While the agencies
are not including any other changes to subpart C in this final rule,
this approach does not reflect any final determination with respect to
the comments received on other aspects of the covered fund provisions.
The agencies continue to consider comments received and intend to
address additional aspects of the covered funds provisions in the
future covered funds proposal.
---------------------------------------------------------------------------

    \556\ In addition, consistent with changes described in Part
IV.B.1.b.i of this Supplementary Information, the final rule removes
references to ``guidance'' from subpart C.
---------------------------------------------------------------------------

2. Section __.11: Permitted Organizing and Offering, Underwriting, and
Market Making With Respect to a Covered Fund
    Section 13(d)(1)(B) of the BHC Act permits a banking entity to
purchase and sell securities and other instruments described in section
13(h)(4) of the BHC Act in connection with the banking entity's
underwriting or market making-related activities.\557\ The 2013 rule
provides that the prohibition against acquiring or retaining an
ownership interest in or sponsoring a covered fund does not apply to a
banking entity's underwriting or market making-related activities
involving a covered fund as long as:
---------------------------------------------------------------------------

    \557\ 12 U.S.C. 1851(d)(1)(B).
---------------------------------------------------------------------------

     The banking entity conducts the activities in accordance
with the requirements of the underwriting exemption in Sec.  __.4(a) of
the 2013 rule or market making exemption in Sec.  __.4(b) of the 2013
rule, respectively.
     The banking entity includes the aggregate value of all
ownership interests of the covered fund acquired or retained by the
banking entity and its affiliates for purposes of the limitation on
aggregate investments in covered funds (the aggregate-fund limit) \558\
and capital deduction requirement; \559\ and
---------------------------------------------------------------------------

    \558\ 2013 rule Sec.  __.12(a)(2)(iii).
    \559\ 2013 rule Sec.  __.12(d).
---------------------------------------------------------------------------

     The banking entity includes any ownership interest that it
acquires or retains for purposes of the limitation on investments in a
single covered fund (the per-fund limit) if the banking entity (i) acts
as a sponsor, investment adviser or commodity trading adviser to the
covered fund; (ii) otherwise acquires and retains an ownership interest
in the covered fund in reliance on the exemption for organizing and
offering a covered fund in Sec.  __.11(a) of the 2013 rule; (iii)
acquires and retains an ownership interest in such covered fund and is
either a securitizer, as that term is used in section 15G(a)(3) of the
Exchange Act, or is acquiring and retaining an ownership interest in
such covered fund in compliance with section 15G of that Act and the
implementing regulations issued thereunder, each as permitted by Sec. 
__.11(b) of the 2013 rule; or (iv) directly or indirectly, guarantees,
assumes, or otherwise insures the obligations or performance of the
covered fund or of any covered fund in which such fund invests.\560\
---------------------------------------------------------------------------

    \560\ See 2013 rule Sec.  __.11(c).
---------------------------------------------------------------------------

    The proposal would have removed the requirement that the banking
entity include for purposes of the aggregate fund limit and capital
deduction the value of any ownership interests of a third-party covered
fund (i.e., covered funds that the banking entity does not advise or
organize and offer pursuant to Sec.  __.11 of the final rule) acquired
or retained in accordance with the underwriting or market-making
exemptions in Sec.  __.4. Under the proposal, these limits, as well as
the per-fund limit, would have applied only to a covered fund that the
banking entity organizes or offers and in which the banking entity
acquires or retains an ownership interest pursuant to Sec.  __.11(a) or
(b) of the 2013 rule. The agencies proposed this change to more closely
align the requirements for engaging in underwriting or market-making-
related activities with respect to ownership interests in a covered
fund with the requirements for engaging in these activities with
respect to other financial instruments.

[[Page 62017]]

    Several commenters supported eliminating these requirements for
underwriting and market making in ownership interests in covered
funds.\561\ Many of these commenters said this proposal would reduce
the compliance burden for banking entities engaged in client-facing
underwriting and market making activities and would facilitate these
permitted activities.\562\ One of these commenters noted in particular
the difficulties for banking entities to determine whether a third-
party fund is a covered fund subject to the limits of the 2013 rule and
to determine with certainty whether certain non-U.S. securities may be
issued by covered funds.\563\ Some of these commenters argued that
providing underwriting and market making in the interests in such funds
increases liquidity and benefits the marketplace generally.\564\ One of
these commenters also stated that this would facilitate capital-raising
activities of covered funds and other issuers.\565\ Other commenters
opposed this change because they believed that it would greatly expand
banking entities' ability to hold ownership interests in covered
funds,\566\ and is contrary to section 13 of the BHC Act.\567\
---------------------------------------------------------------------------

    \561\ See, e.g., ABA; BPI; FSF; Goldman Sachs; IIB; ISDA; and
SIFMA.
    \562\ See, e.g., BPI; FSF; ISDA; and SIFMA.
    \563\ See SIFMA.
    \564\ See ISDA.
    \565\ See SIFMA.
    \566\ See, e.g., AFR; Bean; and Volcker Alliance.
    \567\ See Bean.
---------------------------------------------------------------------------

    Several commenters supported making additional revisions to Sec. 
__.11 by eliminating the aggregate fund limit and capital deduction for
other funds, such as affiliated funds or sponsored funds \568\ and
advised funds.\569\ Certain of these commenters argued that
underwriting and market making in interests in these covered funds
would not expose banking entities to greater risk because ownership
interests in such funds acquired in accordance with the risk-mitigating
hedging, market-making or underwriting exemptions would nevertheless be
subject to the restrictions contained in those exemptions.\570\
---------------------------------------------------------------------------

    \568\ See ISDA.
    \569\ See, e.g., BPI; ISDA; and SIFMA.
    \570\ See, e.g., BPI and ISDA.
---------------------------------------------------------------------------

    The agencies are eliminating the aggregate fund limit and the
capital deduction requirement for the value of ownership interests in
third-party covered funds acquired or retained in accordance with the
underwriting or market-making exemption (i.e., covered funds that the
banking entity does not advise or organize and offer pursuant to Sec. 
__.11(a) or (b) of the final rule).\571\ The agencies believe this
change will better align the compliance requirements for underwriting
and market making involving covered funds with the risks those
activities entail. In particular, the agencies understand that it has
been difficult for banking entities to determine whether ownership
interests in covered funds are being acquired or retained in the
context of trading activities, especially for non-U.S. issuers. Banking
entities have had to undertake an often time-consuming process to
determine whether an issuer is a covered fund and the security issued
is an ownership interest, all for the purpose of ensuring compliance
with the aggregate fund limit and capital deduction requirement for the
period of time that the banking entity holds the ownership interest as
part of its otherwise permissible underwriting and market making
activities.\572\ These compliance challenges are heightened in the case
of third-party funds. However, a banking entity can more readily
determine whether a fund is a covered fund if the banking entity
advises or organizes and offers the fund. Thus, the agencies are not
eliminating the aggregate fund limit and capital deduction requirement
for advised covered funds or covered funds that the banking entity
organizes or offers. The agencies continue to consider whether the
approach being adopted in the final rule may be extended to other
issuers, such as funds advised by the banking entity, and intend to
address and request additional comment on this issue in the future
proposed rulemaking.
---------------------------------------------------------------------------

    \571\ As in the proposal, this requirement is also eliminated
for underwriting and market-making activities involving funds with
respect to which the banking entity directly or indirectly,
guarantees, assumes, or otherwise insures the obligations or
performance of the covered fund or of any covered fund in which such
fund invests. Such funds are not organized and offered pursuant to
Sec.  __.11(a) or (b) of the final rule and thus treatment as a
third-party fund is more appropriate for purposes of the
underwriting and market-making exemption for covered funds. The
agencies note, however, that other provisions of section 13 of the
BHC Act, as well as other laws and regulations, limit banking
entities' ability to guarantee, assume, or otherwise insure the
obligations or performance of covered funds. See 12 U.S.C. 1851(f);
12 U.S.C. 1851(d)(2); Sec. Sec.  __.14 and __.15 of the final rule.
See also 12 CFR 7.1017 (limiting authority of national bank to act
as a guarantor).
    \572\ See SIFMA.
---------------------------------------------------------------------------

    The agencies disagree with the commenter who argued that
eliminating the aggregate fund limit and capital deduction is contrary
to section 13 of the BHC Act.\573\ An exemption from the prohibition on
acquiring or retaining an ownership interest in a covered fund for
underwriting and market making involving covered fund ownership
interests is consistent with and supported by section 13 of the BHC
Act.\574\ Section 13(d)(1)(B) provides a statutory exemption for
underwriting and market making activities and, by its terms, applies to
both prohibitions in section 13(a), whether on proprietary trading or
covered fund activities. Section 13 does not require any per-fund or
aggregate limits, or capital deduction, with respect to covered fund
ownership interests acquired pursuant to the underwriting and market
making exemption in section 13(d)(1)(B), and eliminating these
requirements with respect to third-party funds will improve the
effectiveness of the statutory exemption for these activities.\575\
---------------------------------------------------------------------------

    \573\ See Bean.
    \574\ See 79 FR 5535, 5722.
    \575\ The quantitative limits and capital deduction requirements
in 12 U.S.C. 1851(d)(4)(B) are required to apply only in the case of
seeding investments and other de minimis investments made pursuant
to 12 U.S.C. 1851(d)(4)(B).
---------------------------------------------------------------------------

    The agencies also disagree with commenters who asserted that this
change will greatly expand banking entities' ability to hold ownership
interests in covered funds.\576\ This exemption for underwriting and
market making involving ownership interests in covered funds applies
only to underwriting and market making activities conducted pursuant to
the requirements in section 13(d)(1)(B) of the BHC Act and Sec.  __.4
of the final rule. This exemption is intended to allow banking entities
to engage in permissible underwriting and market making involving
covered fund ownership interests to the same extent as other financial
instruments. It is also intended to increase the effectiveness of the
underwriting and market making exemptions in Sec.  __.4 by
appropriately limiting the covered fund determinations a banking entity
must make in the course of these permissible activities. For these
reasons, and to limit the potential for evasion, the exemption for
underwriting and market making involving ownership interests in covered
funds continues to apply only to activities that satisfy the
requirements of the underwriting or market making exemptions in Sec. 
__.4.
---------------------------------------------------------------------------

    \576\ See, e.g., AFR; Bean; and Volcker Alliance.
---------------------------------------------------------------------------

    One commenter argued that the aggregate fund limit should apply
only at the global consolidated level for all firms.\577\ This
commenter argued that measuring aggregate covered fund ownership at the
parent-level is a better test of immateriality than measuring covered
fund investments at a lower level, such as at the level of an

[[Page 62018]]

intermediate holding company.\578\ This commenter also said the
agencies should expand the per-fund limit to allow bank-affiliated
securitization investment managers to rely on applicable foreign risk
retention regulations as a basis for exceeding the three percent per-
fund limitation, provided that those foreign regulations are generally
comparable to U.S. requirements.\579\ Another commenter asserted that
the preamble to the 2013 rule indicated that direct investments made
alongside a covered fund should be aggregated for purposes of the per-
fund limit in certain circumstances.\580\ This commenter asked the
agencies to clarify that the 2013 rule does not prohibit banking
entities from making direct investments alongside covered funds,
regardless of whether the fund is sponsored or the investments are
coordinated, so long as such investments are otherwise authorized for
such banking entities (e.g., under merchant banking authority). The
agencies continue to consider these issues. As noted above, the
agencies expect to address and request additional comments on these and
other covered fund provisions in the future proposed rulemaking.
---------------------------------------------------------------------------

    \577\ See Credit Suisse.
    \578\ Id.
    \579\ Id.
    \580\ See Goldman Sachs.
---------------------------------------------------------------------------

3. Section __.13: Other Permitted Covered Fund Activities
a. Permitted Risk-Mitigating Hedging
    Section 13(d)(1)(C) of the BHC Act provides an exemption for risk-
mitigating hedging activities in connection with and related to
individual or aggregated positions, contracts, or other holdings of a
banking entity that are designed to reduce the specific risks to the
banking entity in connection with and related to such positions,
contracts, or other holdings.\581\ As described in the preamble to the
proposal, the 2013 rule implemented this authority narrowly in the
context of covered fund activities. Specifically, the 2013 rule
permitted only limited risk-mitigating hedging activities involving
ownership interests in covered funds for hedging employee compensation
arrangements.
---------------------------------------------------------------------------

    \581\ 12 U.S.C. 1851(d)(1)(C).
---------------------------------------------------------------------------

    Like the proposal, the final rule allows a banking entity to
acquire or retain an ownership interest in a covered fund as a hedge
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. This provision is consistent
with the agencies' original 2011 proposal.\582\
---------------------------------------------------------------------------

    \582\ See 83 FR at 33483-84.
---------------------------------------------------------------------------

    The proposal also would have amended Sec.  __.13(a) to align with
the proposed modifications to Sec.  __.5. In particular, the proposal
would have required that a risk-mitigating hedging transaction pursuant
to Sec.  __.13(a) be designed to reduce or otherwise significantly
mitigate one or more specific, identifiable risks to the banking
entity. It would have removed the requirement that the hedging
transaction ``demonstrably'' reduces or otherwise significantly
mitigates the relevant risks, consistent with the proposed
modifications to Sec.  __.5.\583\
---------------------------------------------------------------------------

    \583\ See supra Part IV.B.3.b.ii.
---------------------------------------------------------------------------

    Several commenters supported permitting banking entities to acquire
and retain ownership interests in covered funds as a hedge when acting
as intermediary on behalf of a customer.\584\ Certain of these
commenters argued that acquiring or retaining ownership interests in
covered funds for this purpose (fund-linked products) is beneficial
because it accommodates banking entities' client facilitation and
related risk management activities.\585\ Two commenters noted that
restricting institutions' ability to find the best hedge for a
transaction may increase risks to safety and soundness and, conversely,
permitting banking entities to use the best available hedge for risks
arising from customer facilitation activities would promote safety and
soundness and reduce risk.\586\ Several of these commenters also argued
that fund-linked products are not a high-risk trading strategy.\587\
For example, one commenter argued that the magnitude of counterparty
default risk that banking entities would face in acquiring or retaining
a covered fund ownership interest under these circumstances (i.e., to
hedge a position by the banking entity when acting as intermediary on
behalf of a customer that is not itself a banking entity to facilitate
exposure by the customer to a covered fund) is no different than any
other counterparty default risk that banking entities face when
entering into other risk-mitigating hedges.\588\ Other commenters
opposed this change and noted that, at the time the 2013 rule was
adopted, the agencies considered acting as principal in providing
exposure to the profits and losses of a covered fund for a customer,
even if hedged by the banking entity with ownership interests of the
covered fund, to constitute a high-risk trading strategy.\589\ One
commenter stated that the proposal did not offer specific examples or
explain why such fund-linked products are necessary.\590\ Another
commenter argued that the exemption for risk-mitigating hedging
involving ownership interests in covered funds should be further
restricted or completely removed from the rule.\591\
---------------------------------------------------------------------------

    \584\ See, e.g., ABA; BPI; FSF; Goldman Sachs; IIB; ISDA; SIFMA;
and IIB.
    \585\ See, e.g., BPI and FSF.
    \586\ See, e.g., FSF and SIFMA.
    \587\ See, e.g., FSF; ISDA; and SIFMA.
    \588\ See FSF.
    \589\ See, e.g., AFR and Volcker Alliance.
    \590\ See AFR.
    \591\ See Occupy the SEC.
---------------------------------------------------------------------------

    The final rule adopts the proposed revision without change. This
exemption is tailored to permit bona fide customer facilitation
activities and to limit the risk incurred directly by the banking
entity. The new exemption in Sec.  __.13(a) extends only to a position
taken by the banking entity when 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. The
banking entity's acquisition or retention of the ownership interest as
a hedge must be designed to reduce or otherwise significantly mitigate
one or more specific, identifiable risks arising out of a transaction
conducted solely to accommodate a specific customer request with
respect to the covered fund. As a result, a transaction conducted in
reliance on this exemption must be customer-driven. A banking entity
cannot rely on this exemption to solicit customer transactions in order
to facilitate the banking entity's own exposure to a covered fund.
    As some commenters noted, in the preamble to the 2013 rule, the
agencies stated that they were not adopting an exemption for customer
facilitation activities and related hedging activities involving
ownership interests in covered funds because these activities could
potentially expose a banking entity to the types of risks that section
13 of the BHC Act sought to address. However, in light of other
comments received,\592\ the agencies do not believe that a banking
entity's customer facilitation activities and related hedging
activities involving ownership interests in covered funds necessarily
constitute high-risk trading strategies that could threaten the safety
and soundness of the banking entity. The agencies believe that,
properly monitored and managed, these activities can be conducted
without creating a greater degree of risk to the banking entity than
the other customer facilitation activities permitted by the

[[Page 62019]]

final rule.\593\ In particular, these activities remain subject to all
of the final rule's requirements for risk-mitigating hedging
transactions, including requirements that such transactions must:
---------------------------------------------------------------------------

    \592\ See, e.g., FSF; ISDA; and SIFMA.
    \593\ See, e.g., final rule Sec.  __.3(d)(11).
---------------------------------------------------------------------------

     Be designed to reduce or otherwise significantly mitigate
the specific, identifiable risks to the banking entity;
     be made in accordance with the banking entity's written
policies, procedures and internal controls;
     not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with the risk-mitigating hedging
requirements; and
     be subject to continuing review, monitoring and management
by the banking entity.\594\
---------------------------------------------------------------------------

    \594\ See final rule Sec.  __.13.
---------------------------------------------------------------------------

    In addition, these activities remain subject to Sec.  __.15 of the
final rule and, therefore, to the extent they would in practice
significantly increase the likelihood that the banking entity would
incur a substantial financial loss or would pose a threat to the
financial stability of the United States, they would not be
permissible. The agencies are also adopting without change the
amendment to align Sec.  __.13(a) with Sec.  __.5 by eliminating the
requirement that a risk-mitigating hedging transaction ``demonstrably''
reduces or otherwise significantly mitigates the relevant risks. The
agencies are adopting this amendment to Sec.  __.13(a) for the same
reason the agencies are adopting the amendment to Sec.  __.5.
b. Permitted Covered Fund Activities and Investments Outside of the
United States
    Section 13(d)(1)(I) of the BHC Act permits foreign banking entities
to acquire or retain an ownership interest in, or act as sponsor to, a
covered fund, so long as those activities and investments occur solely
outside the United States and certain other conditions are met (the
foreign fund exemption).\595\ Section 13 of the BHC Act does not
further define ``solely outside of the United States'' (SOTUS).
---------------------------------------------------------------------------

    \595\ Section 13(d)(1)(I) of the BHC Act permits a banking
entity to acquire or retain an ownership interest in, or have
certain relationships with, a covered fund notwithstanding the
restrictions on investments in, and relationships with, a covered
fund, if: (i) Such activity or investment is conducted by a banking
entity pursuant to paragraph (9) or (13) of section 4(c) of the BHC
Act; (ii) the activity occurs solely outside of the United States;
(iii) no ownership interest in such fund is offered for sale or sold
to a resident of the United States; and (iv) the banking entity is
not directly or indirectly controlled by a banking entity that is
organized under the laws of the United States or of one or more
States. See 12 U.S.C. 1851(d)(1)(I).
---------------------------------------------------------------------------

    The 2013 rule established several conditions on the availability of
the foreign fund exemption. Specifically, the 2013 rule provided that
an activity or investment occurs solely outside the United States for
purposes of the foreign fund exemption only if:
     The banking entity acting as sponsor, or engaging as
principal in the acquisition or retention of an ownership interest in
the covered fund, is not itself, and is not controlled directly or
indirectly by, a banking entity that is located in the United States or
organized under the laws of the United States or of any State;
     The banking entity (including relevant personnel) that
makes the decision to acquire or retain the ownership interest or act
as sponsor to the covered fund is not located in the United States or
organized under the laws of the United States or of any State;
     The investment or sponsorship, including any transaction
arising from risk-mitigating hedging related to an ownership interest,
is not accounted for as principal directly or indirectly on a
consolidated basis by any branch or affiliate that is located in the
United States or organized under the laws of the United States or of
any State; and
     No financing for the banking entity's ownership or
sponsorship is provided, directly or indirectly, by any branch or
affiliate that is located in the United States or organized under the
laws of the United States or of any State (the ``financing
prong'').\596\
---------------------------------------------------------------------------

    \596\ See final rule Sec.  __.13(b)(4).
---------------------------------------------------------------------------

    Much like the similar requirement under the exemption for permitted
trading activities of a foreign banking entity, the proposal would have
removed the financing prong of the foreign fund exemption, while
leaving in place the other requirements for an activity or investment
to be considered ``solely outside of the United States.'' Removing the
financing prong was intended to streamline the requirements of the
foreign fund exemption with the intention of improving implementation
of the statutory exemption.
    Several commenters supported removing the financing prong from the
foreign fund exemption.\597\ One commenter argued that this change
would appropriately refocus the foreign fund exemption on the location
of the activities of the banking entity as principal.\598\ Another
commenter argued that the proposed changes to the foreign fund
exemption, including removal of the financing prong, could promote
international regulatory cooperation.\599\ Other commenters argued
against eliminating the financing prong because it could result in a
U.S. branch or affiliate that extends financing to bear some
risks.\600\
---------------------------------------------------------------------------

    \597\ See, e.g., BPI; BVI; EBF; IIB; JBA; and New England
Council.
    \598\ See EBF.
    \599\ See BPI.
    \600\ See, e.g., Better Markets and CAP.
---------------------------------------------------------------------------

    The agencies are adopting the proposal to remove the financing
prong for the same reasons described above in section IV.B.4 for the
trading outside of the United States exemption. This change focuses one
of the key requirements of the foreign fund exemption on the principal
actions and risk of the transaction. Removing the financing prong would
also address concerns that the fungibility of financing has made this
requirement in certain circumstances difficult to apply in practice to
determine whether a particular financing is tied to a particular
activity or investment. Eliminating the financing prong, while
retaining the other prongs of the foreign fund exemption, strikes a
better balance between the risks posed to U.S. banking entities and the
U.S. financial system, on the one hand, and effectuating the statutory
exemption for activities conducted solely outside of the United States,
on the other. The agencies note that a U.S. banking entity's affiliate
lending activities remain subject to other laws and regulations--
including sections 23A and 23B of the Federal Reserve Act and
prudential safety and soundness standards, as applicable.
    One of the restrictions of the statutory exemption for covered fund
activities conducted by foreign banking entities solely outside the
United States is the restriction that ``no ownership interest in such
hedge fund or private equity fund is be offered for sale or sold to a
resident of the United States.\601\ To implement this restriction,
Sec.  __.13(b) of the 2013 rule requires, as one condition of the
foreign fund exemption, that ``no ownership interest in the covered
fund is offered for sale or sold to a resident of the United States''
(the ``marketing restriction'').\602\
---------------------------------------------------------------------------

    \601\ See 12 U.S.C. 1851(d)(1)(I).
    \602\ See final rule Sec.  __.13(b)(1)(iii).
---------------------------------------------------------------------------

    The final rule, like the proposal, clarifies that an ownership
interest in a covered fund is not offered for sale or sold to a
resident of the United States for purposes of the marketing restriction
only if it is not sold and has not been sold pursuant to an offering
that targets residents of the United States in which the banking entity
or any affiliate of the banking entity participates. The final

[[Page 62020]]

rule, like the proposal, also clarifies that if the banking entity or
an affiliate sponsors or serves, directly or indirectly, as the
investment manager, investment adviser, commodity pool operator, or
commodity trading advisor to a covered fund, then the banking entity or
affiliate will be deemed for purposes of the marketing restriction to
participate in any offer or sale by the covered fund of ownership
interests in the covered fund.\603\ This revision adopts existing staff
guidance addressing this issue.\604\ Several commenters supported this
clarification.\605\ Some commenters argued that this clarification
appropriately excludes from the marketing restriction those activities
where the risk occurs and remains outside of the United States and
reflects the intended extraterritorial limitations of the section 13 of
the BHC Act.\606\ In addition, commenters stated that codifying the
previously issued staff guidance will provide greater clarity and
certainty for non-U.S. banking entities making investments in third
party funds (i.e., covered funds that the banking entity does not
advise or organize and offer pursuant to Sec.  __.11(a) or (b) of the
final rule) and will enable long-term strategies in reliance on this
provision.\607\
---------------------------------------------------------------------------

    \603\ See proposal Sec.  __.13(b)(3).
    \604\ See supra note 59, FAQ 13.
    \605\ See, e.g., AIC; BPI; BVI; IIB; and EBF.
    \606\ See, e.g., EBF and IIB.
    \607\ See, e.g., AIC; BPI; and BVI.
---------------------------------------------------------------------------

    The agencies are adopting this clarification as proposed to
formally incorporate the existing staff guidance. As staff noted in the
previous staff guidance, the marketing restriction constrains the
foreign banking entity in connection with its own activities with
respect to covered funds rather than the activities of unaffiliated
third parties.\608\ This ensures that the foreign banking entity
seeking to rely on the foreign fund exemption does not engage in an
offering of ownership interests that targets residents of the United
States. This clarification limits the extraterritorial application of
section 13 to foreign banking entities while seeking to ensure that the
risks of covered fund investments by foreign banking entities occur and
remain solely outside of the United States. If the marketing
restriction were applied to the activities of third parties, such as
the sponsor of a third-party covered fund (rather than the foreign
banking entity investing in a third-party covered fund), the foreign
fund exemption may not be available in certain circumstances even
though the risks and activities of a foreign banking entity with
respect to its investment in the covered fund are solely outside the
United States.
---------------------------------------------------------------------------

    \608\ See supra note 59, FAQ 13.
---------------------------------------------------------------------------

    One commenter asked the agencies to clarify that the requirement
that the banking entity (including the relevant personnel) that makes
the decision ``to acquire or retain the ownership interest or act as
sponsor to the covered fund'' must not be located in the United States
does not prohibit non-U.S. investment funds from utilizing the
expertise of U.S. investment advisers under delegation agreements.\609\
This commenter noted that a foreign investment fund may appoint a
qualified U.S. investment adviser for providing investment management
or investment advisory services under delegation but that the ultimate
responsibility for the investment decisions and compliance with
statutory and contractual investment limits remains with the foreign
management company that manages the foreign investment fund. As stated
in the preamble to the 2013 rule, the foreign fund exemption permits
the U.S. personnel and operations of a foreign banking entity to act as
investment adviser to a covered fund in certain circumstances. For
example, the U.S. personnel of a foreign banking entity may provide
investment advice and recommend investment selections to the manager or
general partner of a covered fund so long as the investment advisory
activity in the United States does not result in U.S. personnel
participating in the control of the covered fund or offering or selling
an ownership interest to a resident of the United States.\610\
Consistent with the foreign trading exemption, as discussed above,\611\
the agencies also are confirming that under the final rule, the foreign
fund exemption does not preclude a foreign banking entity from engaging
a non-affiliated U.S. investment adviser as long as the actions and
decisions of the banking entity as principal occur outside of the
United States. The agencies intend to address and request further
comment on additional covered fund issues in a future proposed
rulemaking.
---------------------------------------------------------------------------

    \609\ See BVI.
    \610\ 79 FR at 5741.
    \611\ See supra Part IV.B.4.
---------------------------------------------------------------------------

4. Section __.14: Limitations on Relationships With a Covered Fund
a. Relationships With a Covered Fund
    Section 13(f) of the BHC Act provides that, with limited
exceptions, no banking entity that serves, directly or indirectly, as
the investment manager, investment adviser, or sponsor to a hedge fund
or private equity fund, or that organizes and offers a hedge fund or
private equity fund pursuant to section 13(d)(1)(G), and no affiliate
of such entity, may enter into a transaction with the fund, or with any
other hedge fund or private equity fund that is controlled by such
fund, that would be a ``covered transaction,'' as defined in section
23A of the Federal Reserve Act, as if such banking entity and the
affiliate thereof were a member bank and the hedge fund or private
equity fund were an affiliate thereof.\612\ The 2013 rule includes this
prohibition as well.\613\ The proposal included a request for comment
regarding the restrictions in section 13(f) of the BHC Act and Sec. 
__.14 of the 2013 rule. As with the other covered fund issues for which
no specific rule text was proposed, the agencies continue to consider
the prohibition in section 13(f) of the BHC Act and intend to issue a
separate proposed rulemaking that addresses this issue.
---------------------------------------------------------------------------

    \612\ See U.S.C. 1851(f)(1).
    \613\ See final rule Sec.  __.14(a)(1).
---------------------------------------------------------------------------

b. Prime Brokerage Transactions
    Section 13(f) of the BHC Act provides an exemption from the
prohibition on covered transactions with a hedge fund or private equity
fund for any prime brokerage transaction with a hedge fund or private
equity fund in which a hedge fund or private equity fund managed,
sponsored, or advised by a banking entity has taken an ownership
interest (a second-tier fund).\614\ The statute by its terms permits a
banking entity with a relationship to a hedge fund or private equity
fund described in section 13(f) of the BHC Act to engage in prime
brokerage transactions (that are covered transactions) only with
second-tier funds and does not extend to hedge funds or private equity
funds more generally.\615\ Under the statute, the exemption for prime
brokerage transactions is available only so long as certain enumerated
conditions are satisfied.\616\ The 2013 rule included this exemption as
well and similarly required satisfaction of certain enumerated
conditions in order for a banking entity to engage in permissible prime
brokerage transactions.\617\ The

[[Page 62021]]

2013 rule's conditions are that (i) the banking entity is in compliance
with each of the limitations set forth in[thinsp]Sec.  __.11 of the
2013 rule with respect to a covered fund organized and offered by the
banking entity or any of its affiliates; (ii) the CEO (or equivalent
officer) of the banking entity certifies in writing annually that the
banking entity does not, directly or indirectly, guarantee, assume, or
otherwise insure the obligations or performance of the covered fund or
of any covered fund in which such covered fund invests; and (iii) the
Board has not determined that such transaction is inconsistent with the
safe and sound operation and condition of the banking entity.
---------------------------------------------------------------------------

    \614\ See U.S.C. 1851(f)(3).
    \615\ Neither the statute nor the proposal limits covered
transactions between a banking entity and a covered fund for which
the banking entity does not serve as investment manager, investment
adviser, or sponsor (as defined in section 13 of the BHC Act) or
have an interest in reliance on section 13(d)(1)(G) of the BHC Act.
Similarly, the final rule does not limit such covered transactions.
    \616\ See 12 U.S.C. 1851(f)(3).
    \617\ See final rule Sec.  __.14(a)(2)(ii).
---------------------------------------------------------------------------

    The proposal retained each of the 2013 rule's conditions for the
prime brokerage exemption described above, including the requirement
that certification be made to the appropriate agency for the banking
entity.\618\ Staffs of the agencies previously issued guidance
explaining when a banking entity was required to provide this
certification during the conformance period.\619\ The proposal
incorporated this guidance into the rule text by requiring banking
entities to provide the CEO certification annually no later than March
31 of the relevant year.\620\ This change was intended to provide
banking entities with certainty about when the required certification
must be provided to the appropriate agency in order to comply with the
prime brokerage exemption. As under the 2013 rule, under the proposal,
the CEO would have a duty to update the certification if the
information in the certification materially changes at any time during
the year when he or she becomes aware of the material change.\621\
---------------------------------------------------------------------------

    \618\ See 83 FR at 33486-87.
    \619\ See supra note 59, FAQ 18.
    \620\ See 83 FR at 33487.
    \621\ This duty to update the certification is required as a
condition of the statutory exemption. See 12 U.S.C.
1851(f)(3)(A)(ii).
---------------------------------------------------------------------------

    One commenter recommended that the agencies expressly state that
the CEO certification for purposes of the prime brokerage exemption is
based on a reasonable review by the CEO and is made based on the
knowledge and reasonable belief of the CEO.\622\ That commenter also
requested that the agencies clarify that the term ``prime brokerage
transaction'' includes transactions and services commonly provided in
connection with prime brokerage transactions, as described under the
2013 rule, including: (1) Lending and borrowing of financial assets,
(2) provision of secured financing collateralized by financial assets,
(3) repurchase and reverse repurchase of financial assets, (4)
derivatives, (5) clearance and settlement of transactions, (6) ``give-
up'' agreements, and (7) purchase and sale of financial assets from
inventory.\623\ Similarly, another commenter requested that the
agencies clarify that the term ``prime brokerage transaction'' applies
to any transaction provided in connection with custody, clearance and
settlement, securities borrowing or lending services, trade execution,
financing, or data, operational, and administrative support regardless
of which business line within the banking entity conducts the
business.\624\ The same commenter suggested that any prime brokerage
transaction with a second-tier covered fund should be presumed to
comply with section __.14 of the rule and the prime brokerage exemption
as long as it is executed in compliance with the requirements of
Section 23B of the Federal Reserve Act.\625\ In addition, one commenter
recommended limiting the prime brokerage exemption by, for instance,
excluding financing and securities lending and borrowing from the prime
brokerage exemption.\626\
---------------------------------------------------------------------------

    \622\ See SIFMA.
    \623\ See id.
    \624\ See ABA.
    \625\ See id.
    \626\ See Occupy the SEC.
---------------------------------------------------------------------------

    The final rule adopts the proposed revision to the prime brokerage
exemption with no changes. The agencies believe that codifying a
deadline for CEO certification with respect to prime brokerage
transactions will provide banking entities with greater certainty and
facilitate supervision and review of the prime brokerage exemption.
With respect to the other issues raised by commenters regarding the
prime brokerage exemption in section 13(f) of the BHC Act, the agencies
continue to consider these issues and intend to issue a separate
proposed rulemaking that specifically addresses these issues.

D. Subpart D--Compliance Program Requirement; Violations

1. Section __.20: Program for Compliance; Reporting
    Section __.20 of the 2013 rule contains compliance program and
metrics collection and reporting requirements. The 2013 rule was
intended to focus the most significant compliance obligations on the
largest and most complex organizations, while minimizing the economic
impact on small banking entities.\627\ To this end, the 2013 rule
included a simplified compliance program for small banking entities and
banking entities that did not engage in extensive trading
activity.\628\ However, as the agencies noted in the proposal, public
feedback has indicated that even determining whether a banking entity
is eligible for the simplified compliance program could require
significant analysis for small banking entities. In addition, certain
traditional banking activities of small banks fall within the scope of
the proprietary trading and covered fund prohibitions and exemptions,
making banks engaging in these activities ineligible for the simplified
compliance program. As the agencies noted in the proposal, public
feedback has also indicated that the compliance program requirements
are unduly burdensome for larger banking entities that must implement
the rule's enhanced compliance program, metrics, and CEO attestation
requirements. Accordingly, the agencies proposed to revise the
compliance program requirements to allow greater flexibility for
banking entities in integrating the Volcker compliance and exemption
requirements into existing compliance programs and to focus the
requirements on the banking entities with the most significant and
complex activities.
---------------------------------------------------------------------------

    \627\ See 79 FR 5753.
    \628\ Banking entities did not have any compliance program
obligations under the 2013 rule if they do not engage in any covered
activities other than trading in certain government, agency, State
or municipal obligations. Sec.  __20(f)(1). Additionally, banking
entities with $10 billion or less in total consolidated assets could
satisfy the compliance program requirements under the 2013 rule by
including appropriate references to the requirements of section 13
of the BHC Act and the implementing regulations in their existing
policies and procedures. Sec.  __.20(f)(2).
---------------------------------------------------------------------------

    Specifically, the agencies proposed applying the compliance program
requirement to banking entities as follows:
     Banking entities with significant trading assets and
liabilities. Banking entities with significant trading assets and
liabilities would have been subject to the six-pillar compliance
program requirement (Sec.  __.20(b) of the 2013 rule), the metrics
reporting requirements (Sec.  __.20(d) of the 2013 rule),\629\ the
covered fund documentation requirements (Sec.  __.20(e) of the 2013
rule), and the CEO attestation

[[Page 62022]]

requirement (Appendix B of the 2013 rule).\630\
---------------------------------------------------------------------------

    \629\ As discussed below, the proposal would have amended the
Appendix A metrics requirements to reduce compliance-related
inefficiencies while allowing for the collection of data to permit
the agencies to better monitor compliance with section 13 of the BHC
Act. In addition, the proposal would have eliminated Appendix B of
the 2013 rule, which would have resulted in Appendix A being re-
designated as the ``Appendix.''
    \630\ Although the proposal would have eliminated Appendix B, as
noted above, it would have continued to apply a modified version of
the CEO attestation to banking entities without limited trading
assets and liabilities.
---------------------------------------------------------------------------

     Banking entities with moderate trading assets and
liabilities. Banking entities with moderate trading assets and
liabilities would have been required to establish the simplified
compliance program (described in Sec.  __.20(f)(2) of the 2013 rule)
and comply with the CEO attestation requirement.
     Banking entities with limited trading assets and
liabilities. Banking entities with limited trading assets and
liabilities would have been presumed to be in compliance with the
proposal and would have had no obligation to demonstrate compliance
with subpart B and subpart C of the implementing regulations on an
ongoing basis. These banking entities would not have been required to
demonstrate compliance with the rule unless and until the appropriate
agency, based upon a review of the banking entity's activities,
determined that the banking entity should have been treated as if it
did not have limited trading assets and liabilities.
    After reviewing all of the comments to this section, the agencies
are finalizing these changes largely as proposed, except for further
tailoring application of the CEO attestation requirement to only
banking entities with significant trading assets and liabilities and
revising the notice and response procedures in subpart D to be more
broadly applicable.
a. Compliance Program Requirements for Banking Entities With
Significant Trading Assets and Liabilities
i. Section 20(b)--Six-Pillar Compliance Program
    Section __.20(b) of the 2013 rule specifies six elements that each
compliance program required under that section must at a minimum
contain.
    The six elements specified in Sec.  __.20(b) are:
     Written policies and procedures reasonably designed to
document, describe, monitor and limit trading activities and covered
fund activities and investments conducted by the banking entity to
ensure that all activities and investments that are subject to section
13 of the BHC Act and the rule comply with section 13 of the BHC Act
and the 2013 rule;
     A system of internal controls reasonably designed to
monitor compliance with section 13 of the BHC Act and the rule and to
prevent the occurrence of activities or investments that are prohibited
by section 13 of the BHC Act and the 2013 rule;
     A management framework that clearly delineates
responsibility and accountability for compliance with section 13 of the
BHC Act and the 2013 rule and includes appropriate management review of
trading limits, strategies, hedging activities, investments, incentive
compensation and other matters identified in the rule or by management
as requiring attention;
     Independent testing and audit of the effectiveness of the
compliance program conducted periodically by qualified personnel of the
banking entity or by a qualified outside party;
     Training for trading personnel and managers, as well as
other appropriate personnel, to effectively implement and enforce the
compliance program; and
     Records sufficient to demonstrate compliance with section
13 of the BHC Act and the 2013 rule, which a banking entity must
promptly provide to the relevant agency upon request and retain for a
period of no less than 5 years.
    Under the 2013 rule, these six elements have to be part of the
required compliance program of each banking entity with total
consolidated assets greater than $10 billion that engages in covered
trading activities and investments subject to section 13 of the BHC Act
and the implementing regulations (excluding trading permitted under
Sec.  __.6(a) of the 2013 rule).
    The agencies proposed further tailoring the compliance program
requirements to make the scale of compliance activity required by the
rule commensurate with a banking entity's size and level of trading
activity. Specifically, the proposal would have applied the six-pillar
compliance program requirements to banking entities with significant
trading assets and liabilities and would have afforded flexibility to
integrate the Sec.  __.20 compliance program requirements into other
compliance programs of the banking entity. The proposal also would have
eliminated the enhanced compliance program requirements found in
Appendix B of the 2013 rule,\631\ except for the CEO attestation
requirement discussed below. The proposal also would have revised the
covered fund documentation requirements in Sec.  __.20(e), which
applied to all banking entities with greater than $10 billion in total
consolidated assets under the 2013 rule, to only apply to firms with
significant trading assets and liabilities.
---------------------------------------------------------------------------

    \631\ The enhanced minimum standards in Appendix B of the 2013
rule required that the firm's compliance program: (1) Be reasonably
designed to identify, document, monitor, and report the trading and
covered fund activities and investments of the banking entity;
identify, monitor and promptly address the risks of these activities
and investments and potential areas of noncompliance; and prevent
activities or investments prohibited by, or that do not comply with,
section 13 of the BHC Act and the 2013 rule; (2) establish and
enforce appropriate limits on the activities and investments of the
banking entity, including limits on the size, scope, complexity, and
risks of the individual activities or investments consistent with
the requirements of section 13 of the BHC Act and the 2013 rule; (3)
subject the effectiveness of the compliance program to periodic
independent review and testing, and ensure that the entity's
internal audit, corporate compliance and internal control functions
involved in review and testing are effective and independent; (4)
make senior management, and others as appropriate, accountable for
the effective implementation of the compliance program, and ensure
that the board of directors and CEO (or equivalent) of the banking
entity review the effectiveness of the compliance program; and (5)
facilitate supervision and examination by the agencies of the
banking entity's trading and covered fund activities and
investments.
---------------------------------------------------------------------------

    Several commenters expressed support for the elimination of the
enhanced compliance program requirements in Appendix B of the 2013
rule.\632\ One commenter requested that the agencies provide greater
discretion to banking entities with significant trading assets and
liabilities to tailor their compliance programs to the size and
complexity of their activities and structure of their business.\633\ A
few commenters opposed the elimination of Appendix B of the 2013
rule.\634\ One asserted that firms have already made investments in
their compliance programs, so there was no justification for the
change.\635\ Another commenter argued that the remaining controls are
not sufficient to ensure compliance with the rule because they lack
specificity.\636\ This commenter also asserted that merging the Volcker
Rule requirements with the safety and soundness compliance framework
would be problematic as the Volcker Rule considers market supply and
demand dynamics while the safety and soundness compliance framework
generally only considers risks.\637\ The concern was that a combined
program might not adequately consider the activities restrictions of
the Volcker Rule.
---------------------------------------------------------------------------

    \632\ See, e.g., Insurance Coalition; Real Estate Associations;
CREFC; Credit Suisse; JBA; FSF; and ABA.
    \633\ See Credit Suisse.
    \634\ See, e.g., Bean; Data Boiler; and AFR.
    \635\ See Bean.
    \636\ See AFR.
    \637\ Id.
---------------------------------------------------------------------------

    The agencies are adopting the six-pillar compliance program
requirements and retaining the covered fund

[[Page 62023]]

documentation requirements for banking entities with significant
trading assets and liabilities as proposed. The agencies continue to
believe that these banking entities are engaged in activities at a
scale that warrants the costs of establishing and maintaining the
detailed and comprehensive compliance program elements described in
Sec. Sec.  __.20(b) and __.20(e) of the rule. Accordingly, the agencies
believe it is appropriate to require banking entities with significant
trading assets and liabilities to maintain a six-pillar compliance
program to ensure that banking entities' activities are conducted in
compliance with section 13 of the BHC Act and the implementing
regulations. Based on experience with the six-pillar compliance program
requirements under the 2013 rule, the agencies believe that such
requirements are appropriate and effective for firms with significant
trading assets and liabilities; these standards impose certain minimum
standards, but permit the banking entity flexibility to reasonably
design the program in light of the banking entity's activities. The
agencies also believe that the prescribed six-pillar compliance
requirements are consistent with the standards banking entities use in
their traditional risk management and compliance processes.
    The agencies believe that banking entities should have discretion
to tailor their compliance programs to the structure and activities of
their organizations. The flexibility to build on compliance programs
that already exist at banking entities, including internal limits, risk
management systems, board-level governance protocols, and the level at
which compliance is monitored, may reduce the costs and complexity of
compliance while also enabling a robust compliance mechanism for the
final rule.
    The agencies therefore believe that removal of the specific,
enhanced minimum standards in Appendix B will afford a banking entity
considerable flexibility to satisfy the elements of Sec.  __.20 in a
manner that it determines to be most appropriate given its existing
compliance regimes, organizational structure, and activities. Allowing
banking entities the flexibility to integrate Volcker Rule compliance
requirements into existing compliance programs should increase the
effectiveness of the Sec.  __.20 requirements by eliminating
duplicative governance and oversight structures arising from the
Appendix B requirement for a stand-alone compliance program.
ii. CEO Attestation Requirement
    The 2013 rule included a requirement in its Appendix B that a
banking entity's CEO must review and annually attest in writing to the
appropriate agency that the banking entity has in place processes to
establish, maintain, enforce, review, test, and modify the compliance
program established pursuant to Appendix B and Sec.  __.20 of the 2013
rule in a manner reasonably designed to achieve compliance with section
13 of the BHC Act and the implementing regulations.
    Under the proposal, Appendix B would have been eliminated, and a
modified CEO attestation requirement would have applied to banking
entities with significant trading assets and liabilities or moderate
trading assets and liabilities. The agencies believed that, while the
revisions to the compliance program requirements under the proposal
generally would simplify the compliance program requirements, this
simplification should be balanced against the requirement for all
banking entities to maintain compliance with section 13 of the BHC Act
and the implementing regulations. Accordingly, the agencies believed
that applying the CEO attestation requirement to banking entities with
meaningful trading activities would ensure that the compliance programs
established by these banking entities pursuant to Sec.  __.20(b) or
Sec.  __.20(f)(2) of the proposal would be reasonably designed to
achieve compliance with section 13 of the BHC Act and the implementing
regulations as proposed. The agencies proposed limiting the CEO
attestation requirement to banking entities with moderate trading
assets and liabilities or significant trading assets and liabilities
because, under the proposal, banking entities with limited trading
assets and liabilities would have been subject to a rebuttable
presumption of compliance. Thus, the agencies did not believe it
necessary to require a CEO attestation for banking entities with
limited trading assets and liabilities as those banking entities would
not be subject to the express requirement to maintain a compliance
program pursuant to Sec.  __.20 under the proposal. Further, the
agencies proposed retaining the 2013 rule's language concerning how the
CEO attestation requirement applies to the U.S. operations of a foreign
banking entity. This language states that, in the case of the U.S.
operations of a foreign banking entity, including a U.S. branch or
agency of a foreign banking entity, the attestation may be provided for
the entire U.S. operations of the foreign banking entity by the senior
management officer of the U.S. operations of the foreign banking entity
who is located in the United States.
    Several commenters expressed support for the CEO attestation
requirement and recommended that the agencies make no changes to the
requirement or apply it to all banking entities.\638\ Other commenters
believed that the CEO attestation requirement should not apply to
banking entities with moderate trading assets and liabilities,\639\ as
requiring the development of costly and burdensome internal compliance
efforts would not be consistent with the activities or risks of such
firms.\640\ One commenter argued that the CEO attestation requirement
duplicates existing quarterly reporting process,\641\ and another
commenter asserted that imposing such a requirement for firms with
moderate trading assets and liabilities would negate the tailoring the
agencies proposed for those banking entities.\642\ One commenter urged
the agencies to limit the application of the compliance program and
reporting requirements to only the U.S. operations of foreign banking
entities.\643\ Other requests for modification included streamlining
the CEO attestation requirement,\644\ adding a knowledge
qualifier,\645\ and limiting the scope to only U.S. operations.\646\ A
few commenters requested that the CEO attestation be completely
eliminated.\647\
---------------------------------------------------------------------------

    \638\ See, e.g., AFR; Merkley; Better Markets; and Data Boiler.
    \639\ See, e.g., Capital One et al.; ABA; Arvest; BB&T; State
Street; BPI; and IIB.
    \640\ See Capital One et al.
    \641\ See BOK.
    \642\ See Capital One et al.
    \643\ See IIB.
    \644\ See, e.g., ABA and JBA.
    \645\ See, e.g., ABA and FSF.
    \646\ See JBA.
    \647\ See BOK and Capital One et al.
---------------------------------------------------------------------------

    After reviewing the comments, the agencies have decided to retain
the CEO attestation requirement but only for banking entities with
significant trading assets and liabilities. The agencies continue to
believe that incorporating the CEO attestation requirement (which was
previously in Appendix B of the 2013 rule) into Sec.  __.20(c) will
help to ensure that the compliance program established pursuant to that
section is reasonably designed to achieve compliance with section 13 of
the BHC Act and the implementing regulations.
    However, the agencies have decided not to apply the CEO attestation
requirement to banking entities without significant trading assets and
liabilities. Such banking entities will still need to comply with
section 13 of the BHC Act and the implementing regulations;

[[Page 62024]]

however, they will not need to provide CEO attestations. This means
that the CEO attestation requirement will not be expanded to cover
banking entities that did not need to provide CEO attestations under
the 2013 rule.\648\ The agencies believe that requiring a CEO
attestation from banking entities with limited or moderate trading
assets and liabilities would result in additional costs and burdens
that would not be commensurate with the type of activities or risks of
these firms.
---------------------------------------------------------------------------

    \648\ The 2013 rule applied the CEO attestation requirement to
all banking entities with total consolidated assets of $50 billion
or more (or, in the case of a foreign banking entity, total U.S.
assets of $50 billion or more). By applying the CEO attestation
requirement to banking entities with moderate trading assets and
liabilities, the proposal would have expanded its applicability to
certain banking entities with less than $50 billion in total U.S.
assets that were not subject to the requirement under the 2013 rule.
---------------------------------------------------------------------------

b. Compliance Program Requirements for Banking Entities With Moderate
Trading Assets and Liabilities
    The 2013 rule provided that a banking entity with total
consolidated assets of $10 billion or less as measured on December 31
of the previous two years that engages in covered activities or
investments pursuant to subpart B or subpart C of the 2013 rule (other
than trading activities permitted under Sec.  __.6(a) of the 2013 rule)
may satisfy the compliance program requirements by including in its
existing compliance policies and procedures appropriate references to
the requirements of section 13 of the BHC Act and subpart D of the
implementing regulations and adjustments as appropriate given the
activities, size, scope, and complexity of the banking entity.\649\
---------------------------------------------------------------------------

    \649\ 2013 rule Sec.  __.20(f)(2).
---------------------------------------------------------------------------

    The agencies proposed extending the availability of this simplified
compliance program to banking entities with moderate trading assets and
liabilities. The agencies believed that streamlining the compliance
program requirements for banking entities with moderate trading assets
and liabilities would be appropriate because the scale and nature of
the activities and investments in which these banking entities are
engaged may not justify the additional costs associated with
establishing the compliance program elements under Sec. Sec.  __.20(b)
and (e) of the 2013 rule. Such activities may be appropriately managed
through an appropriately tailored simplified compliance program. The
agencies noted that banking entities with moderate trading assets and
liabilities would be able to incorporate their simplified compliance
program into existing compliance policies and procedures and tailor
their compliance programs to the size and nature of their activities,
consistent with the approach for banking entities with significant
trading assets and liabilities.
    Other commenters expressed support for a tailored compliance
program for banking entities with moderate trading assets and
liabilities.\650\ The agencies are adopting the compliance program
requirements, as proposed, for banking entities with moderate trading
assets and liabilities, for the aforementioned reasons. Thus, a banking
entity with moderate trading assets and liabilities qualifies for the
simplified compliance program under Sec.  __.20(f)(2) of the final
rule.
---------------------------------------------------------------------------

    \650\ See, e.g., BB&T and JBA.
---------------------------------------------------------------------------

c. Compliance Program Requirements for Banking Entities With Limited
Trading Assets and Liabilities
    Under the proposal, a banking entity with limited trading assets
and liabilities would have been presumed to be in compliance with the
rule. Banking entities with limited trading assets and liabilities
would have had no obligation to demonstrate compliance with subpart B
and subpart C of the implementing regulations on an ongoing basis,
given the limited scale of their trading operations. The agencies
believed, based on experience implementing and supervising compliance
with the 2013 rule, that these banking entities generally engage in
minimal trading and investment activities subject to section 13 of the
BHC Act. Thus, the agencies believed that the limited trading assets
and liabilities of the banking entities qualifying for the presumption
of compliance would be unlikely to warrant the costs of establishing a
compliance program under Sec.  __.20 of the 2013 rule.
    Under the proposed approach, the agencies would not have expected a
banking entity with limited trading assets and liabilities that
qualified for the presumption of compliance to demonstrate compliance
with the proposal on an ongoing basis in conjunction with the agencies'
normal supervisory and examination processes. However, the appropriate
agency would have been able to exercise its authority to treat the
banking entity as if it did not have limited trading assets and
liabilities if, upon review of the banking entity's activities, the
relevant agency determined that the banking entity engaged in
proprietary trading or covered fund activities that were otherwise
prohibited under subpart B or subpart C. A banking entity would have
been expected to remediate any impermissible activity upon being
notified of such determination by the agency within a period of time
deemed appropriate by the agency.
    In addition, irrespective of whether a banking entity had engaged
in activities in violation of subpart B or C, the relevant agency would
have retained its authority to require a banking entity to apply the
compliance program requirements that would otherwise apply if the
banking entity had significant or moderate trading assets and
liabilities if the relevant agency determined that the size or
complexity of the banking entity's trading or investment activities, or
the risk of evasion, did not warrant a presumption of compliance.
    One commenter expressed support for the rebuttable presumption of
compliance for banking entities with limited trading assets and
liabilities.\651\ Another commenter suggested completely exempting
banking entities with limited trading assets and liabilities from
section 13 of the BHC Act.\652\ One commenter requested that the
evidence that an agency would require in response to its attempt to
rebut a presumption should not be greater than what is required of the
banking entity under the presumption.\653\ Another commenter
recommended that the agencies treat inadvertent violations of the rule
as supervisory matters and not as violations.\654\
---------------------------------------------------------------------------

    \651\ See B&F.
    \652\ See JBA.
    \653\ See SIFMA.
    \654\ See ABA.
---------------------------------------------------------------------------

    The final rule adopts the compliance program requirements for
banking entities with limited trading assets and liabilities as
proposed. The agencies note that the removal of the standard compliance
program requirements in Sec.  __.20 for banking entities with limited
trading assets and liabilities does not relieve those banking entities
of the obligation to comply with the prohibitions and other
requirements of the permitted trading activity exemptions, to the
extent that the banking entity engages in such activities, including
RENTD requirements for permitted underwriting and market making, under
the final rule. The agencies believe the presumption of compliance for
banking entities with limited trading assets and liabilities will allow
flexibility for these banking entities to take appropriate actions,
tailored to the individual activities in which the banking entities
engage, to comply with the rule. Such

[[Page 62025]]

actions may include, for example, integrating the requirements for
permitted trading activities under the exemptions in Sec.  __.4, __.5,
and __.6 into existing internal policies and procedures (to the extent
the banking entity engages in such activities), or taking other steps
to satisfy the criteria to engage in such activities under the final
rule. Regarding one commenter's proposal that the agencies completely
exempt banking entities with limited trading activities, the agencies
note that section 13 of the BHC Act does not give the agencies
authority to completely exempt banking entities from the requirements
of the Volcker Rule.
d. Notice and Response Procedures
    The proposed rule included notice and response procedures that an
agency would follow when determining whether to treat a banking entity
with limited trading assets and liabilities as if it did not have
limited trading assets and liabilities.\655\ The notice and response
procedures required the relevant agency to provide a written
explanation of its determination and allowed the banking entity the
opportunity to respond to the agency with any matters that the banking
entity would have the agency consider in reaching its determination.
The response procedures would have required the banking entity to
respond within 30 days unless the agency extended the time period for
good cause or if the agency shortened the time period either with the
consent of the banking entity or because the conditions or activities
of the banking entity so required. Failure to respond within the
applicable timeframe would have constituted a waiver of objection to
the agency's determination. After the close of the response period, the
agency would have decided, based on a review of the banking entity's
response and other information concerning the banking entity, whether
to maintain the agency's determination and would have notified the
banking entity of its decision in writing. These notice and response
procedures were similar, but not identical to, notice and response
procedures found elsewhere in the proposed rule.\656\
---------------------------------------------------------------------------

    \655\ See proposed rule Sec.  __.20(g)(2)(ii).
    \656\ See proposed rule Sec. Sec.  __.3(c), __.3(g)(2),
__.4(a)(8)(iv), __.4(b)(6)(iv).
---------------------------------------------------------------------------

    One commenter suggested that there should be a consistent notice
and response process regarding all presumptions in the final rule.\657\
The agencies agree and have modified the notice and response procedures
in subpart D to apply more broadly to several types of determinations
under the final rule, including determinations and rebuttals made under
Sec. Sec.  __.3, __.4, and __.20.\658\ This change will provide
consistency and enhance transparency with respect to the processes that
an agency will follow for certain determinations throughout the final
rule.
---------------------------------------------------------------------------

    \657\ See IIB.
    \658\ See final rule Sec.  __.20(i).
---------------------------------------------------------------------------

E. Subpart E--Metrics: Appendix to Part []--Reporting and
Recordkeeping Requirements

    Under the 2013 rule, a banking entity with substantial trading
activity \659\ must furnish the following quantitative measurements for
each of its trading desks engaged in covered trading activity,
calculated in accordance with Appendix A:
---------------------------------------------------------------------------

    \659\ Appendix A of the 2013 rule applies to U.S. banking
entities with trading assets and liabilities the average gross sum
of which equals or exceeds $10 billion on a worldwide consolidated
basis over the previous four calendar quarters (excluding trading
assets and liabilities involving obligations of or guaranteed by the
United States or any agency of the United States), and to foreign
banking entities with combined U.S. trading assets and liabilities
the average gross sum of which equals or exceeds $10 billion over
the previous four calendar quarters (excluding trading assets and
liabilities involving obligations of or guaranteed by the United
States or any agency of the United States). 2013 rule Sec. 
__.20(d)(1).
---------------------------------------------------------------------------

     Risk and position limits and usage;
     Risk factor sensitivities;
     Value-at-risk and stressed VaR;
     Comprehensive profit and loss attribution;
     Inventory turnover;
     Inventory aging; and
     Customer-facing trade ratio.
    The proposal explained that, based on the agencies' evaluation of
the effectiveness of the metrics data in monitoring covered trading
activities for compliance with section 13 of the BHC Act and the
associated reporting costs,\660\ the proposed rule would have amended
Appendix A requirements to reduce compliance-related inefficiencies
while allowing for the collection of data to permit the agencies to
better monitor compliance with section 13 of the BHC Act.\661\
Specifically, the proposed rule would have made the following
modifications to the reporting requirements in Appendix A:
---------------------------------------------------------------------------

    \660\ See 79 FR at 5772.
    \661\ As previously noted in the section entitled ``Enhanced
Minimum Standards for Compliance Programs,'' the Agencies are
proposing to eliminate Appendix B of the 2013 rule. Current Appendix
A is therefore re-designated as the ``Appendix'' in the final rule.
---------------------------------------------------------------------------

     Limit the applicability of certain metrics only to market
making and underwriting desks.
     Replace the Customer-Facing Trade Ratio with a new
Transaction Volumes metric to more precisely cover types of trading
desk transactions with counterparties.
     Replace Inventory Turnover with a new Positions metric,
which measures the value of all securities and derivatives positions.
     Remove the requirement to separately report values that
can be easily calculated from other reported quantitative measurements.
     Streamline and make consistent value calculations for
different product types, using both notional value and market value to
facilitate better comparison of metrics across trading desks and
banking entities.
     Eliminate inventory aging data for derivatives because
aging, as applied to derivatives, does not appear to provide a
meaningful indicator of potential impermissible trading activity or
excessive risk-taking.
     Require banking entities to provide qualitative
information specifying for each trading desk the types of financial
instruments traded, the types of covered trading activity the desk
conducts, and the legal entities into which the trading desk books
trades.
     Require a Narrative Statement describing changes in
calculation methods, trading desk structure, or trading desk
strategies.
     Remove the paragraphs labeled ``General Calculation
Guidance'' from the regulation. The Instructions generally would
provide calculation guidance.\662\
---------------------------------------------------------------------------

    \662\ The Instructions will be available on each agency's
respective website at the addresses specified in the Paperwork
Reduction Act section of this Supplementary Information. For the SEC
and CFTC, this document represents the views of SEC staff and CFTC
staff; neither Commission has approved nor disapproved them. The
Instructions are not a rule, regulation, or statement of the SEC or
the CFTC; and like all SEC or CFTC staff guidance, it has no legal
force or effect, does not alter or amend applicable law, and creates
no new or additional SEC or CFTC obligations for any person.
Consistent with changes elsewhere in the final rule and with the
Federal banking agencies' Interagency Statement Clarifying the Role
of Supervisory Guidance (Sept. 11, 2018; https://www.federalreserve.gov/supervisionreg/srletters/sr1805.htm, https://www.occ.gov/news-issuances/news-releases/2018/nr-ia-2018-97a.pdf,
https://www.fdic.gov/news/news/financial/2018/fil18049.html), the
agencies are removing references to guidance and expectations from
the regulatory text of the metrics reporting requirements.
---------------------------------------------------------------------------

     Remove the requirement that banking entities establish and
report limits on Stressed Value-at-Risk at the trading desk-level
because trading desks do not typically use such limits to manage and
control risk-taking.
     Require banking entities to provide descriptive
information about their reported metrics, including information
uniquely identifying and describing

[[Page 62026]]

certain risk measurements and information identifying the relationships
of these measurements within a trading desk and across trading desks.
     Require electronic submission of the Trading Desk
Information, Quantitative Measurements Identifying Information, and
each applicable quantitative measurement in accordance with the XML
Schema specified and published on each agency's website.\663\
---------------------------------------------------------------------------

    \663\ The staff-level Technical Specifications Guidance
describes the XML Schema. The Technical Specifications Guidance and
the XML Schema are available on each agency's respective website at
the addresses specified in the Paperwork Reduction Act section of
this Supplementary Information.
---------------------------------------------------------------------------

    Several commenters objected to the proposed rule's modification of
the metrics. Some commenters suggested that the proposed amendments to
metrics reporting were inappropriate in light of the lack of public
disclosure of previously reported metrics information, and in some
cases recommended that the agencies expand metrics reporting
requirements.\664\ Other commenters recommended that the agencies
simplify or eliminate the metrics.\665\ As described in detail below,
the final rule streamlines the reporting requirements in Appendix A of
the 2013 rule and adopts a limited set of the new requirements
introduced in the proposal. Among other changes, the final rule
entirely eliminates the stressed value-at-risk, risk factor
sensitivities, and inventory aging. Taken together, the agencies
estimate that the revised metrics in the final rule would result in a
67 percent reduction in the number of data items and approximately 94
percent reduction in the total volume of data, relative to the 2013
rule's reporting requirement. The agencies believe the remaining
metrics are generally useful to help firms demonstrate that their
covered trading activities are conducted appropriately, and to enable
the agencies to identify activities that potentially involve
impermissible proprietary trading. Moreover, the agencies believe that
these items do not pose a special calculation burden because firms
generally already record these values in the regular course of
business. The agencies expect that the changes in the final rule will
enable banking entities to leverage calculations from their market risk
capital programs to meet the requirements for the Volcker Rule
quantitative measurements, which will reduce complexity and cost for
banking entities, and improve the effectiveness of the final rule.\666\
As discussed above, in order to give banking entities a sufficient
amount of time to comply with the changes adopted, banking entities
will not be required to comply with the final amendments until January
1, 2021 (although banking entities may voluntarily comply, in whole or
in part, with the amendments adopted in this release prior to the
compliance date, subject to the agencies' completion of necessary
technological changes). By providing an extended compliance period, the
final amendments also should facilitate firms in integrating these
requirements into existing or planned compliance programs.
---------------------------------------------------------------------------

    \664\ See, e.g., AFR; Better Markets; Occupy the SEC; Public
Citizen; and Volcker Alliance.
    \665\ See, e.g., ABA; FSF; IIB; New England Council; and SIFMA.
    \666\ The agencies anticipate the market risk capital
calculations and the Volcker Rule quantitative measurements will
align particularly closely when the banking agencies adopt a rule
implementing the Basel Committee's market risk capital standard in
the United States. However, the agencies note that certain
anticipated changes resulting from the Basel market risk capital
standards may still result in a mismatch between metrics required
under the market risk capital rule and the final rule. The agencies
are aware of this potential issue and intend to address any such
discrepancies at a future date.
---------------------------------------------------------------------------

1. Purpose
    Paragraph I.c of Appendix A of the 2013 rule provides that the
quantitative measurements that are required to be reported under the
rule are not intended to serve as a dispositive tool for identifying
permissible or impermissible activities. The proposal would have
expanded the qualifying language in paragraph I.c of Appendix A to
apply to all of the information required to be reported pursuant to the
appendix, rather than only to the quantitative measurements themselves.
In addition, the proposed rule would have also removed paragraph I.d.
in Appendix A of the 2013 rule, which provides that the agencies would
review the metrics data and revise the metrics collection requirements
based on that review.
    The agencies received no comments on these proposed changes. The
final rule adopts the changes, as proposed. The agencies believe that
the trading desk information and quantitative measurements identifying
information, coupled with the quantitative measurements, should assist
the agencies in monitoring compliance. This information will be used to
monitor patterns and identify activity that may warrant further review.
Additionally, the final rule removes paragraph I.d. Appendix A of the
2013 rule, as the agencies have conducted this preliminary evaluation
of the effectiveness of the quantitative measurements collected to date
and have adopted modifications based on that review.
2. Definitions
    The proposed rule would have clarified the definition of ``covered
trading activity'' by adding the phrase ``in its covered trading
activity'' to clarify that the term ``covered trading activity,'' as
used in the proposed appendix, may include trading conducted under
Sec.  __.3(d), __.6(c), __.6(d), or __.6(e) of the proposal.\667\ In
addition, the proposed rule defined two additional terms for purposes
of the appendix, ``applicability'' and ``trading day,'' that were not
defined in the 2013 rule. The proposal defined ``applicability'' to
clarify when certain metrics are required to be reported for specific
trading desks and thus make several metrics applicable only to desks
engaged in market making or underwriting. Finally, the proposal defined
``trading day,'' a term used throughout Appendix A of the 2013
rule,\668\ to mean a calendar day on which a trading desk is open for
trading.
---------------------------------------------------------------------------

    \667\ The proposed change would clarify that banking entities
would have the discretion (but not the obligation) to report metrics
with respect to a broader range of activities.
    \668\ Appendix A of the 2013 rule provides that the calculation
period for each quantitative measurement is one trading day, but
does not define ``trading day''.
---------------------------------------------------------------------------

    Commenters supported the proposal to define ``applicability'' in
order to clarify that certain metrics are only applicable to desks
engaged in market making or underwriting.\669\ One commenter suggested
defining the scope of ``covered trading activity'' to align with
activity covered under the Basel Committee's revised standard for
market risk capital.\670\ While the agencies received no comments on
the proposed definition of ``trading day'' in the regulation, several
comments expressed serious concerns with the proposed ``trading day''
definition in the 2018 Instructions,\671\ specifically requiring
banking entities to report metrics for trading days when U.S. markets
are closed but non-U.S. locations may be open.\672\ These commenters
argued that this would impose significant operational costs with no
commensurate benefit to the agencies' oversight ability. However, the
Agencies feel the definition of trading day is appropriate because the
potential for impermissible

[[Page 62027]]

trading activity on a desk exists on any day when the desk is open for
trading, regardless of which markets are open. The final rule retains
the definition.
---------------------------------------------------------------------------

    \669\ See, e.g., Credit Suisse; FSF; and JBA.
    \670\ See JBA.
    \671\ The definition in the Instructions require banking
entities to calculate each metric for each calendar day on which a
trading desk is open for trading, even if the desk is closed for
trading in one jurisdiction (for example, due to a national
holiday).
    \672\ See, e.g., ABA; CCMR; FSF; and SIFMA.
---------------------------------------------------------------------------

    The agencies believe that the scope of ``covered trading activity''
in the final rule is appropriate, and note that, due to changes in the
definition of trading account, the scope of ``covered trading
activity'' will align more closely with the scope of activities covered
under the Basel Committee's market risk capital standards for certain
banking entities. Therefore, the final rule adopts these definitions as
proposed.
3. Reporting and Recordkeeping
    Paragraph III.a of Appendix A of the 2013 rule required banking
entities subject to the appendix to furnish seven quantitative metrics
for all trading desks engaged in trading activity conducted pursuant to
Sec.  __.4, Sec.  __.5, or Sec.  __.6(a) (i.e., permitted underwriting,
market making, and risk-mitigating hedging activity and trading in
certain government obligations).\673\
---------------------------------------------------------------------------

    \673\ In addition, the 2013 rule permits banking entities to
optionally include trading under Sec.  __.3(d), Sec.  __.6(c), Sec. 
__.6(d), or Sec.  __.6(e).
---------------------------------------------------------------------------

    The proposal would have made several modifications to streamline
the reporting requirements in paragraph III.a of Appendix A of the 2013
rule. Specifically, the proposal would have: (1) Replaced the Inventory
Turnover and Customer-Facing Trade Ratio metrics with the Positions and
Transaction Volumes quantitative measurements, respectively; (2)
limited the Inventory Aging metric to only apply to securities \674\
and changed the name of the quantitative measurement to the Securities
Inventory Aging; (3) added the phrase ``as applicable'' to paragraph
III.a in order to limit application of the Positions, Transaction
Volumes, and Securities Inventory Aging quantitative measurements to
only trading desks that rely on Sec.  __.4(a) or Sec.  __.4(b) to
conduct underwriting activity or market making-related activity,
respectively; and (4) inserted references in paragraph III.a to the new
qualitative information requirements added to the appendix (i.e.,
Trading Desk Information, Quantitative Measurements Identifying
Information, and Narrative Statement requirements).\675\
---------------------------------------------------------------------------

    \674\ Including derivatives or securities that also meet the
2013 rule's definition of a derivative See infra Part III.E.2.i.v
(discussing the Securities Inventory Aging quantitative
measurement). The definition of ``security'' and ``derivative'' are
set forth in Sec.  __.2 of the 2013 rule. See 2013 rule Sec. Sec. 
__.2 (h), (y).
    \675\ In addition, the proposed rule would have added to
paragraph III.a. a requirement that banking entities include file
identifying information in each submission to the relevant agency
pursuant to Appendix A of the 2013 rule. Specifically, the proposal
would have required the file identifying information to include the
name of the banking entity, the RSSD ID assigned to the top-tier
banking entity by the Board, the reporting period, and the creation
date and time.
---------------------------------------------------------------------------

    A number of commenters supported the proposed changes to remove or
tailor certain of the metrics provided in Appendix A of the 2013 rule,
but opposed the addition of new metrics reporting requirements (i.e.,
Trading Day definition, Trading Desk Information, Quantitative
Measurements Identifying Information, Narrative Statement).\676\ These
commenters argued that, contrary to the proposal's objective to
streamline compliance requirements, the new reporting requirements
would significantly increase the overall compliance burden and impose
substantial compliance costs on firms.\677\ Three commenters argued
that the agencies did not provide reasoned cost benefit analysis to
justify the inclusion of the new metrics.\678\ A few commenters
recommended that the agencies should further streamline the current
metrics to permit individual supervisors and banking entities to
collaborate on determining which metrics are appropriate for that
specific institution.\679\ One commenter expressed concern that the
agencies intended for the newly added metrics to replace onsite
supervision and review, as the new qualitative information requirements
often duplicate the existing compliance program requirements.\680\
---------------------------------------------------------------------------

    \676\ See, e.g., ABA; CCMR; Credit Suisse; FSF; and Goldman
Sachs.
    \677\ See, e.g., ABA; Credit Suisse; CCMR; and FSF.
    \678\ See, e.g., CCMR; Public Citizen; and SIFMA.
    \679\ See, e.g., Goldman Sachs; JBA; and States Street (on
leveraging current industry practices for FX).
    \680\ See SIFMA.
---------------------------------------------------------------------------

    Other commenters opposed all of the proposed revisions to the
metrics, with certain limited exceptions (e.g., limiting Inventory
Aging to securities).\681\ Some of these commenters argued that the
agencies should adopt an approach focused on further streamlining the
metrics requirements included in Appendix A of the 2013 rule.\682\ A
few of these commenters argued that the proposed changes to the
existing metrics would in effect create entirely new metrics and that
the new metrics would not provide new information that cannot be
obtained through the existing metrics.\683\ Other commenters supported
only retaining the Comprehensive Profit and Loss Attribution and Risk
Management metrics.\684\ Another commenter supported retaining the
current requirements, as any revisions would necessitate changes to
firms' current systems and thus impose considerable operational burdens
and costs.\685\ One commenter stressed the inability of the general
public to provide informed comment on the proposed changes as the
agencies have not publically disclosed any data related to firms'
metrics submissions.\686\ Another commenter noted that disclosing
firms' metrics submissions on an aggregated and/or time-delayed basis
would enable the general public to understand the impact of the Volcker
Rule.\687\ In contrast, other commenters urged the agencies not to
publicly disclose the metrics data because the data is confidential
supervisory information that could be used by competitors and could
create distortions in the capital markets.\688\ Another commenter
recommended replacing the metrics with a utility platform that would
automate and perform trade surveillance in real time.\689\
---------------------------------------------------------------------------

    \681\ See, e.g., Data Boiler; IIB; JBA; SIFMA; and State Street.
    \682\ See, e.g., IIB; New England Council; SIFMA; and State
Street.
    \683\ See, e.g., IIB and SIFMA.
    \684\ See, e.g., New England Council and State Street.
    \685\ See JBA.
    \686\ See Public Citizen.
    \687\ See AFR.
    \688\ See, e.g., SIFMA and IIB.
    \689\ See Data Boiler.
---------------------------------------------------------------------------

    As described in detail below, the final rule focuses on
streamlining the 2013 rule's reporting requirements and only adopts a
limited set of the new qualitative requirements introduced in the
proposal. The agencies believe the remaining metrics are generally
useful tools to help both firms and supervisors identify activities
that potentially involve impermissible proprietary trading. Moreover,
the agencies believe that these items do not pose a special calculation
burden because firms already record these values in the regular course
of business.
    Finally, although the agencies are not including any changes
related to public disclosure of the quantitative measurements in this
final rule, the agencies will continue to consider whether some or all
of the quantitative measurements should be publicly disclosed, taking
into account the need to protect sensitive, confidential information,
as well as restrictions on the agencies relating to the disclosure of
sensitive, confidential business and supervisory information on a firm-
specific basis.
4. Trading Desk Information
    The proposed rule added a new paragraph III.b to Appendix A to
require

[[Page 62028]]

banking entities to report certain descriptive information for each
trading desk engaged in covered trading activity, including the trading
desk name and identifier, the type of covered activity conducted by the
desk, a brief description of the trading desk's general strategy (i.e.,
the method for conducting authorized trading activities), the types of
financial instruments purchased and sold by the trading desk, and the
list of legal entities used to book trades including which were the
main booking entities. The proposal also would have required firms to
indicate for each trading desk whether each calendar date is a trading
day or not a trading day and to specify the currency used by a trading
desk as well as the conversion rate to U.S. dollars, if applicable.
    In general, most commenters opposed requiring banking entities to
report any new information outside the scope of the 2013 rule
requirements, including qualitative information for each trading
desk.\690\ These commenters argued that the de minimis benefit to the
agencies' oversight ability did not justify the significant operational
costs associated with the new requirements, in particular identifying
the legal entities used as booking entities by the trading desk as well
as the financial instruments and other products traded by the
desk.\691\
---------------------------------------------------------------------------

    \690\ See, e.g., ABA; Credit Suisse; CCMR; FSF; IIB; JBA; and
SIFMA.
    \691\ See, e.g., ABA; CCMR; and SIFMA.
---------------------------------------------------------------------------

    After considering these comments, the final rule retains a modified
version of the Trading Desk Information. The final rule eliminates the
requirement for each trading desk to identify the financial instruments
and other products traded by the desk. The final rule also replaces the
requirement to identify the legal entities that serve as booking
entities for each trading desk with the simpler requirement that the
banking entity's submission for each trading desk list: (1) Each agency
receiving the submission for the desk; and (2) the exemptions or
exclusions under which the desk conducts trading activity. The
exemption/exclusion identification is particularly necessary in light
of the fact that some of the quantitative measurements identified below
(i.e., the customer-facing activity measurements) are only required for
desks operating under the underwriting or market making exemptions. The
list of the agencies that have received the submission for a desk
should facilitate inter-agency coordination, as generally trading desks
encompass multiple legal entities, for which more than one agency may
be the primary federal regulator. The agencies believe that this
approach appropriately balances the benefit to the agencies and the
cost to firms from the new reporting obligations.
5. Quantitative Measurements Identifying Information
    The proposed rule added a new paragraph III.c. to Appendix A to
require banking entities to prepare and provide five schedules: (i)
Risk and Position Limits Information Schedule; (ii) Risk Factor
Sensitivities Information Schedule; (iii) Risk Factor Attribution
Information Schedule; (iv) Limit/Sensitivity Cross-Reference Schedule;
and (v) Risk factor Sensitivity/Attribution Schedule. The proposed
schedules would have provided descriptive information on the
quantitative measurements on a collective basis for all relevant
trading desks. The new proposed Schedules would have required banking
entities to provide detailed information regarding each limit and risk
factor sensitivity reported in quantitative measurements as well as on
the attribution of existing position profit and loss to the risk factor
reported in the quantitative measurements. In addition, the new Limit/
Sensitivity Cross-Reference Schedule would have required banking
entities to cross-reference, by unique identification label, a limit
reported in the Risk and Position Limits Information Schedule to any
associated risk factor sensitivity reported in the Risk Factor
Sensitivities Information Schedule.
    Many commenters generally opposed requiring banking entities to
report any new information outside the scope of the 2013 rule
requirements, including quantitative measurements identifying
information.\692\ One commenter argued that these new requirements
impose undue costs on firms without providing any new supervisory
benefit as they duplicate existing requirements in Sec.  __.20, which
information the agencies can obtain through the normal supervisory and
examination process.\693\ This commenter further noted that increasing
the scope of the appendix submission may harm the agencies' ability to
effectively supervise Volcker compliance, by increasing the supervisory
resources necessary to review the data at the detriment of performing
normal supervision.
---------------------------------------------------------------------------

    \692\ See, e.g., ABA; CCMR; Credit Suisse; Data Boiler; JBA; and
SIFMA.
    \693\ See SIFMA.
---------------------------------------------------------------------------

    After considering these comments, the final rule retains a modified
version of the Quantitative Measurements Identifying Information that
eliminates the Risk Factor Sensitivities Information Schedule, the
Limit/Sensitivity Cross-Reference Schedule and the Risk-Factor
Sensitivity/Attribution Cross-Reference Schedule. Despite the potential
benefit to the agencies from having a deeper understanding of the
relationship between firms' limits and the risk factor sensitivities,
the agencies agree that the proposed requirements could significantly
increase firms' reporting burden in a way not commensurate with the
potential benefits. The final rule retains the Risk Factor Attribution
Information Schedule and a modified version of the Risk and Position
Limits Information Schedule that includes identification of the
corresponding risk factor attribution for certain limits (``Internal
Limits Information Schedule''). While together these schedules add two
new reporting elements relative to the 2013 Appendix A (i.e., a
description of the limit/risk factor sensitivities and risk factor
attribution for certain limits), the agencies generally expect firms to
realize a net reduction in reporting burden from the elimination of the
duplicative reporting requirements in the current framework. The 2013
rule requires firms report internal limits, including but not limited
to risk and position limits, and risk factor sensitivities established
for each trading desk on a daily basis. As in practice, firms often use
the same limits and risk factors for multiple desks, the 2013 rule
results in firms reporting the same limit on a daily basis for multiple
desks. These two new schedules reduce reporting burden by allowing
firms to submit a comprehensive list of all the internal limits and the
risk factor sensitivities that account for a preponderance of the
profit or loss for the trading desks. Additionally, the final rule
eliminates the requirement to report Risk Factor Sensitivities for each
trading desk on a daily basis. Based on the submissions received to
date, the agencies expect this change alone will reduce the total
volume of data submitted by more than half relative to the 2013 rule.
6. Narrative Statement
    The proposed rule would have added a new paragraph III.d. to
require banking entities to submit a Narrative Statement in a separate
electronic document to the relevant agency that describes any changes
in calculation methods used for its quantitative measurements, or the
trading desk structure (e.g., adding, terminating, or merging pre-
existing desks) or strategies. In addition, in its Narrative Statement,
a banking entity, if applicable, would

[[Page 62029]]

have to explain its inability to report a particular quantitative
measurement and to provide notice if a trading desk changes its
approach to including or excluding products that are not financial
instruments in its metrics. The proposed rule would have required that
banking entities that do not have any information to report in a
Narrative Statement to submit an electronic document stating that the
firm does not have any information to report in a Narrative Statement.
    Most commenters generally opposed requiring banking entities to
report any new information outside the scope of the 2013 rule
requirements, including the Narrative Statement.\694\ While recognizing
that currently banking entities voluntarily provide additional
information about their metrics submissions, one commenter argued that
requiring the Narrative Statement would impose undue costs on banking
entities, as the agencies can already obtain this information through
the normal supervisory process.\695\
---------------------------------------------------------------------------

    \694\ See, e.g., ABA; CCMR; Credit Suisse; Data Boiler; JBA; and
SIFMA.
    \695\ See SIFMA.
---------------------------------------------------------------------------

    After considering all comments received, the agencies are not
adopting the narrative statement requirement in the final rule. Rather,
the final rule retains the provision from the 2013 rule's reporting
instructions that permits, but does not require, firms to provide a
narrative statement describing any additional information they believe
would be helpful to the agencies in identifying material events or
changes. Narrative statements may permit the agencies to understand
aspects of the metrics without going back to the banking entities to
ask questions. While the agencies anticipate that many banking entities
will continue to voluntarily provide clarifying information, the
agencies agree that the compliance costs associated with requiring a
separate document are not commensurate with the potential benefit to
the agencies of receiving information in this format from banking
entities that do not wish to provide it.
7. Frequency and Method of Required Calculation and Reporting
    The 2013 rule established a reporting schedule in Sec.  __.20 that
required banking entities with $50 billion or more in trading assets
and liabilities to report the information required by Appendix A of the
2013 rule within 10 days of the end of each calendar month. The
proposed rule would have extended this reporting schedule for firms
with significant trading activities, as defined in the final rule, to
be within 20 days of the end of each calendar month.\696\
---------------------------------------------------------------------------

    \696\ See Sec.  __.20(d) of the proposal.
---------------------------------------------------------------------------

    In general, commenters supported extending the reporting schedule
to be within 20 days of the end of each calendar month.\697\ Two
commenters suggested further extending this to 30 days.\698\ Of these,
one commenter recommended reducing the frequency from monthly to
quarterly in order to better align the metrics reporting with other
regulatory reporting regimes.\699\
---------------------------------------------------------------------------

    \697\ See, e.g., FSF and Goldman Sachs.
    \698\ See, e.g., Credit Suisse and SIFMA.
    \699\ See SIFMA.
---------------------------------------------------------------------------

    Under the final rule, metrics filers must submit metrics on a
quarterly basis. In addition, the final rule retains the reporting
schedule of 30 days after the end of each quarter, consistent with the
reporting schedule for quarterly filers under the 2013 rule.
Supervisory experience has indicated that this will reduce the
incidence of errors and improve the quality of the data in the metrics
submissions.
    Appendix A of the 2013 rule did not specify a format in which
metrics should be reported. To clarify the formatting requirements for
the data submissions and to help ensure the quality and consistency of
data submissions across banking entities, the proposed rule would have
required banking entities to report all the information contained
within the proposed appendix in accordance with an XML Schema to be
specified and published on the relevant agency's website.\700\
---------------------------------------------------------------------------

    \700\ To the extent the XML Schema is updated, the version of
the XML Schema that must be used by banking entities would be
specified on the relevant agency's website. A banking entity must
not use an outdated version of the XML Schema to report the Trading
Desk Information, Quantitative Measurements Identifying Information,
and applicable quantitative measurements to the relevant agency.
---------------------------------------------------------------------------

    Two commenters opposed transitioning to XML format for reporting
due to the costs of changing reporting software to switch formats.\701\
One commenter fully supported the use of XML as a standardized
format.\702\ Another commenter supported XML and estimated the cost of
switching formats to be low compared to other costs involved in
reporting.\703\ Finally, one commenter asserted that reporting in XML
could be useful in certain cases but that it was not clear that
requiring metrics reporting in XML would be useful. The commenter
recommended deferring the decision to adopt the XML until after a final
rule is adopted. The commenter stated that the decision of whether to
adopt the XML Schema requirement should be subject to separate notice
and comment.\704\
---------------------------------------------------------------------------

    \701\ See, e.g., Credit Suisse and JBA.
    \702\ See Goldman Sachs.
    \703\ See Data Boiler.
    \704\ See SIFMA.
---------------------------------------------------------------------------

    The final rule adopts the use of XML for reporting metrics,
following the format specified in XML Schema to be posted on the
relevant agency's website. The agencies acknowledge that any changes to
the metrics will impose some switching costs on banking entities. As a
very common standard for data transmission, XML is expected to be a
less costly format to employ than a bespoke format. Moreover, the XML
Schema allows for clearer specification, which should reduce
miscommunication, errors, inconsistencies, and the need for data
resubmissions. The agencies believe the benefits of standardization
outweigh the one-time switching costs.
8. Recordkeeping
    Under paragraph III.c. of Appendix A of the 2013 rule, a banking
entity's reported quantitative measurements are subject to the record
retention requirements provided in Appendix A. Under the proposed rule,
this provision would have been moved to paragraph III.f. and expanded
to include the new qualitative information requirements added to the
appendix (i.e., Trading Desk Information, Quantitative Measurements
Identifying Information, and Narrative Statement requirements). The
agencies received no comments on these proposed changes. The final
rule's recordkeeping requirement is being adopted largely as
proposed.\705\
---------------------------------------------------------------------------

    \705\ The recordkeeping requirement in the final rule does not
require that banking entities retain a copy of the Narrative
Statement.
---------------------------------------------------------------------------

9. Quantitative Measurements
    Section IV of Appendix A of the 2013 rule sets forth the individual
quantitative measurements required by the appendix. The proposed rule
would have added an ``Applicability'' paragraph to each quantitative
measurement to identify the trading desks for which a banking entity
would be required to calculate and report a particular metric based on
the type of covered trading activity conducted by the desk. The
proposed rule also would have removed the ``General Calculation
Guidance'' paragraphs in section IV of Appendix A of the 2013 rule for
each quantitative measurement, and provided such guidance in the
Instructions.
    As noted above, commenters generally supported the proposal to
define ``applicability'' in order to clarify that certain metrics are
only applicable

[[Page 62030]]

to desks engaged in market making or underwriting.\706\ The agencies'
received no comments on providing the metrics calculation guidance in
an Instructions document and removing this guidance from the appendix.
The metrics are not intended to serve as a dispositive tool for
identifying permissible or impermissible activities. Thus, the agencies
believe that providing the metrics calculation guidance in the
Instructions and not within the regulation is more appropriate.\707\
Therefore, the agencies are adopting these changes as proposed.
---------------------------------------------------------------------------

    \706\ See, e.g., Credit Suisse; FSF; and JBA.
    \707\ See supra note 662.
---------------------------------------------------------------------------

a. Risk-Management Measurements
i. Internal Limits and Usage
    Like the 2013 rule, the proposed rule would have applied the Risk
and Position Limits and Usage metric to all trading desks engaged in
covered trading activities. Additionally, the proposed rule would have
removed references to Stressed Value-at-Risk (Stressed VaR) in the Risk
and Position Limits and Usage metric and required banking entities to
report the unique identification label for each limit as listed in the
Risk and Position Limits Information Schedule, the limit size
(distinguishing between the upper bound and lower bound of the limit,
where applicable), and the value of usage of the limit.\708\
---------------------------------------------------------------------------

    \708\ If a limit is introduced or discontinued during a calendar
month, the banking entity must report this information for each
trading day that the trading desk used the limit during the calendar
month.
---------------------------------------------------------------------------

    In general, most commenters supported eliminating requirements to
establish limits on Stressed VaR.\709\ One commenter did not support
this change, as any revisions would necessitate changes to firms'
current systems and thus impose considerable operational burdens and
costs.\710\ Another commenter supported further requiring full
reporting of upper and lower bounds of risk and position limits
usage.\711\
---------------------------------------------------------------------------

    \709\ See, e.g., FSF and Data Boiler.
    \710\ See JBA.
    \711\ See Data Boiler.
---------------------------------------------------------------------------

    The final rule largely adopts these changes as proposed. As noted
above, the agencies believe requiring firms to submit one consolidated
Internal Limits Information Schedule for the entire banking entity's
covered trading activity, rather than multiple times in the Risk and
Position Limits and Usage metric for different trading desks, will
alleviate inefficiencies associated with reporting redundant
information and reduce electronic file submission sizes. The unique
identification label should allow the agencies to efficiently obtain
the descriptive information regarding the limit that is separately
reported in the Internal Limits Information Schedule.\712\ Recognizing
that firms may establish internal limits other than risk and position
limits (e.g., inventory aging limits), the final rule adopts an
Internal Limits Information Schedule and daily Internal Limits and
Usage quantitative metric.
---------------------------------------------------------------------------

    \712\ Such information includes the name of the limit, a
description of the limit, the unit of measurement for the limit, the
type of limit, and identification of the corresponding risk factor
attribution in the particular case that the limit type is a limit on
a risk factor sensitivity and profit and loss attribution to the
same risk factor is reported.
---------------------------------------------------------------------------

    As discussed in more detail below, the final rule removes the
metrics for Risk Factor Sensitivities. Accordingly, the final rule also
removes the cross reference between Risk and Position Limits and Risk
Factor Sensitivities, and the cross-reference between Risk Factor
Sensitivities and Profit and Loss Risk Factor Attributions. These
cross-references would have provided an essential link between the
limits on exposures to risk factors and the factors that are
demonstrably important sources of revenue. In place of these two cross-
references, the final rule adopts an identifier within the Internal
Limits Information Schedule indicating the corresponding Risk Factor
Attribution when a desk measures and imposes a limit on exposure to
that risk factor. This identifier facilitates the agencies' review of
the Internal Limits metric and its relation to gains and losses on the
positions measured by that metric.
ii. Risk Factor Sensitivities
    Like the 2013 rule, the proposed rule would have applied the Risk
Factor Sensitivities metric to all trading desks engaged in covered
trading activities. Under the proposal, a banking entity would have to
report for each trading desk the unique identification label associated
with each risk factor sensitivity of the desk, the magnitude of the
change in the risk factor, and the aggregate change in value across all
positions of the desk given the change in risk factor.
    As discussed above in Quantitative Measurements Identifying
Information, to reduce firms' reporting burden the final rule
eliminates the Risk Factor Sensitivities quantitative measurement.
iii. Value-at-Risk and Stressed Value-at-Risk
    The 2013 rule applies the Value-at-Risk and Stressed Value-at-Risk
metric to all trading desks engaged in covered trading activities. The
proposed rule would have modified the description of Stressed VaR to
align its calculation with that of Value-at-Risk and clarified that
Stressed VaR is not required to be reported for trading desks whose
covered trading activity is conducted exclusively to hedge products
excluded from the definition of financial instrument in Sec. 
__.3(d)(2) of the proposal. The proposal would have also revised the
definition of Value-at-Risk to provide that Value-at-Risk is the
measurement of the risk of future financial loss in the value of a
trading desk's aggregated positions at the ninety-nine percent
confidence level over a one-day period, based on current market
conditions.\713\
---------------------------------------------------------------------------

    \713\ Banking entities may base their calculations of Value-at-
Risk on historical observations consistent with other applicable
regulatory requirements relating to the calculation of Value-at-
Risk. See, e.g., 12 CFR part 3 subpart F; 12 CFR part 217 subpart F;
12 CFR part 324 subpart F.
---------------------------------------------------------------------------

    In general, a few commenters supported eliminating Stressed VaR,
including for non-financial instrument hedging.\714\ One commenter did
not support this change, as any revisions would necessitate changes to
firms' current systems and thus impose considerable operational burdens
and costs.\715\ One commenter stated that Stressed VaR was not a
helpful metric because it bears an attenuated relationship to
proprietary trading.\716\
---------------------------------------------------------------------------

    \714\ See, e.g., FSF and Data Boiler.
    \715\ See JBA.
    \716\ See Goldman Sachs.
---------------------------------------------------------------------------

    After considering the comments received, the agencies believe that
eliminating the Stressed VaR metric altogether will reduce burden
without affecting the ability of the agencies to monitor for prohibited
proprietary trading. The agencies believe that the other metrics
retained or adopted in the final rule provide appropriate data to
monitor for prohibited proprietary trading. To avoid duplicative or
unnecessary metrics, the final rule eliminates the Stressed VaR metric.
b. Source-of-Revenue Measurements
i. Comprehensive Profit and Loss Attribution
    The 2013 rule requires banking entities to calculate and report
volatility of comprehensive profit and loss. The proposed rule would
have eliminated this requirement as the measurement can be calculated
from the profit and loss amounts reported under the Comprehensive
Profit and Loss Attribution metric. Additionally, the proposed rule
would have required banking entities to provide, for one or more
factors that explain the

[[Page 62031]]

preponderance of the profit or loss changes due to risk factor changes,
a unique identification label for the factor and the profit or loss due
to the factor change. The proposed rule also would have required
banking entities to report a unique identification label for the factor
so the agencies can efficiently obtain the descriptive information
regarding the factor that is separately reported in the Risk Factor
Attribution Information Schedule.\717\
---------------------------------------------------------------------------

    \717\ Such information includes the name of the risk factor or
other factor, a description of the risk factor or other factor, and
the change unit of the risk factor or other factor.
---------------------------------------------------------------------------

    In general, commenters did not support requiring firms to attribute
profit and loss to specific risk factors.\718\ One commenter expressed
concern that this could disrupt firms' current infrastructure projects
to comply with the Basel Committee's revised market risk capital
standards, which also require specific alignment of risk factor
attribution and risk factor sensitivity hierarchies.\719\ This
commenter also noted the limited utility of this information for
horizontal comparisons across firms as each banking organization
defines these metrics at different levels of granularity. Two
commenters supported eliminating the volatility calculation, as
proposed.\720\
---------------------------------------------------------------------------

    \718\ See SIFMA.
    \719\ See SIFMA.
    \720\ See, e.g., Goldman Sachs and FSF.
---------------------------------------------------------------------------

    After considering these comments, the final rule adopts these
changes as proposed. Under the final rule, banking entities will no
longer be required to report volatility for the Comprehensive Profit
and Loss metric. Banking entities will be required to provide certain
information regarding the factors that explain the preponderance of the
profit or loss changes due to risk factor changes when sub-attributing
comprehensive profit and loss from existing positions to specific and
other factors.
    As in the 2013 rule and the proposal, the final rule requires
trading desks to attribute profit and loss into: (i) Profit and loss
attributable to a trading desk's existing positions, and (ii) profit
and loss attributable to new positions. The final rule retains the
category for residual profit and loss,\721\ but clarifies that this is
a sub-category of profit and loss attributable to existing positions.
---------------------------------------------------------------------------

    \721\ As under the 2013 rule, significant unexplained profit and
loss must be escalated for further investigation and analysis under
the final rule.
---------------------------------------------------------------------------

c. Customer-Facing Activity Metrics
i. Replacement of Inventory Turnover With Positions Metric
    The 2013 rule required banking entities to calculate and report
inventory turnover, or the turnover of a trading desk's inventory, over
a 30-day, 60-day, and 90-day reporting period. The proposed rule would
have replaced the Inventory Turnover metric with the daily data
underlying that metric, rather than proposing specific calculation
periods. The proposal would have replaced Inventory Turnover with the
daily Positions quantitative measurement. As noted in the Supplemental
Information to the proposed rule, positions information that is a
component of the Inventory Turnover metric would be more useful to the
agencies, and is already tracked by banking entities as a component of
the Inventory Turnover metric. The proposal would have limited the
scope of applicability of the Positions metric to trading desks that
rely on Sec.  __.4(a) or Sec.  __.4(b) to conduct underwriting activity
or market making-related activity, respectively. As a result, a trading
desk that did not rely on Sec.  __.4(a) or Sec.  __.4(b) would not have
been subject to the proposed Positions metric.\722\
---------------------------------------------------------------------------

    \722\ For example, a trading desk that relies solely on Sec. 
__.5 to conduct risk-mitigating hedging activity would not have been
subject to the Positions metric under the proposed rule.
---------------------------------------------------------------------------

    The proposal would have also required banking entities subject to
the appendix to separately report the market value of all long
securities positions, the market value of all short securities
positions, the market value of all derivatives receivables, the market
value of all derivatives payables, the notional value of all
derivatives receivables, and the notional value of all derivatives
payables.\723\ Finally, the proposal also would have clarified that
positions reported as ``derivatives'' need not be reported as
``securities,'' thereby clarifying the treatment of certain positions
that may have met both definitions. This technical change would have
addressed the possibility that a position could have been reported in
both the ``securities'' and ``derivatives'' positions, and thus been
double-counted.
---------------------------------------------------------------------------

    \723\ Under the proposal, banking entities would have been
required to report the effective notional value of derivatives
receivables and derivatives payables for those derivatives whose
stated notional amount is leveraged.
---------------------------------------------------------------------------

    A few commenters recommended that the agencies eliminate the
Positions metric, but retain the inventory turnover metric.\724\ These
commenters expressed concern that the new ``Positions'' metric would
be, in effect, a ``new'' metric that would require reporting banking
entities to modify their systems to generate as a standalone metric and
noted that this metric could create ``false positives'' due to daily
changes in inventory that may be driven by fluctuations in the
expectation of customer demand. Other commenters recommended that the
agencies eliminate inventory turnover metrics reporting requirements
for derivatives, including foreign exchange derivatives.\725\ One
commenter supported the positions metric, but recommended removing the
requirement to report market values for derivative positions--as
notional value measures are sufficient to assess the size of a trading
desk's derivative inventory.\726\
---------------------------------------------------------------------------

    \724\ See, e.g., GFMA and SIFMA.
    \725\ See, e.g., GFMA; Goldman Sachs; and State Street.
    \726\ See e.g., Credit Suisse.
---------------------------------------------------------------------------

    The final rule adopts the ``Positions'' metric and eliminates the
``Inventory Turnover'' metric consistent with the proposal. The
``Positions'' metric is itself a necessary component firms already must
calculate to generate the ``Inventory Turnover'' metric. Therefore,
producing the ``Positions'' metric as a standalone figure would not
require firms to generate additional data not produced internally
today, but will result in a more effective metrics reporting framework.
The agencies are aware that all changes to the metrics reporting
requirements require changes to the underlying systems required to
generate and report metrics to the agencies. However, the Positions
metric will allow both the agencies and the firms themselves to analyze
firms' trading activities over different time horizons, as appropriate;
the Inventory Turnover metric, by contrast, relied on the same
underlying positions data as the final rule requires to be reported,
but aggregated it in a manner (with 30-day, 60-day, and 90-day rolling
averages) that is more complicated than a direct reporting of positions
metrics, and is less effective. The final rule differs from the
proposal in that it eliminates the requirement to report the notional
value of derivatives. Removing the requirement to report notional value
of derivative positions will avoid potential complexity arising from
using different calculation methods for determining the notional value
for different types of derivatives. Additionally, as the definition of
financial instrument in section __.3 lists securities, derivatives and
futures as distinct types of financial instruments, the agencies are
clarifying that futures positions

[[Page 62032]]

should be reported as ``derivatives,'' and are not expected to be
broken out separately. The agencies are making this technical change to
avoid confusion as to whether or how to classify futures for this
metric.\727\
---------------------------------------------------------------------------

    \727\ See final rule Sec.  __.3(c)(1) (defining ``financial
instrument'' to mean (i) a security, including an option on a
security; (ii) a derivative, including an option on a derivative; or
(iii) a contract of sale of a commodity for future delivery, or
option on a contract of sale of a commodity for future delivery).
---------------------------------------------------------------------------

ii. Transaction Volumes and the Customer-Facing Trade Ratio
    Paragraph IV.c.3. of Appendix A of the 2013 rule requires banking
entities to calculate and report a Customer-Facing Trade Ratio
comparing transactions involving a counterparty that is a customer of
the trading desk to transactions with a counterparty that is not a
customer of the desk. Appendix A of the 2013 rule requires the
Customer-Facing Trade Ratio to be computed by measuring trades on both
a trade count basis and value basis. In addition, Appendix A of the
2013 rule provides that the term ``customer'' for purposes of the
Customer-Facing Trade Ratio is defined in the same manner as the terms
``client, customer, and counterparty'' used in Sec.  __.4(b) of the
2013 rule describing the permitted activity exemption for market
making-related activities. This metric is required to be calculated on
a daily basis for 30-day, 60-day, and 90-day calculation periods.
    The proposed rule would have replaced the Customer-Facing Trade
Ratio with a daily Transaction Volumes quantitative measurement that
would allow the agencies to calculate customer-facing trade ratios over
any period of time and to conduct more meaningful analysis of trading
desks' customer-facing activity.\728\ The proposed Transaction Volumes
metric would measure the number and value \729\ of all securities and
derivatives transactions \730\ conducted by a trading desk engaged in
permitted underwriting activity or market making-related activity under
the 2013 rule with four categories of counterparties: (i) Customers
(excluding internal transactions); (ii) non-customers (excluding
internal transactions); (iii) trading desks and other organizational
units where the transaction is booked into the same banking entity; and
(iv) trading desks and other organizational units where the transaction
is booked into an affiliated banking entity.\731\ The proposed rule
would have clarified that the term ``customer'' for purposes of this
metric has the same meaning as ``client, customer, and counterparty''
in Sec.  __.4(a) for underwriting desks and in Sec.  __.4(b) for
market-making desks. To reduce reporting inefficiencies, the proposed
rule would have only required trading desks engaged in underwriting or
market making-related activity under Sec.  __.4(a) or Sec.  __.4(b) to
calculate this quantitative measurement for each trading day. As with
the Positions metric, the proposed rule would also have further reduced
reporting volume by replacing the 30-day, 60-day, and 90-day
calculation periods for each transaction with a single daily
transaction value and count for each type.
---------------------------------------------------------------------------

    \728\ As noted in the proposal the current Customer-Facing Trade
Ratio metric does not provide meaningful information when a trading
desk only conducts customer-facing trading activity. The numerator
of the ratio represents transactions with counterparties that are
customers, while the denominator represents transactions with
counterparties that are not customers. If a trading desk only trades
with customers, it will not be able to calculate this ratio because
the denominator will be zero.
    \729\ The proposal defined value to mean gross market value with
respect to securities, gross notional value (i.e., the current
dollar market value of the quantity of the commodity underlying the
derivative) for commodity derivatives, and gross notional value for
all other derivatives.
    \730\ As noted in the Positions metric preamble, in calculating
the Transactions Volume quantitative metric, futures positions
should be reported as ``derivatives.''
    \731\ The proposal noted that in order to avoid double-counting
transactions, these four categories would be exclusive of each other
(i.e., a transaction could only be reported in one category).
---------------------------------------------------------------------------

    The proposed rule would have required banking entities to
separately report the value and number of securities and derivatives
transactions conducted by a trading desk with the four categories of
counterparties described above. The proposed classification of
securities and derivatives described above for Positions would have
also applied to Transaction Volumes.
    A few commenters opposed the replacing the Customer-Facing Trade
Ratio with the new Transactions Volume quantitative metric.\732\ These
commenters argued that the proposed changes would effectively create an
entirely new metric, in particular by requiring firms to classify
inter-affiliate transactions within the prescribed categories. One
commenter also asserted that distinguishing trades that occur across
banking entities from those within a single banking entity would not
provide any informational value to the agencies in monitoring
compliance with section 13 of the BHC Act.\733\ One commenter supported
the proposal, but also recommended excluding inter-affiliate
transactions.\734\
---------------------------------------------------------------------------

    \732\ See, e.g., IIB and SIFMA.
    \733\ See SIFMA.
    \734\ See, e.g., Credit Suisse.
---------------------------------------------------------------------------

    The final rule adopts the proposed change to add a category of
counterparty for desk-to-desk transactions within the same legal entity
and transactions between affiliates (collectively, Internal
Transactions). In order to connect the transactions metric with the
other quantitate measurements, for example risk, profit and loss, and
positions, it is important for transactions metrics to include all
transactions conducted by the desk, including: (i) Desk-to-desk
transfers within the same legal entity; (ii) transactions between
affiliates; and (iii) transactions with non-affiliated external
counterparties. It is also important for supervisors to be able to
distinguish Internal Transactions from transactions with external non-
affiliated counterparties because, based on supervisory experience
under the 2013 rule, firms report these transactions inconsistently
depending on a desk's purpose and business model.\735\ Considering the
trading activities of a desk without Internal Transactions may not give
a complete picture of the desk's positions, risk exposure or trading
strategies. To understand the activity of the desk the agencies need to
observe its Internal Transactions.
---------------------------------------------------------------------------

    \735\ Internal Transactions are used for a number of reasons,
including to transfer risk to a desk better equipped to manage the
position's risk; to allow a desk with better market access or
specialized market knowledge to facilitate another desk better
equipped to face customers; or to allocate funding costs via
transfer pricing, in which case one desk treats other internal desks
or affiliate desks in much the same way as external clients.
Supervisory experience has shown that, depending on the purpose of
the internal transaction, banking entities sometimes report these
internal transactions as transactions with customers, sometimes as
transactions with non-customers, and sometimes do not report them at
all.
---------------------------------------------------------------------------

    Transactions between one trading desk and another trading desk in
which the second desk books the position in the same banking entity as
the first are not purchases or sales of financial instruments subject
to the rule, including the prohibition on proprietary trading in Sec. 
__.3. However, in practice many trading desks book positions into
multiple affiliated banking entities and also engage in desk-to-desk
transactions within the same legal entity. Distinguishing Internal
Transactions that move positions to new legal entities from desk-to-
desk transactions that occur purely within the same legal entity would
require an additional layer of recordkeeping. The agencies agree that
the benefit of distinguishing trades across affiliated banking entities
from desk-to-desk transactions within the same legal entity does not
justify the

[[Page 62033]]

extra record-keeping costs. The final rule consolidates these two
proposed categories into one category, transactions with trading desks
and other organizational units where the transaction is booked into
either the same banking entity or an affiliated banking entity.
d. Securities Inventory Aging
    The 2013 rule requires all trading desks engaged in covered trading
activities to report Inventory Aging metrics for their securities and
derivative positions. The proposed rule would have only required
trading desks that relied on Sec.  __.4(a) or Sec.  __.4(b) to conduct
underwriting or market making-related activity to report Inventory
Aging and limited the scope of this metric to only securities
positions.\736\ To reflect the revised scope, the proposed rule would
have revised the name of this metric to be Securities Inventory Aging.
Finally, the proposal would have required a banking entity to calculate
and report the Securities Inventory Aging metric according to a
specific set of age ranges. Specifically, banking entities would have
to calculate and report the market value of security assets and
security liabilities over the following holding periods: 0-30 calendar
days; 31-60 calendar days; 61-90 calendar days; 91-180 calendar days;
181-360 calendar days; and greater than 360 calendar days.
---------------------------------------------------------------------------

    \736\ The proposed Securities Inventory Aging metric would not
require banking entities to prepare an aging schedule for
derivatives or include in its securities aging schedules those
``securities'' that are also ``derivatives,'' as those terms are
defined under the 2013 rule. See 2013 rule Sec. Sec.  __.2(h), (y).
See also supra Part III.E.2.i (discussing the classification of
securities and derivatives for purposes of the proposed Positions
quantitative measurement).
---------------------------------------------------------------------------

    In general, commenters supported reducing the Inventory Aging
metric, as inventory aging data is not readily available or
particularly useful for derivative positions.\737\ After consideration
of comments and in light of the general desire to reduce reporting
burden, the agencies believe that the Inventory Aging metric may be
overly prescriptive as an indicator of compliance with the rule.
Therefore, the final rule no longer requires the Inventory Aging metric
for all desks and position types. For those desks where banking
entities identify inventory aging as a meaningful control, the entities
should report their internal limits on inventory aging under the
Internal Limits and Usage metric and consequently ``Inventory Aging''
has been added as a potential type of limit under the Internal Limits
Information Schedule.
---------------------------------------------------------------------------

    \737\ See, e.g., Data Boiler; Credit Suisse; FSF; Goldman Sachs,
GFMA; and State Street.
---------------------------------------------------------------------------

V. Administrative Law Matters

A. Use of Plain Language

    Section 722 of the Gramm-Leach-Bliley Act \738\ requires the OCC,
Board, and FDIC (Federal banking agencies) to use plain language in all
proposed and final rules published after January 1, 2000. The Federal
banking agencies have sought to present the proposed rule in a simple
and straightforward manner and did not receive any comments on plain
language.
---------------------------------------------------------------------------

    \738\ Public Law 106-102, section 722, 113 Stat. 1338, 1471
(1999).
---------------------------------------------------------------------------

B. Paperwork Reduction Act

    Certain provisions of the final rule contain ``collection of
information'' requirements within the meaning of the Paperwork
Reduction Act (PRA) of 1995 (44 U.S.C. 3501-3521). In accordance with
the requirements of the PRA, the agencies may not conduct or sponsor,
and a respondent is not required to respond to, an information
collection unless it displays a currently valid Office of Management
and Budget (OMB) control number. The agencies reviewed the final rule
and determined that the final rule revises certain reporting and
recordkeeping requirements that have been previously cleared under
various OMB control numbers. The agencies did not receive any specific
comments on the PRA. The agencies are extending for three years, with
revision, these information collections. The information collection
requirements contained in this final rule have been submitted by the
OCC and FDIC to OMB for review and approval under section 3507(d) of
the PRA (44 U.S.C. 3507(d)) and section 1320.11 of the OMB's
implementing regulations (5 CFR 1320). The Board reviewed the final
rule under the authority delegated to the Board by OMB. The Board will
submit information collection burden estimates to OMB and the
submission will include burden for Federal Reserve-supervised
institutions, as well as burden for OCC-, FDIC-, SEC-, and CFTC-
supervised institutions under a holding company. The OCC and the FDIC
will take burden for banking entities that are not under a holding
company.
Abstract
    Section 13 to the BHC Act generally prohibits any banking entity
from engaging in proprietary trading or from acquiring or retaining an
ownership interest in, sponsoring, or having certain relationships with
a covered fund, subject to certain exemptions. The exemptions allow
certain types of permissible trading activities such as underwriting,
market making, and risk-mitigating hedging, among others. The 2013 rule
implementing section 13 became effective on April 1, 2014. Section
__.20(d) and Appendix A of the 2013 final rule require certain of the
largest banking entities to report to the appropriate agency certain
quantitative measurements.
Current Actions
    This final rule contains requirements subject to the PRA and the
changes relative to the 2013 rule are discussed herein. The new and
modified reporting requirements are found in sections __.4(c)(3)(i),
__.20(d), __.20(i), and the Appendix. The new and modified
recordkeeping requirements are found in sections, __.3(d)(3),
__.4(c)(3)(i), __.5(c), __.20(b), __.20(c), __.20 (d), __.20(e),
__.20(f), and the Appendix. The modified information collection
requirements \739\ would implement section 13 of the BHC Act. The
respondents are for-profit financial institutions, including small
businesses. A covered entity must retain these records for a period
that is no less than 5 years in a form that allows it to promptly
produce such records to the relevant agency on request.
---------------------------------------------------------------------------

    \739\ In an effort to provide transparency, the total cumulative
burden for each agency is shown. In addition to the changes
resulting from this final rule, the agencies are also applying a
conforming methodology for calculating the burden estimates in order
to be consistent across the agencies.
---------------------------------------------------------------------------

Reporting Requirements
    Section __.4(c)(3)(i) requires a banking entity to make available
to the agency upon request records regarding (1) any limit that is
exceeded and (2) any temporary or permanent increase to any limit(s),
in each case in the form and manner as directed by the primary
financial regulatory agency. The agencies estimate that the average
time per response would be 15 minutes.
    Section __.20(d) is modified by extending the reporting period for
certain banking entities from within 10 days of the end of each
calendar month to 30 days of the end of each calendar quarter. The
threshold for reporting under section __.20(d) is modified from $10
billion or more in trading assets and liabilities to $20 billion or
more in trading assets and liabilities. The metrics reporting changes
to the Appendix would impact the reporting burden under section
___.20(d). The agencies estimate that the current average hours per
response will

[[Page 62034]]

decrease by 14 hours (decrease 40 hours for initial set-up).
    Sections __.3(b)(4), __.4(c)(4), __.20(g)(2), and __.20(h) would
implicate the notice and response procedures pursuant to section
__.20(i) that an agency would follow when rebutting a presumption or
exercising a reservation of authority. The agencies estimate that the
average hours per response would be 20 hours.
Recordkeeping Requirements
    Section __.3(d)(3) would expand the scope of the recordkeeping to
include foreign exchange forward (as that term is defined in section
1a(24) of the Commodity Exchange Act (7 U.S.C. 1a(24)), foreign
exchange swap (as that term is defined in section 1a(25) of the
Commodity Exchange Act (7 U.S.C. 1a(25)), or cross-currency swap. The
agencies estimate that the current average hour per response will not
change.
    Section __.4(c)(3)(i) requires a banking entity to maintain records
regarding (1) any limit that is exceeded and (2) any temporary or
permanent increase to any limit(s), in each case in the form and manner
as directed by the primary financial regulatory agency. The agencies
estimate that the average time per response would be 15 minutes.
    Section __.5(c) is modified by reducing the requirements for
banking entities that do not have significant trading assets and
liabilities and eliminating documentation requirements for certain
hedging activities. The agencies estimate that the current average
hours per response will decrease by 20 hours (decrease 10 hours for
initial set-up).
    Section __.20(b) is modified by limiting the requirement only to
banking entities with significant trading assets and liabilities. The
agencies estimate that the current average hour per response will not
change.
    Section __.20(c) is modified by limiting the CEO attestation
requirement to a banking entity that has significant trading assets and
liabilities. The agencies estimate that the current average hours per
response will decrease by 1,100 hours (decrease 3,300 hours for initial
set-up).
    Section __.20(d) is modified by extending the time period for
reporting for certain banking entities from within 10 days of the end
of each calendar month to 30 days of the end of each calendar quarter.
The agencies estimate that the current average hours per response will
decrease by 3 hours.
    Section __.20(e) is modified by limiting the requirement to banking
entities with significant trading assets and liabilities. The agencies
estimate that the current average hours per response will not change.
    Section __.20(f)(2) is modified by limiting the requirement to
banking entities with moderate trading assets and liabilities. The
agencies estimate that the current average hours per response will not
change.
    The Instructions for Preparing and Submitting Quantitative
Measurement Information, Technical Specifications Guidance, and XML
Schema will be available on each agency's public website:
     OCC: http://www.occ.treas.gov/topics/capital-markets/financial-markets/trading/volcker-rule-implementation/index-volcker-rule-implementation.html;
     Board: https://www.federalreserve.gov/apps/reportforms/review.aspx;
     FDIC: https://www.fdic.gov/regulations/reform/volcker/index.html;
     CFTC: https://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_28_VolckerRule/index.htm; and
     SEC: https://www.sec.gov/structureddata/dera_taxonomies.
Proposed Revision, With Extension, of the Following Information
Collections
    Estimated average hours per response:
Reporting
    Section __.4(c)(3)(i)--0.25 hours for an average of 20 times per
year.
    Section __.12(e)--20 hours (Initial set-up 50 hours) for an average
of 10 times per year.
    Section __.20(d)--41 hours (Initial set-up 125 hours) quarterly.
    Section __.20(i)--20 hours.
Recordkeeping
    Section __.3(d)(3)--1 hour (Initial set-up 3 hours).
    Section __.4(b)(3)(i)(A)--2 hours quarterly.
    Section __.4(c)(3)(i)--0.25 hours for an average of 40 times per
year.
    Section __.5(c)--80 hours (Initial setup 40 hours).
    Section __.11(a)(2)--10 hours.
    Section __.20(b)--265 hours (Initial set-up 795 hours).
    Section __.20(c)--100 hours (Initial set-up 300 hours).
    Section __.20(d)- 10 hours.
    Section __.20(e)--200 hours.
    Section __.20(f)(1)--8 hours.
    Section __.20(f)(2)--40 hours (Initial set-up 100 hours).
Disclosure
    Section __.11(a)(8)(i)--0.1 hours for an average of 26 times per
year.
OCC
    Title of Information Collection: Reporting, Recordkeeping, and
Disclosure Requirements Associated with Restrictions on Proprietary
Trading and Certain Relationships with Hedge Funds and Private Equity
Funds.
    Frequency: Annual, quarterly, and event driven.
    Affected Public: Businesses or other for-profit.
    Respondents: National banks, state member banks, state nonmember
banks, and state and federal savings associations.
    OMB control number: 1557-0309.
    Estimated number of respondents: 39.
    Proposed revisions estimated annual burden: -3,503 hours.
    Estimated annual burden hours: 19,823 hours (3,482 hours for
initial set-up and 16,341 hours for ongoing).
Board
    Title of Information Collection: Reporting, Recordkeeping, and
Disclosure Requirements Associated with Regulation VV.
    Frequency: Annual, quarterly, and event driven.
    Affected Public: Businesses or other for-profit.
    Respondents: State member banks, bank holding companies, savings
and loan holding companies, foreign banking organizations, U.S. State
branches or agencies of foreign banks, and other holding companies that
control an insured depository institution and any subsidiary of the
foregoing other than a subsidiary for which the OCC, FDIC, CFTC, or SEC
is the primary financial regulatory agency. The Board will take burden
for all institutions under a holding company including:
     OCC-supervised institutions,
     FDIC-supervised institutions,
     Banking entities for which the CFTC is the primary
financial regulatory agency, as defined in section 2(12)(C) of the
Dodd-Frank Act, and
     Banking entities for which the SEC is the primary
financial regulatory agency, as defined in section 2(12)(B) of the
Dodd-Frank Act.
    Legal authorization and confidentiality: This information
collection is authorized by section 13 of the BHC Act (12 U.S.C.
1851(b)(2) and 12 U.S.C. 1851(e)(1)). The information collection is
required in order for covered entities to obtain the benefit of
engaging in certain types of proprietary trading or investing in,
sponsoring, or having certain relationships with a hedge fund or
private equity fund, under the restrictions set forth in

[[Page 62035]]

section 13 and the final rule. If a respondent considers the
information to be trade secrets and/or privileged such information
could be withheld from the public under the authority of the Freedom of
Information Act (5 U.S.C. 552(b)(4)). Additionally, to the extent that
such information may be contained in an examination report such
information could also be withheld from the public (5 U.S.C. 552
(b)(8)).
    Agency form number: FR VV.
    OMB control number: 7100-0360.
    Estimated number of respondents: 255.
    Proposed revisions estimated annual burden: -169,466 hours.
    Estimated annual burden hours: 31,044 hours (4,035 hours for
initial set-up and 27,009 hours for ongoing).
FDIC
    Title of Information Collection: Volcker Rule Restrictions on
Proprietary Trading and Relationships with Hedge Funds and Private
Equity Funds.
    Frequency: Annual, quarterly, and event driven.
    Affected Public: Businesses or other for-profit.
    Respondents: State nonmember banks, state savings associations, and
certain subsidiaries of those entities.
    OMB control number: 3064-0184.
    Estimated number of respondents: 13.
    Proposed revisions estimated annual burden: -15,172 hours.
    Estimated annual burden hours: 3,115 hours (1,656 hours for initial
set-up and 1,459 hours for ongoing).

C. Regulatory Flexibility Act Analysis

    OCC: The Regulatory Flexibility Act, 5 U.S.C. 601 et seq., (RFA),
requires an agency, in connection with a final rule, to prepare a Final
Regulatory Flexibility Analysis describing the impact of the rule on
small entities (defined by the SBA for purposes of the RFA to include
commercial banks and savings institutions with total assets of $600
million or less and trust companies with total assets of $41.5 million
or less) or to certify that the rule will not have a significant
economic impact on a substantial number of small entities.
    The OCC currently supervises approximately 782 small entities.\740\
Under the EGRRCPA, banking entities with total consolidated assets of
$10 billion or less generally are not ``banking entities'' within the
scope of Section 13 of the BHCA if their trading assets and trading
liabilities do not exceed 5 percent of their total consolidated assets.
Thus, the final rule will not impact any OCC-supervised small entities.
Therefore, the OCC certifies that the final rule will not have a
significant impact on a substantial number of OCC-supervised small
entities.
---------------------------------------------------------------------------

    \740\ The number of small entities supervised by the OCC is
determined using the SBA's size thresholds for commercial banks and
savings institutions, and trust companies, which are $600 million
and $41.5 million, respectively. Consistent with the General
Principles of Affiliation 13 CFR 121.103(a), the OCC counts the
assets of affiliated financial institutions when determining if the
OCC should classify an OCC-supervised institution a small entity.
The OCC used December 31, 2018, to determine size because a
``financial institution's assets are determined by averaging the
assets reported on its four quarterly financial statements for the
preceding year.'' See footnote 8 of the U.S. Small Business
Administration's Table of Size Standards.
---------------------------------------------------------------------------

    Board: The RFA requires an agency to either provide a regulatory
flexibility analysis with a rule or certify that the rule will not have
a significant economic impact on a substantial number of small
entities. The U.S. Small Business Administration (SBA) establishes size
standards that define which entities are small businesses for purposes
of the RFA.\741\ Except as otherwise specified below, the size standard
to be considered a small business for banking entities subject to the
proposal is $600 million or less in consolidated assets.\742\
---------------------------------------------------------------------------

    \741\ U.S. SBA, Table of Small Business Size Standards Matched
to North American Industry Classification System Codes, available at
https://www.sba.gov/sites/default/files/files/Size_Standards_Table.pdf.
    \742\ See id. Pursuant to SBA regulations, the asset size of a
concern includes the assets of the concern whose size is at issue
and all of its domestic and foreign affiliates. 13 CFR 121.103(6).
---------------------------------------------------------------------------

    The Board has considered the potential impact of the proposed rule
on small entities in accordance with the RFA. Based on the Board's
analysis, and for the reasons stated below, the Board believes that
this proposed rule will not have a significant economic impact on a
substantial of number of small entities. No comments were received
related to the Board's initial RFA analysis, which was published with
the proposal.
    As discussed in the Supplementary Information, the agencies are
revising the 2013 rule in order to provide clarity to banking entities
about what activities are prohibited, reduce compliance costs, and
improve the ability of the agencies to make supervisory assessments
regarding compliance relative to the 2013 rule. The agencies are
explicitly authorized under section 13(b)(2) of the BHC Act to adopt
rules implementing section 13.\743\
---------------------------------------------------------------------------

    \743\ 12 U.S.C. 1851(b)(2).
---------------------------------------------------------------------------

    The Board's rule generally applies to state-chartered banks that
are members of the Federal Reserve System, bank holding companies,
foreign banking organizations, and nonbank financial companies
supervised by the Board (collectively, Board-regulated entities).
However, EGRRCPA, which was enacted on May 24, 2018, amended section 13
of the BHC Act and modified the scope of the definition of banking
entity by amending the term ``insured depository institution'' to
exclude certain community banks.\744\ The Board is not aware of any
Board-regulated entities that meet the SBA's definition of ``small
entity'' that are subject to section 13 of the BHC Act and the rule
following the enactment of EGRRCPA. Furthermore, to the extent that any
Board-regulated entities that meet the definition of ``small entity''
are or become subject to section 13 of the BHC Act and the rule, the
Board does not expect the total number of such entities to be
substantial. Accordingly, the Board's rule is not expected to have a
significant economic impact on a substantial number of small entities.
---------------------------------------------------------------------------

    \744\ Under EGRRCPA, a community bank and its affiliates are
generally excluded from the definition of banking entity, and thus
section 13 of the BHC Act, if the bank and all companies that
control the bank have total consolidated assets equal to $10 billion
or less and trading assets and liabilities equal to 5 percent or
less of total consolidated assets.
---------------------------------------------------------------------------

    The Board has not identified any federal statutes or regulations
that would duplicate, overlap, or conflict with the proposed revisions,
and the Board is not aware of any significant alternatives to the rule
that would reduce the economic impact on Board-regulated small
entities.
FDIC
(a) Regulatory Flexibility Analysis
    The RFA generally requires an agency, in connection with a final
rule, to prepare and make available for public comment a final
regulatory flexibility analysis that describes the impact of a rule on
small entities.\745\ However, a regulatory flexibility analysis is not
required if the agency certifies that the rule will not have a
significant economic impact on a substantial number of small entities.
The SBA has defined ``small entities'' to include banking organizations
with total assets of less than or equal to $600 million.\746\

[[Page 62036]]

Generally, the FDIC considers a significant effect to be a quantified
effect in excess of 5 percent of total annual salaries and benefits per
institution, or 2.5 percent of total noninterest expenses. The FDIC
believes that effects in excess of these thresholds typically represent
significant effects for FDIC-supervised institutions. As discussed
further below, the FDIC certifies that this final rule will not have a
significant economic impact on a substantial number of FDIC-supervised
small entities.
---------------------------------------------------------------------------

    \745\ 5 U.S.C. 601 et seq.
    \746\ The SBA defines a small banking organization as having
$600 million or less in assets, where an organization's ``assets are
determined by averaging the assets reported on its four quarterly
financial statements for the preceding year.'' See 13 CFR 121.201
(as amended by 84 FR 34261, effective August 19, 2019). In its
determination, the ``SBA counts the receipts, employees, or other
measure of size of the concern whose size is at issue and all of its
domestic and foreign affiliates.'' See 13 CFR 121.103. Following
these regulations, the FDIC uses a covered entity's affiliated and
acquired assets, averaged over the preceding four quarters, to
determine whether the covered entity is ``small'' for the purposes
of RFA.
---------------------------------------------------------------------------

(b) Reasons for and Policy Objectives of the Final Rule
    The agencies are issuing this final rule to amend the 2013 rule in
order to provide banking entities with additional clarity and certainty
about what activities are prohibited and seek to improve the efficacy
of the regulations where possible. The agencies acknowledge that many
banking entities have found certain aspects of the 2013 rule to be
complex or difficult to apply in practice. This final rule amends the
2013 rule to make its requirements more efficient.
(c) Description of the Rule
    First, the FDIC is amending its regulations to tailor the
application of the final rule based on the size and scope of a banking
entity's trading activities. In particular, the FDIC aims to further
reduce compliance obligations for firms that do not have large trading
operations and therefore reduce costs and uncertainty faced by firms in
complying with the final rule, relative to their amount of trading
activity. In addition to tailoring the application of the final rule,
the FDIC is also streamlining and clarifying for all banking entities
certain definitions and requirements related to the proprietary trading
prohibition and limitations on covered fund activities and investments.
Finally, the FDIC is reducing reporting, recordkeeping, and compliance
program requirements for all banking entities and expanding tailoring
to make the scale of compliance activity required by the rule
commensurate with a banking entity's size and level of trading
activity.
(d) Other Statutes and Federal Rules
    On May 24, 2018, EGRRCPA was enacted, which, among other things,
amends section 13 of the BHC Act. As a result, section 13 excludes from
the definition of ``banking entity'' any institution that, together
with their affiliates and subsidiaries, has: (1) Total assets of $10
billion or less, and (2) trading assets and liabilities that comprise 5
percent or less of total assets.
    The FDIC has not otherwise identified any likely duplication,
overlap, and/or potential conflict between this final rule and any
other federal rule.
(e) Small Entities Affected
    The FDIC supervises 3,465 depository institutions,\747\ of which,
2,705 are defined as small banking organizations according to the
RFA.\748\ Almost all FDIC-supervised small banking entities are exempt
from the requirements of section 13 of the BHC Act, pursuant to
EGRRCPA, and hence the final rule does not affect them.
---------------------------------------------------------------------------

    \747\ Categories of FDIC-supervised depository institutions are
set forth in 12 U.S.C. 1813(q)(2).
    \748\ FDIC Call Report, March 31, 2019.
---------------------------------------------------------------------------

    Only one FDIC-supervised small banking entity is not exempt from
the requirements of section 13 of the BHC Act under EGRRCPA because it
has trading assets and liabilities greater than five percent of total
consolidated assets. This bank has trading activity at levels that
would place it in the final rule's limited trading assets and
liabilities compliance category, and it thus could benefit from the
final rule which contains a rebuttable presumption of compliance for
such banking entities. The FDIC estimates that banks with limited
trading will save, on average, $115,233 from the reduced burden of this
rule. This amount is far less than 5 percent of total salaries and 2.5
percent of total non-interest expenses for this one institution.
    Consequently, the FDIC does not believe that this rule will have a
significant economic impact on a substantial number of small entities.
(f) Certification Statement
    Section 13 of the BHC Act, as amended by EGRRCPA, exempts all but
one of the 2,705 FDIC-supervised small banking entities from compliance
with section 13 of the BHC Act. Therefore, the FDIC certifies that this
final rule will not have a significant economic impact on a substantial
number of FDIC-supervised small banking entities.
    CFTC: Pursuant to 5 U.S.C. 605(b), the CFTC hereby certifies that
the amendments to the 2013 final rule will not have a significant
economic impact on a substantial number of small entities for which the
CFTC is the primary financial regulatory agency.
    As discussed in this SUPPLEMENTARY INFORMATION, the Agencies are
revising the 2013 final rule in order to provide clarity to banking
entities about what activities are prohibited, reduce compliance costs,
and improve the ability of the Agencies to make assessments regarding
compliance relative to the 2013 final rule. To minimize the costs
associated with the 2013 final rule, the Agencies are simplifying and
tailoring the rule to allow banking entities to more efficiently
provide financial services in a manner that is consistent with the
requirements of section 13 of the BHC Act.
    The revisions will generally apply to banking entities, including
certain CFTC-registered entities. These entities include bank-
affiliated CFTC-registered swap dealers, futures commission merchants,
commodity trading advisors and commodity pool operators.\749\ The CFTC
has previously determined that swap dealers, futures commission
merchants and commodity pool operators are not small entities for
purposes of the RFA and, therefore, the requirements of the RFA do not
apply to those entities.\750\ As for commodity trading advisors, the
CFTC has found it appropriate to consider whether such registrants
should be deemed small entities for purposes of the RFA on a case-by-
case basis, in the context of the particular regulation at issue.\751\
---------------------------------------------------------------------------

    \749\ The revisions may also apply to other types of CFTC
registrants that are banking entities, such as introducing brokers,
but the CFTC believes it is unlikely that such other registrants
will have significant activities that would implicate the revisions.
See 2013 final rule (CFTC), 79 FR 5808 at 5813 (Jan. 31, 2014).
    \750\ See Policy Statement and Establishment of Definitions of
``Small Entities'' for Purposes of the Regulatory Flexibility Act,
47 FR 18618 (Apr. 30, 1982) (futures commission merchants and
commodity pool operators); and Registration of Swap Dealers and
Major Swap Participants, 77 FR 2613, 2620 (Jan. 19, 2012) (swap
dealers and major swap participants).
    \751\ See Policy Statement and Establishment of Definitions of
``Small Entities'' for Purposes of the Regulatory Flexibility Act,
47 FR 18618, 18620 (Apr. 30, 1982).
---------------------------------------------------------------------------

    In the context of the revisions to the 2013 final rule, the CFTC
believes it is unlikely that a substantial number of the commodity
trading advisors that are potentially affected are small entities for
purposes of the RFA. In this regard, the CFTC notes that only commodity
trading advisors that are registered with the CFTC are covered by the
2013 final rule, and generally those that are registered have larger
businesses. Similarly, the 2013 final rule applies to only those
commodity trading advisors that are affiliated with banks that are
within the scope of the Volcker Rule, which the CFTC expects are larger
businesses.\752\
---------------------------------------------------------------------------

    \752\ In this regard, the CFTC notes that the agencies recently
revised the 2013 final rule in order to be consistent with statutory
amendments made by EGRRCPA to section 13 of the BHC Act. The general
result of one of these statutory revisions was to exclude community
banks and their affiliates and subsidiaries from the scope of the
Volcker Rule. See 84 FR 35008. The CFTC believes this exclusion
lessens the likelihood that any commodity trading advisors that
remain within the scope of the Volcker Rule are small entities.

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

[[Page 62037]]

    The CFTC requested that commenters address whether any CFTC
registrants covered by the proposed revisions to the 2013 final rule
are small entities for purposes of the RFA. The CFTC did not receive
any public comments on this or any other aspect of the RFA as it
relates to the rule.
    Because the CFTC believes there are not a substantial number of
commodity trading advisors within the scope of the Volcker Rule that
are small entities for purposes of the RFA, and the other CFTC
registrants that may be affected by the proposed revisions have been
determined not to be small entities, the CFTC believes that the
revisions to the 2013 final rule will not have a significant economic
impact on a substantial number of small entities for which the CFTC is
the primary financial regulatory agency.
    SEC: In the proposal, the SEC certified that, pursuant to 5 U.S.C.
605(b), the proposal would not, if adopted, have a significant economic
impact on a substantial number of small entities. Although the SEC
solicited written comments regarding this certification, no commenters
responded to this request.
    As discussed in the Supplementary Information, the Agencies are
adopting revisions to the 2013 rule that are intended to provide
banking entities with clarity about what activities are prohibited and
improve supervision and implementation of section 13 of the BHC Act.
    The revisions the agencies are adopting today will generally apply
to banking entities, including certain SEC-registered entities.\753\
These entities include SEC-registered broker-dealers, investment
advisers, security-based swap dealers, and major security-based swap
participants that are affiliates or subsidiaries of an insured
depository institution.\754\ Based on information in filings submitted
by these entities, the SEC believes that there are no banking entity
registered investment advisers,\755\ broker-dealers,\756\ security-
based swap dealers, or major security-based swap participants that are
small entities for purposes of the RFA.\757\ For this reason, the SEC
certifies that the rule, as adopted, will not have a significant
economic impact on a substantial number of small entities.
---------------------------------------------------------------------------

    \753\ The SEC's Economic Analysis, below, discusses the economic
effects of the final amendments. See SEC Economic Analysis, supra
Part V.F.
    \754\ See 2013 rule Sec.  _.2(c) (definition of banking entity);
2013 rule Sec.  _.2(r) as amended (definition of insured depository
institution).
    \755\ For the purposes of an SEC rulemaking in connection with
the RFA, an investment adviser generally is a small entity if it:
(1) Has assets under management having a total value of less than
$25 million; (2) did not have total assets of $5 million or more on
the last day of the most recent fiscal year; and (3) does not
control, is not controlled by, and is not under common control with
another investment adviser that has assets under management of $25
million or more, or any person (other than a natural person) that
had total assets of $5 million or more on the last day of its most
recent fiscal year. See 17 CFR 275.0-7.
    \756\ For the purposes of an SEC rulemaking in connection with
the RFA, a broker-dealer will be deemed a small entity if it: (1)
Had total capital (net worth plus subordinated liabilities) of less
than $500,000 on the date in the prior fiscal year as of which its
audited financial statements were prepared pursuant to 17 CFR
240.17a-5(d), or, if not required to file such statements, had total
capital (net worth plus subordinated liabilities) of less than
$500,000 on the last day of the preceding fiscal year (or in the
time that it has been in business, if shorter); and (2) is not
affiliated with any person (other than a natural person) that is not
a small business or small organization. See 17 CFR 240.0-10(c).
Under the standards adopted by the SBA, small entities also include
entities engaged in financial investments and related activities
with $38.5 million or less in annual receipts. See 13 CFR 121.201
(Subsector 523).
    \757\ Based on SEC analysis of Form ADV data, the SEC believes
that there are not a substantial number of registered investment
advisers affected by the proposal that qualify as small entities
under RFA. Based on SEC analysis of broker-dealer FOCUS filings and
NIC relationship data, the SEC believes that there are no SEC-
registered broker-dealers affected by the proposal that qualify as
small entities under RFA. With respect to security-based swap
dealers and major security-based swap participants, based on
feedback from market participants and information about the
security-based swap markets, the Commission believes that the types
of entities that would engage in more than a de minimis amount of
dealing activity involving security-based swaps--which generally
would be large financial institutions--would not be ``small
entities'' for purposes of the RFA. See Regulation SBSR--Reporting
and Dissemination of Security-Based Swap Information, 81 FR 53546,
53553 (Aug. 12, 2016).
---------------------------------------------------------------------------

D. Riegle Community Development and Regulatory Improvement Act

    Section 302(a) of the Riegle Community Development and Regulatory
Improvement Act of 1994 (RCDRIA) \758\ requires that each Federal
banking agency, in determining the effective date and administrative
compliance requirements for new regulations that impose additional
reporting, disclosure, or other requirements on insured depository
institutions, consider, consistent with principles of safety and
soundness and the public interest, any administrative burdens that such
regulations would place on depository institutions, including small
depository institutions, and customers of depository institutions, as
well as the benefits of such regulations. The agencies have considered
comment on these matters in other parts of this Supplementary
Information.
---------------------------------------------------------------------------

    \758\ 12 U.S.C. 4802(a).
---------------------------------------------------------------------------

    In addition, under section 302(b) of the RCDRIA, new regulations
that impose additional reporting, disclosures, or other new
requirements on insured depository institutions generally must take
effect on the first day of a calendar quarter that begins on or after
the date on which the regulations are published in final form.\759\
Therefore, the effective date for the OCC, Board, and FDIC is January
1, 2020, the first day of the calendar quarter.\760\
---------------------------------------------------------------------------

    \759\ 12 U.S.C. 4802(b).
    \760\ Additionally, the Administrative Procedure Act generally
requires that the effective date of a rule be no less than 30 days
after publication in the Federal Register. 5 U.S.C. 553(d)(1). The
effective date, January 1, 2020, will be more than 30 days after
publication in the Federal Register.
---------------------------------------------------------------------------

E. OCC Unfunded Mandates Reform Act Determination

    The OCC has analyzed the rule under the factors set forth in the
Unfunded Mandates Reform Act of 1995 (UMRA) (2 U.S.C. 1532). Under this
analysis, the OCC considered whether the rule includes a Federal
mandate that may result in the expenditure by State, local, and Tribal
governments, in the aggregate, or by the private sector, of $100
million or more in any one year (adjusted for inflation). The cost
estimate for the final rule is approximately $4.1 million in the first
year. Therefore, the OCC finds that the final rule does not trigger the
UMRA cost threshold. Accordingly, the OCC has not prepared the written
statement described in section 202 of the UMRA.

F. SEC Economic Analysis

1. Broad Economic Considerations
a. Scope
    As discussed above, section 13 of the Bank Holding Company (BHC)
Act generally prohibits banking entities from engaging in proprietary
trading and from acquiring or retaining an ownership interest in,
sponsoring, or having certain relationships with a hedge fund or
private equity fund (covered funds), subject to certain exemptions.
Section 13(h)(1) of the BHC Act defines the term ``banking entity'' to
include (i) any insured depository institution (as defined by statute),
(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

[[Page 62038]]

International Banking Act of 1978, and (iv) any affiliate or subsidiary
of such an entity.\761\ In addition, as discussed above, the Economic
Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA),
enacted on May 24, 2018, amended section 13 of the BHC Act to exclude
from the definition of ``insured depository institution'' any
institution that does not have and is not controlled by a company that
has (1) more than $10 billion in total consolidated assets; and (2)
total trading assets and trading liabilities, as reported on the most
recent applicable regulatory filing filed by the institution, that are
more than 5% of total consolidated assets.\762\
---------------------------------------------------------------------------

    \761\ See 12 U.S.C. 1851(h)(1).
    \762\ These and other aspects of the regulatory baseline against
which the SEC is assessing the economic effects of the final rule on
SEC banking entities are discussed in the economic baseline. On July
22, 2019, the agencies adopted a final rule amending the definition
of ``insured depository institution'' in a manner consistent with
EGRRCPA.
---------------------------------------------------------------------------

    Certain SEC-regulated entities, such as broker-dealers, security-
based swap dealers (SBSDs), and registered investment advisers (RIAs)
affiliated with a banking entity, fall under the definition of
``banking entity'' and are subject to the prohibitions of section 13 of
the BHC Act.\763\ This economic analysis is limited to areas within the
scope of the SEC's function as the primary securities markets regulator
in the United States. In particular, the SEC's economic analysis is
focused on the potential effects of the final rule on SEC registrants,
in their capacity as such, the functioning and efficiency of the
securities markets, investor protection, and capital formation. SEC
registrants affected by the final rule include SEC-registered broker-
dealers, SBSDs, and RIAs. Thus, the below analysis does not consider
broker-dealers, SBSDs, and investment advisers that are not banking
entities, or banking entities that are not SEC registrants, in either
case for purposes of section 13 of the BHC Act, beyond the potential
spillover effects on these entities and effects on efficiency,
competition, investor protection, and capital formation in securities
markets. Other sections of this Supplementary Information discuss the
effects of the final rule on banking entities not overseen by the SEC
for purposes of section 13 of the BHC Act.
---------------------------------------------------------------------------

    \763\ Throughout this economic analysis, the term ``banking
entity'' generally refers only to banking entities for which the SEC
is the primary financial regulatory agency unless otherwise noted.
While section 13 of the BHC Act and its associated rules apply to a
broader set of banking entities, this economic analysis is limited
to those banking entities for which the SEC is the primary financial
regulatory agency as defined in Section 2(12)(B) of the Dodd-Frank
Act. See 12 U.S.C. 1851(b)(2); 12 U.S.C. 5301(12)(B).
    Compliance with SBSD registration requirements is not yet
required and there are currently no registered SBSDs. However, the
SEC has previously estimated that as many as 50 entities may
potentially register as SBSDs and that as many as 16 of these
entities may already be SEC-registered broker-dealers. See Capital,
Margin, and Segregation Requirements for Security-Based Swap Dealers
and Major Security-Based Swap Participants and Capital and
Segregation Requirements for Broker-Dealers, Exchange Act Release
No. 86175 (June 21, 2019), 84 FR at 43872 (Aug. 22, 2019),
(henceforth ``Capital, Margin, and Segregation Adopting Release'').
    For the purposes of this economic analysis, the term ``dealer''
generally refers to SEC-registered broker-dealers and SBSDs.
---------------------------------------------------------------------------

    In the proposal, the SEC solicited comment on all aspects of the
costs and benefits associated with the proposed amendments for SEC
registrants, including any spillover effects the proposed amendments
may have on efficiency, competition, and capital formation in
securities markets. The SEC has considered these comments, as discussed
in greater detail in the sections that follow.
b. Economic Effects and Justification
    As stated in the proposal, in implementing section 13 of the BHC
Act, the agencies sought to increase the safety and soundness of
banking entities, promote financial stability, and reduce conflicts of
interest between banking entities and their customers.
    In the proposal, the SEC recognized a number of effects of the 2013
rule.\764\ The SEC continues to recognize that distinguishing between
permissible and prohibited activities may be complex and costly for
some firms,\765\ which may impede the conduct of permissible
activities.\766\ The SEC continues to believe that the 2013 rule may
have resulted in a complex and costly compliance regime that is unduly
restrictive and burdensome for some banking entities, particularly
smaller firms that do not qualify for the simplified compliance
regime.\767\ Since the 2013 rule became effective, new estimates
regarding compliance burdens and new information about the various
effects of the 2013 rule have become available.\768\ The passage of
time has also enabled an assessment of the value of individual
requirements that enable SEC oversight, such as the requirement to
report certain quantitative metrics, relative to reporting and other
compliance burdens.\769\
---------------------------------------------------------------------------

    \764\ See 83 FR at 33520-33552.
    \765\ See, e.g., 83 FR at 33521.
    \766\ See, e.g., 83 FR at 33532.
    \767\ Id.
    \768\ See, e.g., 83 FR at 33522.
    \769\ Id.
---------------------------------------------------------------------------

    As discussed below, a number of commenters have indicated that the
proposed amendments would have altered the scope of permissible
activities and compliance requirements of the 2013 rule in a way that
significantly affects the economic costs and benefits of the 2013 rule.
In addition, commenters offered a variety of views on the baseline
economic effects, which include section 13 of the BHC Act, the 2013
rule, sections 203 and 204 of EGRRCPA and conforming amendments, and
current practices of banking entities aimed at compliance with these
regulations.\770\ As part of the proposal's economic baseline, the SEC
discussed the effects of the agencies' 2013 rule.\771\ The economic
baseline section below discusses these effects in greater detail.
---------------------------------------------------------------------------

    \770\ See, e.g., Occupy the SEC; Better Markets; SIFMA and
Center for American Entrepreneurship.
    \771\ See 83 FR at 33520-33521.
---------------------------------------------------------------------------

    The final rule includes amendments that impact the scope of
permitted activities for all or a subset of banking entities (e.g.,
trading account definition, underwriting and market making, and trading
and investing activities by foreign banking entities), and amendments
that simplify, tailor, or eliminate the application of certain aspects
of the 2013 rule intended to reduce compliance and reporting burdens
while preserving and, in some cases, enhancing the effectiveness of the
2013 rule. Many of the final amendments seek to provide greater clarity
and certainty about which activities are permitted under the 2013 rule,
which may increase the ability and willingness of banking entities to
engage in permitted activities, and to promote the effective allocation
of compliance resources.
    Broadly, the SEC believes that a greater ability and willingness to
engage in permitted activities would benefit the parties to those
transactions and capital markets as a whole. Reduced compliance costs
may translate into increased willingness of banking entities to engage
in activities that facilitate risk-sharing and capital formation, such
as underwriting securities and making markets. Accordingly, the rule
may also benefit clients, customers, and counterparties in the form of
an increased ability to transact with banking entities.
    The SEC continues to recognize that some of these changes may also,
in certain circumstances, increase activities involving risk exposure
or increase the incidence of conflicts of interest among some market
participants. The returns and risks from

[[Page 62039]]

the activities of banking entities may flow through to their investors.
In general, to the extent that the final rule increases or decreases
the scope of permissible activities, the final rule may dampen or
magnify some of the economic tensions inherent in this rulemaking. As
discussed above, various aspects of the final rule are designed to
ensure that the prudential objectives of the rule are not diminished.
Moreover, amendments adopted as part of the final rule that redefine
the scope of entities subject to certain provisions of the 2013 rule
may have an effect on competition, allocative efficiency, and capital
formation. Where the final rule reduces burdens on some groups of
market participants (e.g., on banking entities without significant
trading assets and liabilities and certain foreign banking entities),
the final rule is expected to increase competition and trading activity
in related market segments.
    Other amendments to the 2013 rule reduce compliance program,
reporting, and documentation requirements for some banking entities.
The SEC believes that these amendments may reduce the compliance
burdens of SEC-regulated banking entities, which may enhance
competition, trading activity, and capital formation. The SEC
recognizes that these amendments may alter the mix of tools available
for regulatory oversight and supervision. However, the SEC believes
that the final rule as a whole is unlikely to reduce the efficacy of
the agencies' regulatory oversight.\772\ Further, under the final rule,
banking entities (other than banking entities with limited trading
assets and liabilities for which the presumption of compliance has not
been rebutted) are still required to develop and provide for the
continued administration of a compliance program that is reasonably
designed to ensure and monitor compliance with the prohibitions and
restrictions set forth in section 13 of the BHC Act. Finally, the final
rule does not change the scope of entities subject to the statutory
obligations and prohibitions of section 13 of the BHC Act.
---------------------------------------------------------------------------

    \772\ See, e.g., sections IV.B.2 and IV.D.1.
---------------------------------------------------------------------------

c. Analytical Approach
    The SEC's economic analysis is informed by research on the effects
of section 13 of the BHC Act and the 2013 rule and on related
incentives conflicts, by comments received by the agencies from a
variety of interested parties, and by the agencies' experience
administering the 2013 rule since its adoption. Throughout this
economic analysis, the SEC discusses how different market participants
may respond to various aspects of the final rule and considers the
potential effects of the final rule on activities by banking entities
that involve risk, on their willingness and ability to engage in
client-facilitation activities, and on competition, market quality, and
capital formation, as informed, among other things, by research and
comment letters. The SEC's analysis also recognizes that the overall
risk exposure of banking entities may arise out of a combination of
activities, including proprietary trading, market making, and
traditional banking, as well as the volume and structure of hedging and
other risk-mitigating activities. As discussed further below, the SEC
recognizes the complex baseline effects of section 13 of the BHC Act,
as amended by sections 203 and 204 of EGRRCPA, and implementing rules,
on overall levels and structure of banking entity risk exposures.
    The SEC also considered the investor protection implications of the
final rule. Broadly, the SEC notes that market liquidity can be
important to investors as it may enable investors to exit (in a timely
manner and at an acceptable price) from their positions in instruments,
products, and portfolios. At the same time, excessive risk exposures of
banking entities can adversely affect markets and, therefore,
investors.
    The final rule tailors, removes, or alters the scope of various
requirements in the 2013 rule and adds certain new requirements. Since
section 13 of the BHC Act and the 2013 rule combined a number of
different requirements, and, as discussed above, the type and level of
risk exposure of a banking entity is the result of a combination of
activities,\773\ it is difficult to attribute the observed effects to a
specific provision or set of requirements. In addition, analysis of the
effects of the implementation of the 2013 rule is confounded by
macroeconomic factors, other policy interventions, and post-crisis
changes to market participants' risk aversion and return expectations.
Because of the extended timeline of implementation of section 13 of the
BHC Act and the overlap of the 2013 rule period with other post-crisis
changes affecting the same group or certain sub-groups of SEC
registrants, the SEC cannot rely on typical quantitative methods that
might otherwise enable causal attribution and quantification of the
effects of section 13 of the BHC Act and the 2013 rule on measures of
capital formation, liquidity, competition, and informational or
allocative efficiency. Moreover, empirical measures of capital
formation or liquidity do not reflect issuance and transaction activity
that does not occur as a result of the 2013 rule. Accordingly, it is
difficult to quantify the primary issuance and secondary market
liquidity that would have been observed following the financial crisis
absent various provisions of Section 13 of the BHC Act and the 2013
final rule.
---------------------------------------------------------------------------

    \773\ See, e.g., 79 FR 5541.
---------------------------------------------------------------------------

    Importantly, the existing securities markets--including market
participants, their business models, market structure, etc.--differ in
significant ways from the securities markets that existed prior to
enactment of Section 13 of the BHC Act and the implementation of the
2013 rule. For example, the role of dealers in intermediating trading
activity has changed in important ways, including the following: In
recent years, on both an absolute and relative basis bank-dealers
generally committed less capital to intermediation activities while
nonbanking dealers generally committed more; the volume and
profitability of certain trading activities after the financial crisis
may have decreased for bank-dealers while it may have increased for
other intermediaries, including nonbanking entities that provide
intraday liquidity using sophisticated electronic trading algorithms
and high speed access to data and trading venues; and the introduction
of alternative credit markets may have contributed to liquidity
fragmentation across markets while potentially increasing access to
capital.\774\
---------------------------------------------------------------------------

    \774\ See Sec. & Exch. Comm'n, Access To Capital And Market
Liquidity, (2017) [hereinafter SEC Report 2017].
---------------------------------------------------------------------------

    Where possible, this analysis attempts to quantify the costs and
benefits expected to result from the final rule. In many cases,
however, the SEC is unable to quantify these potential economic
effects. Some of the primary economic effects, such as the effect on
incentives that may give rise to conflicts of interest in various
regulated entities and the efficacy of regulatory oversight under
various compliance regimes, are inherently difficult to quantify.
Moreover, some of the benefits of the 2013 rule's prohibitions that are
being amended here, such as potential benefits for resilience during a
crisis, are less readily observable under strong economic conditions
and cannot be isolated from the effects of other post-crisis regulatory
efforts intended to enhance resilience. Lastly, because of overlapping
implementation periods of various post-crisis regulations affecting

[[Page 62040]]

the same group or certain sub-groups of SEC registrants, the long
implementation timeline of the 2013 rule, and the fact that many market
participants changed their behavior in anticipation of future changes
in regulation, it is difficult to quantify the net economic effects of
individual amendments to the 2013 rule adopted here.
    In some instances, the SEC lacks the information or data necessary
to provide reasonable estimates for the economic effects of the final
rule. For example, the SEC lacks information and data, and commenters
have not provided such information or data, to allow a quantification
of (1) the volume of trading activity that does not occur because of
uncertainty about how to demonstrate that underwriting or market making
activities satisfy the reasonably expected near-term demand (RENTD)
requirement; (2) the extent to which internal limits may capture
expected customer demand; (3) how accurately correlation analysis
reflects underlying exposures of banking entities with, and without,
significant trading assets and liabilities in normal times and in times
of market stress; (4) the feasibility and costs of reorganization that
may enable some U.S. banking entities to become foreign banking
entities for the purposes of relying on the foreign trading exemption;
and (5) the extent of the overall risk reduction (if any) caused by the
2013 rule. Where the SEC cannot quantify the relevant economic effects,
the SEC discusses them in qualitative terms.
2. Baseline
    The baseline against which the SEC is assessing the economic
effects of the final rule includes the legal and regulatory framework
as it exists at the time of this release and current practices aimed at
compliance with these regulations.
a. Regulation
    The regulatory baseline includes section 13 of the BHC Act, as
amended by EGRRCPA, and the 2013 rule, as amended by the agencies'
amendments conforming to EGRRCPA. Further, the baseline accounts for
the fact that since the adoption of the 2013 rule, the staffs of the
agencies have provided FAQ responses to questions about the 2013
rule.\775\ In addition, the federal banking agencies released a 2019
policy statement with respect to foreign excluded funds.\776\
---------------------------------------------------------------------------

    \775\ See https://www.sec.gov/divisions/marketreg/faq-volcker-rule-section13.htm, originally published on June 10, 2014, and most
recently updated on March 4, 2016.
    \776\ See Statement regarding Treatment of Certain Foreign Funds
under the Rules Implementing Section 13 of the Bank Holding Company
Act (July 17, 2019), available at https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20190717a1.pdf. This policy
statement continued the position of the Federal banking agencies
that was released on July 21, 2017, and the position that the
agencies expressed in the proposal. See 83 FR 33444.
---------------------------------------------------------------------------

    The subsections below discuss in greater detail the legal and
regulatory baseline applicable to entities that are registered with the
SEC and that the SEC oversees for purposes of section 13 of the BHC
Act. In particular, the SEC discusses the exemptions for permissible
underwriting and market making-related activities, risk-mitigating
hedging, and foreign trading; requirements and exemptions related to
covered funds; compliance and metrics reporting requirements; and
sections of EGRRCPA and conforming amendments that exempt certain
banking entities from section 13 of the BHC Act and the 2013 rule.
i. The 2013 Rule
(1) Definition of the Trading Account
    The scope of prohibited proprietary trading activity is determined
by the definition of ``trading account'' and related exclusions.\777\
As discussed in detail in section IV.B.1.a, the 2013 rule's definition
of trading account includes three prongs: The short-term intent prong,
the market risk capital rule prong, and the dealer prong. In addition,
the 2013 rule includes a rebuttable presumption, under which a purchase
(or sale) of a financial instrument is presumed to be for the trading
account under the short-term intent prong if the banking entity holds
the financial instrument for fewer than 60 days or substantially
transfers the risk of the financial instrument within 60 days of the
purchase (or sale).
---------------------------------------------------------------------------

    \777\ This aspect of the baseline is discussed in section
V.F.3.b.
---------------------------------------------------------------------------

    The 2013 rule provides several exclusions from the definition of
proprietary trading in section Sec.  __.3(d). In particular, under
certain conditions, the 2013 rule excludes from the definition of
proprietary trading any purchases or sales that arise under a
repurchase or reverse repurchase agreement or under a transaction in
which the banking entity lends or borrows a security temporarily, any
purchase or sale of a security for the purpose of liquidity management
in accordance with a documented liquidity management plan,\778\ any
purchase or sale by a banking entity that is a derivatives clearing
organization or a clearing agency in connection with clearing financial
instruments, any excluded clearing activities, any purchase or sale
that satisfies an existing delivery obligation or an obligation in
connection with a judicial, administrative, self-regulatory
organization, or arbitration proceeding, any purchase or sale by a
banking entity that is acting solely as agent, broker, or custodian,
any purchase or sale through a deferred compensation, stock-bonus,
profit-sharing, or pension plan, and any purchase or sale in the
ordinary course of collecting a debt previously contracted in good
faith.
---------------------------------------------------------------------------

    \778\ This aspect of the baseline is discussed in section
IV.B.1.b.i.
---------------------------------------------------------------------------

    In addition, section Sec.  __.3(e)(13) of the 2013 rule defines
``trading desk'' as the smallest discrete unit of organization of a
banking entity that purchases or sells financial instruments for the
trading account of the banking entity or an affiliate thereof, and
applies certain requirements at the ``trading desk''-level of
organization.\779\
---------------------------------------------------------------------------

    \779\ See 2013 rule Sec. Sec.  __.4, __.5, App. A., App. B;
final rule Sec. Sec.  __.4, __.5, App. A.
---------------------------------------------------------------------------

(2) Exemption for Underwriting and Market Making-Related Activity
    Section 13(d)(1)(B) of the BHC Act contains an exemption from the
prohibition on proprietary trading for underwriting and market making-
related activities. Under the 2013 rule, all banking entities with
covered activities must satisfy several requirements with respect to
their underwriting activities to qualify for the exemption for
underwriting activities, discussed in detail in section IV.B.2.a
above.\780\ In addition, under the current baseline, all banking
entities with covered activities must satisfy six requirements with
respect to their market making-related activities to qualify for the
exemption for market making-related activities, as discussed in section
IV.B.2.a.\781\
---------------------------------------------------------------------------

    \780\ See 2013 rule Sec.  __.4 (a).
    \781\ See 2013 rule Sec.  __.4 (b).
---------------------------------------------------------------------------

    The SEC also notes that, under the baseline, an organizational unit
or a trading desk of another banking entity that has consolidated
trading assets and liabilities of $50 billion or more is generally not
considered a client, customer, or counterparty for the purposes of the
RENTD requirement.\782\ Thus, such demand does not contribute to RENTD
unless such demand is affected through an anonymous trading facility or
unless the trading desk documents how and why the organizational unit
of said large banking entity should be treated as a client,

[[Page 62041]]

customer, or counterparty. To the extent that such documentation
requirements increase the cost of intermediating interdealer
transactions, this requirement may affect the volume and cost of
interdealer trading.
---------------------------------------------------------------------------

    \782\ See 2013 rule Sec.  __.4 (b)(3)(i).
---------------------------------------------------------------------------

(3) Exemption for Risk-Mitigating Hedging
    Under the baseline, certain risk-mitigating hedging activities may
be exempt from the restriction on proprietary trading under the risk-
mitigating hedging exemption. To make use of this exemption, the 2013
rule requires all banking entities to comply with a comprehensive and
multi-faceted set of requirements, including (1) the establishment,
implementation, and maintenance of an internal compliance program; (2)
satisfaction of various criteria for hedging activities; and (3) the
existence of compensation arrangements for persons performing risk-
mitigating hedging activities that are designed not to reward or
incentivize prohibited proprietary trading. In addition, certain
activities under the exemption for risk-mitigating hedging are subject
to documentation requirements.\783\
---------------------------------------------------------------------------

    \783\ See 2013 rule Sec.  __.5.
---------------------------------------------------------------------------

    Specifically, the 2013 rule requires that a banking entity seeking
to rely on the exemption for risk-mitigating hedging must establish,
implement, maintain, and enforce an internal compliance program that
includes reasonably designed written policies and procedures regarding
the positions, techniques, and strategies that may be used for hedging,
including documentation indicating what positions, contracts, or other
holdings a particular trading desk may use in its risk-mitigating
hedging activities, as well as position and aging limits with respect
to such positions, contracts, or other holdings. The compliance program
must also provide for internal controls and ongoing monitoring,
management, and authorization procedures, including relevant escalation
procedures. In addition, the 2013 rule requires that all banking
entities, as part of their compliance program, must conduct analysis,
including correlation analysis, and independent testing designed to
ensure that the positions, techniques, and strategies that may be used
for hedging are designed to reduce or otherwise significantly mitigate
and demonstrably reduce or otherwise significantly mitigate the
specific, identifiable risk(s) being hedged.
    The 2013 rule does not require a banking entity to prove
correlation mathematically--rather, the nature and extent of the
correlation analysis should be dependent on the facts and circumstances
of the hedge and the underlying risks targeted. Moreover, if
correlation cannot be demonstrated, the analysis needs to state the
reason and explain how the proposed hedging position, technique, or
strategy is designed to reduce or significantly mitigate risk and how
that reduction or mitigation can be demonstrated without
correlation.\784\ In the proposal, the SEC referenced market
participants' estimate that the inability to perform correlation
analysis, for instance, for non-trading assets such as mortgage
servicing assets, can add as much as 2% of the asset value to the cost
of hedging.\785\
---------------------------------------------------------------------------

    \784\ See 79 FR 5631.
    \785\ See 83 FR at 33534 citing to note 18 regarding Notice
Seeking Public Input on the Volcker Rule (August 2017), available at
https://www.occ.gov/news-issuances/news-releases/2017/nr-occ-2017-89a.pdf. Corresponding comment letters are available at https://www.regulations.gov/docketBrowser?rpp=25&so=DESC&sb=commentDueDate&po=0&dct=PS&D=OCC-2017-0014. Letter from BOK Financial can be accessed directly at
https://www.regulations.gov/document?D=OCC-2017-0014-0016.
---------------------------------------------------------------------------

    To qualify for the exemption for risk-mitigating hedging, the
hedging activity, both at inception and at the time of any adjustment
to the hedging activity, must be designed to reduce or otherwise
significantly mitigate and demonstrably reduce or significantly
mitigate one or more specific identifiable risks.\786\ Hedging
activities also must not give rise, at the inception of the hedge, to
any significant new or additional risk that is not itself hedged
contemporaneously. Additionally, the hedging activity must be subject
to continuing review, monitoring, and management by the banking entity,
including ongoing recalibration of the hedging activity to ensure that
the hedging activity satisfies the requirements for the exemption and
does not constitute prohibited proprietary trading.
---------------------------------------------------------------------------

    \786\ See 2013 rule Sec.  __.5(b)(2)(ii).
---------------------------------------------------------------------------

    Finally, the 2013 rule requires banking entities to document and
retain information related to the purchase or sale of hedging
instruments that are either (1) established by a trading desk that is
different from the trading desk establishing or responsible for the
risks being hedged; (2) established by the specific trading desk
establishing or responsible for the risks being hedged but that are
effected through means not specifically identified in the trading
desk's written policies and procedures; or (3) established to hedge
aggregate positions across two or more trading desks. \787\ The
documentation must include the specific identifiable risks being
hedged, the specific risk-mitigating strategy that is being
implemented, and the trading desk that is establishing and responsible
for the hedge. These records must be retained for a period of not less
than 5 years in a form that allows them to be promptly produced if
requested.\788\
---------------------------------------------------------------------------

    \787\ See 2013 rule Sec.  __.5(c)(1).
    \788\ See 2013 rule Sec.  __.5(c)(3). See also 2013 rule Sec. 
__.20(b)(6).
---------------------------------------------------------------------------

(4) Exemption for Foreign Trading
    Under the 2013 rule, a foreign banking entity that has a branch,
agency, or subsidiary located in the United States (and is not itself
located in the United States) is subject to the proprietary trading
prohibitions and related compliance requirements unless the transaction
meets five criteria.\789\ First, a branch, agency, or subsidiary of a
foreign banking organization that is located in the United States or
organized under the laws of the United States or of any state may not
engage as principal in the purchase or sale of financial instruments
(including any personnel that arrange, negotiate, or execute a purchase
or sale). Second, the banking entity (including relevant personnel)
that makes the decision to engage in the transaction must not be
located in the United States or organized under the laws of the United
States or of any state. Third, the transaction, including any
transaction arising from risk-mitigating hedging related to the
transaction, must not be accounted for as principal directly or on a
consolidated basis by any branch or affiliate that is located in the
United States or organized under the laws of the United States or of
any state. Fourth, no financing for the transaction can be provided by
any branch or affiliate of a foreign banking entity that is located in
the United States or organized under the laws of the United States or
of any state (the financing prong). Fifth, the transaction must
generally not be conducted with or through any U.S. entity (the
counterparty prong), unless (1) no personnel of a U.S. entity that are
located in the United States are involved in the arrangement,
negotiation, or execution of such transaction; (2) the transaction is
with an unaffiliated U.S. market intermediary acting as principal and
is promptly cleared and settled through a central counterparty; or (3)
the transaction is executed through an unaffiliated U.S. market
intermediary acting as agent, conducted anonymously through an

[[Page 62042]]

exchange or similar trading facility, and is promptly cleared and
settled through a central counterparty.\790\
---------------------------------------------------------------------------

    \789\ See 2013 rule Sec.  __.6(e).
    \790\ See 2013 rule Sec.  __.6(e)(3).
---------------------------------------------------------------------------

(5) Covered Funds
    The 2013 rule generally defines covered funds as issuers that would
be investment companies but for section 3(c)(1) or 3(c)(7) of the
Investment Company Act of 1940 and then excludes specific types of
entities from the definition. As described above, the 2013 rule
provides for market making and hedging exemptions to the prohibition on
proprietary trading. However, the 2013 rule places additional
restrictions on the amount of underwriting, market making, and hedging
a banking entity can engage in when those transactions involve covered
funds. For underwriting and market making transactions in covered
funds, if the banking entity sponsors or advises a covered fund, or
acts in any of the other capacities specified in Sec.  __.11(c)(2) of
the 2013 rule, then any ownership interests acquired or retained by the
banking entity and its affiliates in connection with underwriting and
market making-related activities for that particular covered fund must
be included in the per-fund and aggregate covered fund investment
limits in Sec.  __.12 of the 2013 rule and is subject to the capital
deduction provided in Sec.  __.12(d) of the 2013 rule.\791\
Additionally, a banking entity's aggregate investment in all covered
funds is limited to 3% of a banking entity's tier 1 capital, and
banking entities must include all ownership interests in covered funds
acquired or retained in connection with underwriting and market making-
related activities for purposes of this calculation.\792\ Moreover,
under the 2013 rule, the exemption for risk-mitigating hedging
activities related to covered funds is available only for transactions
that mitigate risks associated with the compensation of a banking
entity employee or an affiliate that provides advisory or other
services to the covered fund.\793\
---------------------------------------------------------------------------

    \791\ See 2013 rule Sec.  __.12(a)(2)(ii); see also Sec. 
__.11(c)(2).
    \792\ See 2013 rule Sec.  __.12(a)(2)(iii); see also Sec. 
__.11(c)(3).
    \793\ See 2013 rule Sec.  __.13(a).
---------------------------------------------------------------------------

    Under the 2013 rule, foreign banking entities can acquire or retain
an ownership interest in, or act as sponsor to, a covered fund, so long
as those activities and investments occur solely outside of the United
States, no ownership interest in such fund is offered for sale or sold
to a resident of the United States (the marketing restriction), and
certain other conditions are met. Under the 2013 rule, an activity or
investment occurs solely outside of the United States if (1) the
banking entity is not itself, and is not controlled directly or
indirectly by, a banking entity that is located in the United States or
established under the laws of the United States or of any state; (2)
the banking entity (and relevant personnel) that makes the decision to
acquire or retain the ownership interest or act as sponsor to the
covered fund is not located in the United States or organized under the
laws of the United States or of any state; (3) the investment or
sponsorship, including any risk-mitigating hedging transaction related
to an ownership interest, is not accounted for as principal by any U.S.
branch or affiliate; and (4) no financing is provided, directly or
indirectly, by any U.S. branch or affiliate. In addition, the staffs of
the agencies have issued FAQs concerning the requirement that no
ownership interest in such fund is offered for sale or sold to a
resident of the United States.\794\
---------------------------------------------------------------------------

    \794\ See Responses to Frequently Asked Questions Regarding the
Commission's Rule under Section 13 of the Bank Holding Company Act,
June 10, 2014, updated March 4, 2016, available at https://www.sec.gov/divisions/marketreg/faq-volcker-rule-section13.htm.
---------------------------------------------------------------------------

(6) Compliance Program
    For compliance purposes, the 2013 rule differentiates banking
entities on the basis of certain thresholds, including the amount of
the banking entity's consolidated trading assets and liabilities and
total consolidated assets. More specifically, U.S. banking entities
that have, together with affiliates and subsidiaries, trading assets
and liabilities (excluding trading assets and liabilities involving
obligations of or guaranteed by the United States or any agency of the
United States) the average gross sum of which--on a worldwide
consolidated basis, over the previous consecutive four quarters, as
measured as of the last day of each of the four prior calendar
quarters--equals $10 billion or more are subject to reporting
requirements of Appendix A under the 2013 rule. Banking entities that
have $50 billion or more in total consolidated assets as of the
previous calendar year end and banking entities with over $10 billion
in consolidated trading assets and liabilities are subject to the
requirement to adopt an enhanced compliance program pursuant to
Appendix B of the 2013 rule. Additionally, banking entities that engage
in covered activities and that have total consolidated assets of $10
billion or less as reported on December 31 of the previous 2 calendar
years qualify for the simplified compliance regime.
    The 2013 rule emphasized the importance of a strong compliance
program and sought to tailor the compliance program to the size of
banking entities and the size of their trading activity. As noted in
the preamble to the 2013 rule, the agencies believed it was necessary
to balance compliance burdens posed on smaller banking entities with
specificity and rigor necessary for large and complex banking
organizations facing high compliance risks. As a result, the compliance
regime under the 2013 rule is progressively more stringent with the
size of covered activities and/or balance sheet of banking entities.
    Under the 2013 rule, all banking entities with covered activities
must develop and maintain a compliance program that is reasonably
designed to ensure and monitor compliance with section 13 of the BHC
Act and the implementing regulations. The terms, scope, and detail of
the compliance program depend on the types, size, scope, and complexity
of activities and business structure of the banking entity.\795\
---------------------------------------------------------------------------

    \795\ See 2013 rule Sec.  __.20(a).
---------------------------------------------------------------------------

    Under the 2013 rule, banking entities that qualify for the
simplified compliance program (banking entities that have total
consolidated assets of less than $10 billion) are able to incorporate
compliance with the 2013 rule into their regular compliance policies
and procedures by reference, adjusting as appropriate given the
entities' activities, size, scope, and complexity.\796\
---------------------------------------------------------------------------

    \796\ See 2013 rule Sec.  __.20(f). Note that if an entity does
not have any covered activities, it is not required to establish a
compliance program until it begins to engage in covered activity.
---------------------------------------------------------------------------

    All other banking entities with covered activities are, at a
minimum, required to implement a six-pillar compliance program. The six
pillars include (1) written policies and procedures reasonably designed
to document, describe, monitor and limit proprietary trading and
covered fund activities and investments for compliance; (2) a system of
internal controls reasonably designed to monitor compliance; (3) a
management framework that clearly delineates responsibility and
accountability for compliance, including management review of trading
limits, strategies, hedging activities, investments, and incentive
compensation; (4) independent testing and audit of the effectiveness of
the compliance program; (5) training for personnel to

[[Page 62043]]

effectively implement and enforce the compliance program; and (6)
recordkeeping sufficient to demonstrate compliance.\797\
---------------------------------------------------------------------------

    \797\ See 2013 rule Sec.  __.20(b).
---------------------------------------------------------------------------

    In addition, under the 2013 rule, banking entities with covered
activities that do not qualify as those with modest activity (banking
entities that have total consolidated assets in excess of $10 billion)
and that are either subject to the reporting requirements of Appendix A
or have more than $50 billion in total consolidated total assets as of
the previous calendar year end are required to comply with the enhanced
minimum standards for compliance as specified in Appendix B of the 2013
rule.\798\
---------------------------------------------------------------------------

    \798\ See 2013 rule Sec.  __.20(c) and Appendix B.
---------------------------------------------------------------------------

    Appendix B requires the compliance program of the banking entities
that are subject to it to (1) be reasonably designed to supervise the
permitted trading and covered fund activities and investments, identify
and monitor the risks of those activities and potential areas of
noncompliance, and prevent prohibited activities and investments; (2)
establish and enforce appropriate limits on the covered activities and
investments, including limits on the size, scope, complexity, and risks
of the individual activities or investments consistent with the
requirements of section 13 of the BHC Act and the 2013 rule; (3)
subject the compliance program to periodic independent review and
testing and ensure the entity's internal audit, compliance, and
internal control functions are effective and independent; (4) make
senior management and others accountable for the effective
implementation of the compliance program, and ensure that the chief
executive officer and board of directors review the program; and (5)
facilitate supervision and examination by the agencies.
    Additionally, under the 2013 rule, any banking entity that has more
than $10 billion in total consolidated assets as reported in the
previous 2 calendar years is required to maintain additional records
related to covered funds. In particular, a banking entity must document
the exclusions or exemptions relied on by each fund sponsored by the
banking entity (including all subsidiaries and affiliates) in
determining that such fund is not a covered fund, including
documentation that supports such determination; for each seeding
vehicle that will become a registered investment company or SEC-
regulated business development company, a written plan documenting the
banking entity's determination that the seeding vehicle will become a
registered investment company or SEC-regulated business development
company, the period of time during which the vehicle will operate as a
seeding vehicle, and the banking entity's plan to market the vehicle to
third-party investors and convert it into a registered investment
company or SEC-regulated business development company within the time
period specified.\799\
---------------------------------------------------------------------------

    \799\ See 2013 rule Sec.  __.20(e).
---------------------------------------------------------------------------

(7) Metrics
    Under Appendix A of the 2013 rule, banking entities with trading
assets and liabilities (excluding trading assets and liabilities
involving obligations of or guaranteed by the United States or any
agency of the United States) the average gross sum of which--on a
worldwide consolidated basis, over the four previous quarters, as
measured by the last day of each of the four prior calendar quarters--
equals or exceeds $10 billion to meet requirements concerning recording
and reporting certain measurements for each trading desk engaged in
covered trading activity.\800\ Banking entities subject to Appendix A
are required to record and report the following quantitative
measurements for each trading day and for each trading desk engaged in
covered trading activities: (i) Risk and Position Limits and Usage;
(ii) Risk Factor Sensitivities; (iii) Value-at-Risk and Stress Value-
at-Risk; (iv) Comprehensive Profit and Loss Attribution; (v) Inventory
Turnover; (vi) Inventory Aging; and (vii) Customer-Facing Trade Ratio.
---------------------------------------------------------------------------

    \800\ See 2013 rule Sec.  __.20(d) and Appendix A.
---------------------------------------------------------------------------

    The metrics reporting requirements are intended to assist banking
entities, the SEC, and other regulators in achieving the following: A
better understanding of the scope, type, and profile of covered trading
activities; identification of covered trading activities that warrant
further review or examination by the banking entity to verify
compliance with the rule's proprietary trading restrictions; evaluation
of whether the covered trading activities of trading desks engaged in
permitted activities are consistent with the provisions of the
permitted activity exemptions; evaluation of whether the covered
trading activities of trading desks that are engaged in permitted
trading activities (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; identification of the profile
of particular covered trading activities of the banking entity, and its
individual trading desks, to help establish the appropriate frequency
and scope of the SEC's examinations of such activity; and the
assessment and addressing of the risks associated with the banking
entity's covered trading activities.\801\
---------------------------------------------------------------------------

    \801\ See 2013 rule Sec.  __.20 and Appendix A.
---------------------------------------------------------------------------

    Under the 2013 rule, banking entities with significant trading
assets and liabilities (Group A entities) and with moderate trading
assets and liabilities (Group B entities) that have less than $50
billion in consolidated trading assets and liabilities are required to
report metrics for each quarter within 30 days of the end of that
quarter. In contrast, Group A and Group B banking entities with total
trading assets and liabilities equal to or above $50 billion are
required to report metrics more frequently--each month within 10 days
of the end of that month.\802\
---------------------------------------------------------------------------

    \802\ See 2013 rule Sec.  __.20(d)(3).
---------------------------------------------------------------------------

ii. EGRRCPA and Conforming Amendments
    In accordance with section 203 of EGRRCPA,\803\ the agencies
amended the definition of ``insured depository institution'' in Sec. 
__.2(r) of the 2013 rule to exclude an institution if it, and every
entity that controls it, has both (1) $10 billion or less in total
consolidated assets and (2) total consolidated trading assets and
liabilities that are 5% or less of its total consolidated assets. The
agencies also amended the 2013 rule to reflect the changes made by
section 204 of EGRRCPA. That provision modified section 13 of the BHC
Act to permit, in certain circumstances, bank-affiliated investment
advisers to share their name with the hedge funds or private equity
funds they organize and offer.
---------------------------------------------------------------------------

    \803\ Specifically, section 203 of EGRRCPA provides that the
term ``insured depository institution,'' for purposes of the
definition of ``banking entity'' in section 13(h)(1) of the BHC Act
(12 U.S.C. 1851(h)(1)), does not include an insured depository
institution that does not have, and is not controlled by a company
that has (1) more than $10 billion in total consolidated assets; and
(2) total trading assets and trading liabilities, as reported on the
most recent applicable regulatory filing filed by the institution,
that are more than 5% of total consolidated assets.
---------------------------------------------------------------------------

    As discussed elsewhere,\804\ certain SEC-regulated entities, such
as dealers and RIAs, fell under the definition of ``banking entity''
for the purposes of section 13 of the BHC Act before the enactment of
EGRRCPA and qualified for the final amendments implementing

[[Page 62044]]

sections 203 and 204 of EGRRCPA.\805\ Therefore, the economic baseline
against which the SEC is assessing the final rule incorporates the
economic effects of sections 203 and 204 of EGRRCPA, as analyzed in the
agencies' release adopting the conforming amendments.\806\
---------------------------------------------------------------------------

    \804\ See EGRRCPA Conforming Amendments Adopting Release, 84 FR
at 35008.
    \805\ The SEC continues to believe that all bank-affiliated
entities that may register with the SEC as security-based swap
dealers and major security-based swap participants were unaffected
by section 203 of EGRRCPA or the conforming amendments because of
the size of their balance sheets and the amount of trading activity
of their affiliated banking entities. The SEC's analysis was based
on DTCC Derivatives Repository Limited Trade Information Warehouse
(TIW) data on single-name credit-default swaps.
    \806\ See EGRRCPA Conforming Amendments Adopting Release, 84 FR
at 35008.
---------------------------------------------------------------------------

b. Response to Commenters Regarding Economic Baseline and Effects of
Section 13 of the BHC Act and the 2013 Rule
    In the proposal, the SEC described the baseline effects of the 2013
rule \807\ and recognized that amendments that increase or decrease the
scope of permissible activities may magnify or attenuate the baseline
economic effects of the 2013 rule.\808\ The SEC also noted that
amendments that decrease (or increase) compliance program and reporting
obligations could alter the economic effects toward (or away from)
competition, trading activity, and capital formation on the one hand,
and against (or in favor of) regulatory and internal oversight on the
other. However, the SEC noted that the proposed amendments may enhance
trading liquidity and capital formation and that some of the proposed
changes need not reduce the efficacy of the regulation or the agencies'
regulatory oversight.\809\
---------------------------------------------------------------------------

    \807\ See 83 FR at 33520-33521.
    \808\ See 83 FR at 33521.
    \809\ Id.
---------------------------------------------------------------------------

    A number of commenters, however, have indicated that the proposed
amendments would have changed the scope of permissible activities and
the compliance regime in the 2013 rule in a manner that significantly
alters the costs and benefits of that rule and offered a variety of
assessments of the baseline economic effects of section 13 of the BHC
Act and the 2013 rule.\810\ In response to those comments, this section
expands the discussion of the baseline and supplements the analysis in
the proposal with a discussion of the comments received by the agencies
and, in response to comments, recent research on that topic. In the
2013 rule, the agencies sought to increase the safety and soundness of
banking entities and to promote financial stability,\811\ and to reduce
conflicts of interest between banking entities and their customers,
clients, and counterparties,\812\ while preserving the provision of
valuable client-oriented services \813\ and mitigating unnecessary
compliance burdens and related competitive effects.\814\ Accordingly,
the sections that follow address the SEC's understanding of the
baseline effects of section 13 of the BHC Act and the 2013 rule on (a)
risk exposures, (b) conflicts of interest between banking entities and
their customers and counterparties, (c) client-oriented financial
services and market quality, and (d) compliance burdens and
competition.
---------------------------------------------------------------------------

    \810\ See, e.g., Occupy the SEC, Better Markets, SIFMA, Center
for American Entrepreneurship.
    \811\ See, e.g., 79 FR at 5666, 79 FR at 5574, 79 FR at 5541.
    \812\ See, e.g., 79 FR at 5659.
    \813\ See, e.g., 79 FR at 5541.
    \814\ See, e.g., 79 FR at 5541, 79 FR at 5584, 79 FR at 5616, 79
FR at 5671, 79 FR at 5673, 79 FR at 5675, 79 FR at 5713.
---------------------------------------------------------------------------

    The SEC's analysis of these various effects reflects comments
received, academic research, and the SEC's experience overseeing
registered entities for purposes of section 13 of the BHC Act.
Importantly, research studies cited below are limited to their specific
settings and are subject to various methodological and measurement
limitations, as discussed in the sections that follow. Moreover, as
described below, some studies empirically examine the relevant effects
around the implementation of the 2013 rule, while others focus on the
anticipatory response of market participants around the enactment of
section 13 of the BHC Act and prior to the effective date of the 2013
rule. As a result, the SEC recognizes that these findings may have
limited generalizability and may or may not extend to various groups of
SEC registrants.
    As discussed below, some research suggests that section 13 of the
BHC Act and the 2013 rule may have reduced risk exposures of banking
entities related to trading, but may not have reduced the overall
exposure to risk of some banking entities. Other research suggests that
the 2013 rule may have partly mitigated certain conflicts of interest
between banking entities and clients in a limited set of banking
entity-client relationships. Moreover, some research suggests that the
2013 rule imposed large compliance costs that may have
disproportionately affected smaller banking entities and may have
decreased the willingness and ability of banking entities to engage in
certain client facilitation activities.
    In addition, commenters suggested that the agencies must consider
the effects of the 2013 rule and proposed amendments in light of the
overall effects of new requirements on banking entities, including
Basel III, regulations of systemically important financial
institutions, the SEC's money market reform, and the liquidity coverage
ratio.\815\ Where relevant, the analysis that follows discusses the
direct effects of section 13 of the BHC Act, the 2013 rule, sections
203 and 204 of EGRRCPA and conforming amendments, and the final rule,
as well as how they may interact with the effects of other related
financial regulations.
---------------------------------------------------------------------------

    \815\ See CCMC; Oonagh McDonald; JBA; Occupy the SEC and
Systemic Risk Council.
---------------------------------------------------------------------------

i. Risk Exposure
    As discussed in the proposal, in implementing section 13 of the BHC
Act, the agencies sought to increase the safety and soundness of
banking entities and to promote financial stability, among other
things.\816\ The regulatory regime created by the 2013 rule was
intended to enhance regulatory oversight and compliance with the
substantive prohibitions in section 13 of the BHC Act.\817\
---------------------------------------------------------------------------

    \816\ See, e.g., 79 FR at 5666, 79 FR at 5574, 79 FR at 5541, 79
FR at 5659. See also Senators Merkley et al.
    \817\ See, e.g., 83 FR at 33520.
---------------------------------------------------------------------------

    In response to the proposal, some commenters indicated that the
benefits from the statutory prohibition in section 13 of the BHC Act
and implementing rules on proprietary trading include reduced banking
profits resulting from proprietary trading and corresponding reductions
in the costs associated with bailouts; \818\ prudent risk management
that makes job-creating functions of banks more viable; \819\ greater
financial stability; \820\ dampened bubbles in products such as
synthetic collateralized debt obligations,\821\ and reduced highly
risky bank trading activities and hedge fund and private equity
investments that can threaten financial stability.\822\ Other
commenters stated that proprietary trading was not the cause of the
2007-2008 financial crisis and that almost every financial crisis in
history has been driven by classic extensions of credit; \823\ that
rather than reducing systemic risk, section 13 of the BHC Act and the
implementing rules harm the healthy functioning of the financial
services

[[Page 62045]]

industry; \824\ and that section 13 of the BHC Act and the implementing
rules are no longer necessary given Basel III capital requirements,
stress testing, and liquidity coverage ratio rules that promote short-
term resilience of bank risk profiles.\825\
---------------------------------------------------------------------------

    \818\ See, e.g., Occupy the SEC.
    \819\ Id.
    \820\ See, e.g., Better Markets and NAFCU.
    \821\ See, e.g., Volcker Alliance.
    \822\ See, e.g., CAP.
    \823\ See, e.g., American Action Forum.
    \824\ See, e.g., American Action Forum and CAP.
    \825\ See Oonagh McDonald. See also infra note 849.
---------------------------------------------------------------------------

    In response to the comments discussed above, the SEC has analyzed
relevant academic research on these issues. Most existing qualitative
analysis and quantitative research on moral hazard,\826\ incentives to
increase risk exposures that arise out of deposit insurance \827\ and
implicit bailout guarantees,\828\ and systemic risk implications of
proprietary trading do not explicitly analyze the effects of section 13
of the BHC Act or of the 2013 rule.\829\
---------------------------------------------------------------------------

    \826\ A classic definition of moral hazard is ``the loss
exposure of an insurer (the FDIC) that results from the character or
circumstances of the insured'' (here, the banking entity). See
Anthony Saunders & Marcia Cornett, Financial Institutions
Management: A Risk Management Approach, 573 (8th ed. 2014) p. 573.
    \827\ Saunders and Cornett (2014) discusses how deposit
insurance reduces the risks of depositors or other liability holders
engaging in a run on a banking entity and the related costs of a
banking entity's failure. However, if the risk of bank failure is
not adequately priced in the insurance premium paid by the banking
entity, deposit insurance can create incentives to engage in more
risky activities. Moreover, even absent deposit insurance, the
limited liability of a banking entity's shareholders still creates
incentives to risk shift at the expense of depositors, bondholders,
and other fixed claimants. See Saunders and Cornett (2014), ch. 19.
    \828\ Deposit insurance and implicit bailout guarantees may give
rise to risk taking incentives that are not specific to proprietary
trading. In other words, even in the absence of proprietary trading,
both deposit insurance and implicit bailout guarantees may create
incentives for banking entities to increase risk exposures from
permissible activities such as lending, underwriting, and market
making. Thus, a prohibition of proprietary trading need not by
itself reduce moral hazard or overall risk exposures of banking
entities if banking entities increase risk exposures from other
activities during the same time.
    \829\ For a literature review, see, e.g., Sylvain, Benoit et
al., Where the Risks Lie: A Survey on Systemic Risk, 21 Rev. Fin.
109 (2017). See also 83 FR 33533 note 350.
---------------------------------------------------------------------------

    Several recent academic studies examined the baseline effects of
section 13 of the BHC Act and implementing regulations on activities by
banking entities that involve market risk. As discussed in detail
below, this research suggests that, although section 13 of the BHC Act
and the 2013 rule may have reduced risk exposure related to trading, it
is not clear that the 2013 rule reduced the overall risk of individual
banking entities and potentially of banking entities as a whole.
    For example, one study \830\ compares changes in equity returns and
CDS spreads of 93 U.S. listed banks affected by post-crisis financial
reforms and of those that were not. Specifically, the study finds that
news concerning the potential enactment of substantive prohibitions in
section 13 of the BHC Act \831\ led to a rise in credit default swap
(CDS) spreads (by as much as 17-18 basis points) and to a decrease in
equity prices (statistically significant in most specifications). The
paper interprets the results as an indication that the proprietary
trading prohibition reduced bank profitability because of the spinoffs
of profitable trading and swap desks. In an additional analysis, the
paper finds that these effects were more significant for investment
banks, for banks that are more likely to be systemically
important,\832\ and for banks that are closer to default. Notably, the
paper does not examine changes in specific types of risky activities,
so it is possible that the observed effects may have occurred for
reasons unrelated to the proprietary trading prohibitions.\833\ While
the paper concludes that the reforms reduced bail-out expectations, the
rise in CDS spreads and the decrease in equity prices are also
consistent with the interpretation that market participants reacted to
the event as a change increasing the risk to banking entities, for
instance because of the expected shift to risk taking through lending
or reduced hedging of lending activities with trading activities. For
instance, a shift away from trading activity and toward more illiquid
and potentially less diversified lending or trading activities may have
increased banking entities' exposure to liquidity and counterparty
risks, and this risk may have been priced in higher CDS spreads of
banking entities.
---------------------------------------------------------------------------

    \830\ See Alexander Sch[auml]fer et al., Financial Sector Reform
after the Subprime Crisis: Has Anything Happened?, 20 Rev. Fin. 77
(2016).
    \831\ Specifically, the paper performs an event study around
January 21, 2010, when President Obama announced support for Volcker
Rule-type restrictions on proprietary trading by banking entities.
See Remarks by the President on Financial Reform, Office of the
Press Secretary, The White House, January 21, 2010, available at
https://obamawhitehouse.archives.gov/the-press-office/remarks-president-financial-reform, last accessed 6/27/2019.
    \832\ Specifically, the paper measured systemic importance on
the basis of the Financial Stability Board's list of 29 global
systemically important financial institutions published on November
4, 2011. See Financial Stability Board Identifies 29 Global SIFIs
and Announces Agreed Policy Measures, Mondaq, November 4, 2011, last
accessed 7/9/2013.
    \833\ Another study by Gropp et al. (2011) finds that government
guarantees can increase risk-taking incentives in competitor, but
not in protected, banks. See Reint Gropp et al., Competition, Risk-
Shifting, and Public Bailout Policies, 24 Rev. Fin. Stud. 2084
(2011).
---------------------------------------------------------------------------

    In contrast, another paper \834\ examines the cumulative market
reaction to 15 events related to section 13 of the BHC Act using a
sample of 784 listed banks and seeks to distinguish the events from
announcements surrounding Orderly Liquidation Authority events. The
paper finds significant negative cumulative abnormal equity returns (-
11.97%) for targeted banks,\835\ consistent with targeted banks losing
out on profitable opportunities, and positive cumulative abnormal
returns (7.1%) for non-targeted banks. Similarly, the paper estimates
that targeted banks experienced a 0.021% increase in CDS spreads,
consistent with the changes making targeted banks riskier, whereas non-
targeted banks experienced a decline in CDS spreads of -0.049%. In
addition, banks with a higher measure of systemic risk (marginal
expected shortfall), higher illiquidity (Amihud (2002) \836\ measure
and the bid-ask spread), and worse reporting quality (abnormal loan
loss provisions) experienced more negative market reactions to events
surrounding section 13 of the BHC Act and the 2013 rule. On aggregate,
the paper finds that equity returns rose and CDS spreads declined for
sample banks, and concludes that the rule targeted larger institutions
and enhanced the relative position of smaller banks.
---------------------------------------------------------------------------

    \834\ See Fayez Elayan et al., The Impact of the Volcker Rule on
Targeted Banks, Systemic Risk, Liquidity, and Financial Reporting
Quality, 96 J. Econ. & Bus. 69 (2018).
    \835\ The paper defines targeted banks as banks that issued or
had exposure to mortgage-backed securities or other securitized
products or had other asset write-downs reported in news sources.
    \836\ See Amihud Yakov, Illiquidity and Stock Returns: Cross-
section and Time Series Effects, 5 J. Fin Markets 31 (2002).
---------------------------------------------------------------------------

    Four factors limit the interpretation of this paper's results.
First, the validity of inference from event studies is affected by the
presence of confounding events on announcement days. While a study of a
greater number of event days may provide a more complete picture of
market responses to even minor announcements concerning the reform of
interest, it increases the likelihood of confounding events occurring
on event days, ceteris paribus. Second, the proprietary trading
prohibitions scoped in all, not just a subset of, banking entities,
while the paper hypothesizes differential effects of the proprietary
trading prohibition on targeted and non-targeted banks. As a result,
the measurement of targeted banks may simply be capturing prior
performance of an institution during times of severe

[[Page 62046]]

stress or the likelihood of an institution being affected by other
regulatory restrictions or sanctions and not necessarily the degree of
exposure to the proprietary trading prohibition. Third, since the
management of bank balance sheets and risk exposures can take several
quarters, narrow event windows may reflect market participants'
expectations but may not be informative about ex-post changes in risky
bank activities in response to the event.\837\ Finally, all but one
event considered in this study relate to the substantive prohibitions
in section 13 of the BHC Act (and not the agencies' implementing
rules), and all of the events examined in this study precede the
adoption of the 2013 rule.
---------------------------------------------------------------------------

    \837\ For example, see the below discussion of a study by Keppo
and Korte (2018) examining changes in bank risk taking over a 10
quarter period and finding that banks did not decrease risk-taking.
---------------------------------------------------------------------------

    A recent paper uses regulatory data on net trading profits reported
by bank holding companies to the Federal Reserve under the Market Risk
Capital Rule and examines the risk-taking of U.S. banks via trading
books before and after the 2013 rule.\838\ The paper finds that, prior
to 2014, U.S. banks had significant exposures to equity risk factors
through their trading books, but that such trading exposures declined
after the implementing regulations. The paper also finds that, in
response to the 2013 rule, the trading desks of U.S. banks have
decreased their exposures to interest rate risk but not to credit risk.
Consistent with bank reliance on certain exemptions with respect to
commodities, foreign exchange, and currency trading, U.S. banks also
continue to be exposed to currency risk. Importantly, post-2013 rule
credit and dollar risk exposures are far less significant in magnitude
compared to pre-2013 rule exposure to equity risk factors. The paper
concludes that the ban on proprietary trading was effective in
curtailing large exposures. These results seem to suggest that holding
companies significantly reduced their exposure to risk from trading
activities.
---------------------------------------------------------------------------

    \838\ See Antonio Falato et al., ``Banks as Regulated Traders,''
Finance Fin. & Econ. Discussion Series 2019-005, Washington: Board
of Governors of the Fed. Reserve System (2019), available at https://doi.org/10.17016/FEDS.2019.005, last accessed 5/20/2019.
---------------------------------------------------------------------------

    Four considerations limit the interpretation of these results.
First, the paper's tests focus on data aggregated to the weekly
frequency, and it is not clear if the results would continue to hold
using daily, monthly, or quarterly frequencies. For example, the
results appear inconsistent with other research analyzing FR Y-9C data
on trends in quarterly trading positions and trading revenues, which
does not find significant changes in equity profits and losses after
the 2013 rule.\839\ Second, anticipatory compliance and confounding
regulatory and macroeconomic events (unaccounted for in the paper)
complicate definitive causal inference. Third, the paper does not
examine the possibility that, since higher risk is generally
compensated with higher expected returns,\840\ banking entities may
have offset risk reductions in their trading books by shifting risk
into illiquid banking books. Fourth, the paper also does not test
changes in the total amount of risk on bank balance sheets before and
after the relevant regulatory shocks or consider the effects of the
implementing regulations on the overall risk of U.S. banking entities.
---------------------------------------------------------------------------

    \839\ See Begenau, 2019, Discussion of ``Banks as Regulated
Traders,'' NBER CF Spring meeting, April 12, available at https://begenau.people.stanford.edu/sites/g/files/sbiybj1926/f/nber_cfspring2019_begenau_disc.pdf, last accessed 07/15/2019. See
also Juliane Begenau et al., Banks' Risk Exposures, (Nat'l Bureau of
Econ. Research, Working Paper No. 21334, 2015) available at http://www.nber.org/papers/w21334, last accessed 07/15/2019.
    \840\ This effect is commonly known as the ``risk-return
tradeoff'': If an investor is willing to take on risk, there is a
reward of higher expected returns. See ZVI Bodie et al.,
Investments, G-11 (9th ed. 2011).
---------------------------------------------------------------------------

    Another study empirically examines the effects of the substantive
prohibitions of section 13 of the BHC Act on the returns and overall
risk of publicly traded U.S. bank holding companies before and after
the third quarter of 2010.\841\ Consistent with the papers discussed
above, this paper finds that most affected bank holding companies, i.e.
those with the largest trading books before 2010, reduced trading books
relative to total assets by 2.34% more than other bank holding
companies. However, this result is generally consistent with mean
reversion in trading activity by banks that may have suffered the
greatest trading losses during the crisis. In addition, the paper does
not directly distinguish between proprietary trading and client
facilitation trading or hedging trading. Although the paper finds a
decline in trading activity and a general decline in overall bank risk
(measured by the z-score),\842\ the paper does not find a pronounced
effect on most affected bank holding companies; in fact, some of the
results suggest that most affected banks became riskier than less
affected banks. The paper finds that the channel for this effect on
overall risk is an increase in asset return volatility of affected bank
holding companies. In addition, the paper finds no significant
differences in the volatility of bank stock prices and liquidity ratios
of affected and unaffected entities. The paper concludes that the risk
taking incentives of banking entities have not changed and that
affected banks have been able to maintain their levels of risk taking
by becoming less likely to use remaining trading assets to hedge
banking book returns.\843\ The SEC notes that the sample period of the
paper ends prior to the full effective date of the 2013 final rule,
which may partly limit the interpretation of these results.
---------------------------------------------------------------------------

    \841\ See Jussi Keppo & Josef Korte, Risk Targeting and Policy
Illusions--Evidence from the Announcement of the Volcker Rule, 64
Mgmt. Sci. 215 (2018). Also cited as an example of ``pathbreaking
work assessing the many costs and benefits of the Rule'' in Robert
J. Jackson Jr., ``Proposed Amendments to the Volcker Rule,''
Securities and Exchange Commission, June 5, 2018, note 21 available
at https://www.sec.gov/news/public-statement/jackson-statement-proposed-amendments-volcker-rule.
    \842\ The z-score is one of the most popular multiple
discriminant analysis models of bankruptcy, originally developed by
Altman (1968) and updated frequently since. Multiple discriminant
analysis consists of identifying a linear combination of accounting
measures that provides the best fit for the observed default and
non-default outcomes in a particular sample of firms. The variables
that enter into the z-score include: The ratio of working capital to
total assets; retained earnings to total assets; earnings before
interest and taxes to total assets; market value of equity to total
liabilities; and net sales to total assets. While the weights on
these components of the z-score are periodically recalibrated using
more recent samples, all components enter with a positive sign, such
that an increase in each of the variables decreases the probability
of bankruptcy. See Phillippe Jorion, GARP Financial Risk Manager
Handbook: Frm Part I/Part II, 475 (2011).
    \843\ In another context, Keppo and Korte (2018) also find that,
after the passage of the Gramm-Leach-Bliley Act that repealed the
Glass-Steagall Act, the overall risk (measured by the z-score) of
affected banks relative to unaffected banks did not change. In that
context, the paper finds that affected banks did significantly
increase their trading risk and decrease the risk of their banking
book.
---------------------------------------------------------------------------

    Another recent paper \844\ uses structural methods to isolate and
estimate the effects of the limitation of bank proprietary trading in
section 13 of the BHC Act on the probability of bank defaults,
earnings, and the value of their equity. Using a model calibrated to
the data from a sample of 34 of the most affected U.S. banks, this
paper finds that banks--and particularly banks most affected by section
13 of the BHC Act--

[[Page 62047]]

may have become riskier after the statutory change. In the model, the
key mechanism behind this effect is the banks' ability to respond to
shocks: Since the rule leads to a reduction in the size of the trading
book and increases the relative weight of an illiquid banking book,
banks face greater difficulties scaling down the bank book when faced
with negative earnings shocks after the rule. The model assumes no
implementation costs, as the costs were sunk when the statutory
prohibition came into effect and yields an estimate of between -0.72%
and 56.72% increase in average bank default probability after the law.
This estimate range may suggest that the overall risk of some banks may
have increased, in some cases, after the law. In the model, banks for
which a small trading book is optimal, banks with a profitable and low-
risk bank book, and banks that take more risk through leverage, do not
experience this rise in the default risk after the proprietary trading
prohibition. Because the banking book is more profitable and volatile
than the trading book for most affected banks, the paper actually
estimates no significant decrease and, in some cases, an increase in
banks' expected earnings and earnings volatility (a range of -0.04% to
0.73% depending on calibration).\845\ An important caveat for the
interpretation of these results is the sensitivity of the estimates to
modeling assumptions, the limited sample used in model calibration, and
the extremely broad range of estimates of an increase in average bank
default probability after the law.
---------------------------------------------------------------------------

    \844\ See Sohhyun Chung et al., The Impact of Volcker Rule on
Bank Profits and Default Probabilities, (SSRN Working Paper, Feb.
27, 2019), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2167773, last accessed 4/23/2019
     Also cited in Robert J. Jackson Jr., ``Proposed Amendments to
the Volcker Rule,'' Securities and Exchange Commission, June 5,
2018, note 22 available at https://www.sec.gov/news/public-statement/jackson-statement-proposed-amendments-volcker-rule.
    \845\ The estimate of -0.04% was obtained using parameters for
``median hedge fund banks,'' calculated as the median of the 34
sample banks, for which the drift and volatility of the trading
earnings were estimated from Credit Suisse Long/Short Equity Hedge
Fund Index data for 2000 through the beginning of 2010. The estimate
of 0.73% was obtained using drift and trading earnings volatility
for an asset-weighted mean of sample banks.
---------------------------------------------------------------------------

    Finally, a recent paper \846\ identified three potential channels
behind the effects of section 13 of the BHC Act and the 2013 rule on
risky activities of bank holding companies: (i) Risks from proprietary
trading activity itself, (ii) risk from a lack of diversification of
bank revenue (trading and non-trading revenue), and (iii) risk from
similarity among banks. The paper measures overall risk with the z-
score (as well as volatility in returns, revenues, and returns on
assets) and systemic risk with marginal expected shortfall (average
stock return of each bank holding company during bottom 5th percentile
shocks to 1-year market returns; it also measures marginal expected
shortfall for the financial industry, and tail beta) \847\ and
documents two main results. First, an index of bank revenue
diversification reduces measures of bank and systemic risk, while
similarity across banks increases systemic risk, and trading activity
increases both. Second, the 2013 rule reduced risks from trading
activity of affected banks, reduced the diversification of bank revenue
of affected banks, and increased similarity across banks.
---------------------------------------------------------------------------

    \846\ See Christina Bui and Talis Putnins, The Intended and
Unintended Effects of the Volcker Rule, (Aug. 31, 2018) (working
paper), available at http://fmaconferences.org/SanDiego/Papers/Volcker_SubmissionFMA.pdf, last accessed 4/23/2019.
    \847\ Acharya et al. (2017) finds that a bank's impact on
systemic expected shortfall is affected by its marginal expected
shortfall and leverage. See Viral Acharya et al., Measuring Systemic
Risk, 30 Rev. Fin. Stud. 2 (2017).
---------------------------------------------------------------------------

    The interpretation of these results may be limited because of
respective methodologies, measurement, identifying assumptions, and
residual confounding, as well as the general limitations noted at the
outset. However, these results are broadly consistent with other
research that finds that banking entities can respond to regulations by
risk shifting within an asset class while remaining in compliance \848\
and that the implementation of other financial reforms can create
effects inconsistent with the regulators' intentions.\849\
---------------------------------------------------------------------------

    \848\ See Ran Duchin and Denis Sosyura, Safer Ratios, Riskier
Portfolios: Banks' Response to Government Aid, 113 J. Fin. Econ. 1
(2014).
    \849\ For example, Sundaresan and Xiao (2019) show that the
interaction of liquidity requirements of Basel III and the money
market fund reform may have increased the reliance of private
financial institutions on liquidity provided by Federal Home Loan
Banks that enjoy an implicit government guarantee. The paper
concludes that the rules increased the role of a government-
sponsored enterprise in the aggregate liquidity transformation and
the reliance of private institutions on public liquidity backstops.
In another context, Baghai et al. (2019) finds that following the
money market fund reforms, safer funds exited the industry, the
remaining funds increased their portfolio risk, and issuers with
lower credit risk experienced a reduced access to money market
funding. See Suresh Sundaresan and Kairong Xiao, Unintended
Consequences of Post-Crisis Liquidity Regulation (Aug. 9, 2019)
(working paper) last accessed 8/29/2019. See also Ramin Baghai et
al., Liability Structure and Risk-Taking: Evidence from the Money
Market Fund Industry, (Aug. 18, 2019) (working paper) last accessed
8/29/2019.
---------------------------------------------------------------------------

    Some commenters indicated that restricting pay practices of banking
entities may effectively reduce proprietary trading cross-subsidized by
taxpayers and accordingly lower the risks of banking entities.\850\
While the final rule does not amend existing requirements or impose new
requirements related to compensation practices of banking entities, the
SEC notes two incentive effects relevant for the consideration of these
issues. First, as discussed above, proprietary trading is one of many
activities through which a banking entity can take risk. Both deposit
insurance and implicit government bailout guarantees incentivize risk
taking that is not specific to proprietary trading. Even in the absence
of proprietary trading, deposit insurance and implicit bailout
guarantees may lead banking entities to take greater risks through
lending and permitted underwriting and market making, among other
things. As a result, a prohibition on proprietary trading need not by
itself reduce the overall risk of banking entities if banking entities
increase risk through other activities during the same time.
---------------------------------------------------------------------------

    \850\ See, e.g., CAP and Public Citizen, citing Robert J.
Jackson Jr., ``Proposed Amendments to the Volcker Rule,'' Securities
and Exchange Commission, June 5, 2018, available at https://www.sec.gov/news/public-statement/jackson-statement-proposed-amendments-volcker-rule on potential effects of pay practices on
proprietary trading.
---------------------------------------------------------------------------

    Second, the incentives to take on greater risks described above are
those of both a banking entity's shareholders who are residual
claimants on the banking entity's assets and management. Under limited
liability, all shareholders enjoy a limited downside (at worst,
shareholders stand to lose their investment) and an unlimited upside if
the firm performs well (the value of shareholders' equity depends on
the value of the assets net of the value of fixed claims, such as
claims of debtholders, depositors, and employees).\851\ Thus, the
incentives of banking entities to take on greater risks discussed above
may persist so long as any restrictions on pay practices leave the
incentives of a banking entity's management and employees even partly
aligned with those of shareholders.
---------------------------------------------------------------------------

    \851\ See, e.g., Jonathan Berk & Peter DeMarzo, Corporate
Finance, 552-53 (3rd ed. 2014), discussing how leverage can (1)
incentivize shareholders to shift from lower-risk to higher-risk
assets (the ``asset substitution'' problem); and (2) induce
shareholders to undertake negative net present value, but
sufficiently risky projects (the ``over-investment'' problem). See
also Michael Jensen and William Meckling, Theory of the Firm:
Managerial Behavior, Agency Costs and Ownership Structure, 3 J. Fin.
Econ. 305 (1976).
---------------------------------------------------------------------------

ii. Conflicts of Interest
    As discussed in the proposal, in implementing section 13 of the BHC
Act, the agencies also sought to reduce conflicts of interest between
banking entities and their customers.\852\ Some commenters indicated
that bank trading activities and interests in hedge funds and private
equity funds resulted in

[[Page 62048]]

significant conflicts of interest between banks and their
customers.\853\ One commenter also indicated that the agencies should
amend the provisions concerning material conflicts of interest by
permitting banking entities to rely on information barriers under
certain circumstances.\854\
---------------------------------------------------------------------------

    \852\ See, e.g., 79 FR at 5659.
    \853\ See, e.g., CAP.
    \854\ See SIFMA.
---------------------------------------------------------------------------

    In response to these comments, the SEC reviewed relevant research
on conflicts of interest between banking entities and their customers.
As discussed below, related research generally examines trading of
banking entities in stocks, bonds, or options of their advisory and
underwriting clients. While the findings are somewhat mixed and limited
to their specific empirical settings, this research is consistent with
the presence of such conflicts in certain groups of merger and
acquisition (M&A) deals. In addition, one study finds that a narrow
type of conflicts of interest between banking entities and their
clients may have decreased after the implementation of the 2013 rule.
    Specifically, a recent study \855\ examines both the presence of
conflicts of interest between advisor banks and their customers based
on banks' options holdings, and changes in such trading activity around
the implementation of the Volcker Rule. The paper documents three main
results. First, the paper finds that merger advisors tend to increase
their holdings in call options relative to put options in merger
targets during the quarter before the announcement. Second, merger
advisors are significantly more likely to increase put option holdings
in the acquirer firm.\856\ In combination with the literature's general
finding of average negative announcement returns in acquirer firms and
positive announcement returns in target firms, the paper argues that
these results are suggestive of informed trading by advisor banks on
client firms. Third, within the subsample of affected deals (deals in
which one or more advisor banks ceased proprietary trading operations
around the enactment of section 13 of the BHC Act) after 2011, the
paper finds that advisors did not increase their net call option
holdings on target firms before merger announcements. The paper
concludes that, in this narrow setting, the Volcker Rule may have
decreased banks' options trading on client information. Importantly,
the paper finds that some of this bank activity was replaced by hedge
fund activity: Specifically, hedge funds increased their informed
trading in options of M&A client firms around the same time in the same
subsample of deals.
---------------------------------------------------------------------------

    \855\ See Michelle Lowry et al., Informed Trading By Advisor
Banks: Evidence from Options Holdings, 32 Rev. Fin. Stud 605 (2018).
    \856\ To the degree that some advisor banks may have an
underlying (long) risk exposure to acquirer firms' equity, buying
put options is also consistent with risk-mitigating hedging.
---------------------------------------------------------------------------

    The SEC is also aware of a broader body of research that
empirically tests the existence and magnitude of conflicts of interest
between banks and their customers in the context of advising and
underwriting relationships and that does not directly empirically test
the effects of section 13 of the BHC Act or the 2013 rule on the
presence or magnitude of such conflicts. One article in the legal
literature \857\ empirically measures the profitability of trading by
banks that have advisory clients and are subject to reporting
requirements as temporary insiders. They document that such trading by
banks in the stocks of advisory clients is profitable (with an
estimated average 25% return on their trades), that the trading centers
around adverse events, and that the elimination of Glass-Steagall
restrictions in 2002 was associated with more frequent and more
profitable trading. However, the paper does not empirically test the
effects of section 13 of the BHC Act or of the 2013 rule.
---------------------------------------------------------------------------

    \857\ See Sureyya Avci et al., Eliminating Conflicts of
Interests in Banks: The Significance of the Volcker Rule, 35 Yale J.
Reg. 343 (2017). Also cited in Robert J. Jackson Jr., ``Proposed
Amendments to the Volcker Rule,'' Securities and Exchange
Commission, June 5, 2018, note 20, available at https://www.sec.gov/news/public-statement/jackson-statement-proposed-amendments-volcker-rule.
---------------------------------------------------------------------------

    Finance research on this type of conflict of interest between banks
and their customers finds mixed effects. One of the earlier papers
\858\ examines trading in M&A target firms by the advisor banks of
bidders and links advisor pre-announcement stakes in target firms with
the probability of deal success and with the target premium. They
document positive returns of this trading strategy and conclude that
advisors acquire positions in deals of their advisory clients, as well
as influence deal outcomes. Since such advisor behavior benefits the
bidder, the authors recognize that they cannot rule out the alternative
explanation that the bidder's board retains the advisor with strong
incentives for deal completion. Outside of the M&A context, other work
\859\ explores the trading activity of IPO underwriters and finds that
lead underwriter trades in IPO firms are associated with subsequent IPO
abnormal returns.
---------------------------------------------------------------------------

    \858\ See Andriy Bodnaruk et al., Investment Banks as Insiders
and the Market for Corporate Control, 22 Rev. Fin. Stud. 4989
(2009).
    \859\ See Yao-Min Chiang et al., The Information Advantage of
Underwriters in IPOs, Mgmt. Sci. (forthcoming 2019).
---------------------------------------------------------------------------

    Another study \860\ focuses on bond trading and uses a sample
covering 1994 through 2006 to examine the trading of bond dealers
affiliated with M&A advisory banks with insurance companies. The study
finds weak evidence that when affiliated dealers are one side of a bond
transaction, they earn higher bond returns than unaffiliated dealers,
and that affiliated dealers sell more of the bonds that may lose value
ahead of bad news than unaffiliated dealers. The paper observes only a
subset of such dealer trades with insurance companies and is unable to
evaluate whether affiliated dealers are net buyers or sellers of
affected bonds before bad news. The study concludes that there is weak
and suggestive evidence that transfer of information within financial
institutions is one of the potential information sources before public
announcements.
---------------------------------------------------------------------------

    \860\ See Semi Kedia and Xing Zhou, Informed Trading Around
Acquisitions: Evidence From Corporate Bonds, 18 J. Fin. Mkt. 182
(2014).
---------------------------------------------------------------------------

    Similarly, another paper \861\ finds no evidence of information
leakage because of investment bank M&A advisory, underwriting, or
lending relationships from 1997 through 2002. Specifically, the paper
finds no evidence that investment bank clients buy shares in takeover
targets in advised deals. Similarly, bank clients with previous
underwriter or lending relationships do not trade or earn abnormal
returns before earnings announcements. The paper also examines market
making imbalances and investment returns by connected brokerage houses
and finds that they do not trade profitably ahead of earnings
announcements by their IPO, SEO, M&A client, or borrower firms. The
paper concludes that neither brokerage houses nor their clients trade
on inside information available to the brokerage because of their
market making or advising roles.
---------------------------------------------------------------------------

    \861\ See John M. Griffin et al., Examining the Dark Side of
Financial Markets: Do Institutions Trade on Information from
Investment Bank Connections, 25 J. Fin. Econ. 2155 (2012).
---------------------------------------------------------------------------

    The SEC continues to note that the above studies are limited to
their specific empirical settings and, as can be seen above, different
empirical design, measurement, and identification approaches limit
inference in each of the papers discussed above. Moreover, the SEC
continues to note that the scope of this economic analysis is limited
to SEC registrants, investors in securities markets, and the
functioning of securities markets. While the research discussed above
does not focus

[[Page 62049]]

specifically on banking entities that are SEC registrants, some of the
incentive effects and conflicts of interest discussed above may extend
to banking entities overseen by the SEC.
iii. Client-Oriented Services and Market Quality
    In the 2013 rule, the agencies recognized that client-oriented
financial services, such as underwriting and market making, are
critical to capital formation and can facilitate the provision of
market liquidity and that the ability to hedge is fundamental to
prudent risk management as well as capital formation.\862\
---------------------------------------------------------------------------

    \862\ See, e.g., 79 FR at 5541, 79 FR at 5546, 79 FR at 5561.
---------------------------------------------------------------------------

    In the proposal, the agencies stated that compliance with the
conditions of the underwriting and market making exemptions under the
2013 rule, such as RENTD, creates ambiguity for some market
participants, is over-reliant on historical demand, and necessitates an
accurate calibration of RENTD for different asset classes, time
periods, and market conditions.\863\ Since forecasting future customer
demand involves uncertainty, particularly in less liquid and more
volatile instruments and products, banking entity affiliated dealers
face uncertainty about the ability to rely on the underwriting and
market making exemptions. This uncertainty can reduce a banking
entity's willingness to engage in principal transactions \864\ with
customers, which, along with reducing profits, may reduce the volume of
transactions intermediated by banking entities.\865\
---------------------------------------------------------------------------

    \863\ See, e.g., 83 FR at 33532.
    \864\ Dealers can trade as agents, matching customer buys to
customer sells, or as principals, absorbing customer buys and
customer sells into inventory and committing the necessary capital.
    \865\ See, e.g., 83 FR at 33532.
---------------------------------------------------------------------------

    Moreover, consistent with the views of some commenters,\866\ the
SEC believes that, as a baseline matter, the 2013 rule creates
significant uncertainty among market participants regarding their
ability to rely on the risk-mitigating hedging exemption. For example,
there may be considerable uncertainty regarding whether a potential
hedging activity will continue to demonstrably reduce or significantly
mitigate an identifiable risk after it is implemented.\867\
Unforeseeable changes in market conditions and other factors could
reduce or eliminate the intended risk-mitigating effect of the hedging
activity, making it difficult for a banking entity to comply with the
continuous requirement that the hedging activity demonstrably reduce or
significantly mitigate specific, identifiable risks.\868\ According to
commenters, uncertainty and compliance burdens related to the risk-
mitigating hedging exemption are leading to less timely, less flexible,
and less efficient hedging.\869\
---------------------------------------------------------------------------

    \866\ See, e.g., ABA.
    \867\ See, e.g., 83 FR at 33465.
    \868\ Id.
    \869\ See, e.g., JBA and SIFMA.
---------------------------------------------------------------------------

    The SEC continues to recognize that SEC-regulated entities
routinely engage in both static and dynamic hedging at the portfolio
(not the transaction) level and monitor and reevaluate on an ongoing
basis aggregate portfolio risk exposures, rather than the risk exposure
of individual transactions.\870\ Dynamic hedging may be particularly
common among dealers with large derivative portfolios, especially when
the values of these portfolios are nonlinear functions of the prices of
the underlying assets (e.g., gamma hedging of options).\871\ As a
baseline matter, the SEC notes that the 2013 rule permits dynamic
hedging. However, the 2013 rule requires the banking entity to document
and support its decisions regarding individual hedging transactions,
strategies, and techniques for ongoing activity in the same manner as
for its initial activities, rather than permitting a banking entity to
provide documentation for the hedging decisions regarding a portfolio
as a whole.
---------------------------------------------------------------------------

    \870\ See, e.g., 83 FR at 33535.
    \871\ Id.
---------------------------------------------------------------------------

    The agencies have received a number of comments concerning the
baseline effects of section 13 of the BHC Act and the 2013 rule on
client facilitation activities, hedging, and market quality. The
agencies received comments that the 2013 rule maintains the depth and
liquidity of U.S. capital markets and that market liquidity remains
within historical norms; \872\ that there is no clear evidence that the
2013 rule has affected liquidity at a level that should cause concern;
\873\ and that liquidity may signal a bubble and should not be a key or
even a major metric in assessing the effects of reforms.\874\ Other
commenters stated that the 2013 rule has imperiled valuable market
making and risk-mitigating hedging and reduced market liquidity; \875\
that the prescriptive nature of the 2013 rule has raised costs of
providing liquidity, which has been passed along to investors and may
have exacerbated dislocations,\876\ and that less liquid capital
markets have made it difficult for derivative end-users to raise
capital in times of stress.\877\
---------------------------------------------------------------------------

    \872\ See, e.g., NAFCU and CAP.
    \873\ See, e.g., AFR and Occupy the SEC.
    \874\ See, e.g., Public Citizen.
    \875\ See, e.g., SIFMA and American Action Forum.
    \876\ See, e.g., FSF and SIFMA.
    \877\ See, e.g., Coalition for Derivative End Users.
---------------------------------------------------------------------------

    The role of dealers in market making and client facilitation may be
more significant in dealer markets, such as derivative and corporate
bond markets. The SEC has elsewhere discussed several key changes in
liquidity in bond markets and security-based swaps after the financial
crisis. For example, the SEC found that, in corporate bond markets,
although estimated average transaction costs have decreased, trading
activity has become more concentrated in less complex bonds and bonds
with large issue sizes; that transaction costs have increased for some
subgroups of corporate bonds; and that dealers have, in aggregate,
reduced their capital commitment since its 2007 peak, consistent with
the claim that the Volcker Rule and other reforms potentially reduced
the liquidity provision in corporate bonds.\878\ The SEC recognizes
difficulties in causal attribution of the various provisions of section
13 of the BHC Act and the 2013 rule and notes that some studies do not
find significant structural breaks associated with post-crisis
financial regulations in several measures of market liquidity.\879\
However, the SEC continues to be informed by both comments discussed
above and a body of research drawing causal inference concerning the
adverse effects of section 13 of the BHC Act and the 2013 rule on
dealer provision of liquidity and on the risk of market dislocations in
times of stress.\880\
---------------------------------------------------------------------------

    \878\ See SEC Report 2017, supra note 774, for a detailed data
analysis and literature survey.
    \879\ See, e.g., Francesco Trebbi and Kairong Xiao, 2018,
Regulation and Market Liquidity, 6 Mgmt. Sci. 1949 (2019). The
generalizability of the paper's result is limited by the sample
period, which ends in December 2014 and before the full
implementation of the 2013 rule. For more methodological limitations
of this paper, such as heuristic choices of parameters, and crucial
assumptions, as well as other issues, see SEC Report 2017, supra
note 774, at 118-119. See also Tobias Adrian et al., Liquidity,
Leverage, and Regulation 10 Years After the Global Financial Crisis,
10 Ann. Rev. Fin. Econ. 1 (2018).
    \880\ Id. See also 83 FR at 33520-33522, 33532-33533.
---------------------------------------------------------------------------

    Importantly, the 2013 rule included a large number of requirements
and provisions, and aspects of the 2013 rule most likely to affect
banking entities' client facilitation activity (such as the RENTD
requirement for the underwriting and market making exemptions) are not
quantifiable or subject to public or regulatory reporting. As a result,
existing research primarily seeks to document trends in various aspects
of market liquidity in general and the effects of section 13 of the BHC

[[Page 62050]]

Act and the 2013 rule on dimensions of market liquidity in particular.
However, the most likely channels for the below effects of section 13
of the BHC Act and the 2013 rule on client facilitation activities are
the requirements for the exemptions (such as RENTD) and uncertainty
around the ability to rely on exemptions for client facilitation
activities.
    As discussed below, several studies show significant declines in
various measures of liquidity after the financial crisis and post-
crisis reforms, including a recent study that ties the effects to the
underwriting exemption of the 2013 rule. In addition, some research
that reconciles the deterioration in dealer liquidity provision with
improvements in price-based measures of liquidity attributes those
effects to the reduced willingness of dealers to provide liquidity on a
principal basis after implementation of the 2013 rule. Further,
existing research suggests that the 2013 rule resulted in reduced
liquidity during times of stress, with an increase in liquidity
provision by dealers unaffiliated with banks failing to fully offset
the reduction in liquidity provision by bank-affiliated dealers.
Moreover, some research suggests that post-crisis financial reforms led
to persistent deviations from no-arbitrage conditions across markets,
with the effect driven by banking entities and levered nonbanking
entities that rely on systemically important banking entities for
funding liquidity. Finally, new evidence indicates that post-crisis
financial regulations may also be having effects on the co-movement in
liquidity metrics across markets. Though the research discussed below
is unable to attribute observed trends to specific provisions of the
2013 rule, these findings are largely consistent with the claim that
the 2013 rule had adverse effects on certain aspects of client
facilitation activity by banking entities, as discussed below.
    A number of studies documented declines in several dimensions of
liquidity after the financial crisis and post-crisis reforms. For
example, one study \881\ finds that the willingness of dealers to
commit capital overnight, turnover, the frequency of block trades, and
average trade size have all declined after the financial crisis.
Importantly, the paper finds that the shift away from market-makers
absorbing customer imbalances and toward agency trading was most acute
when banks were required to comply with the proprietary trading
prohibition. Further, the paper finds that these declines in dealer
provision of liquidity stem from bank-affiliated dealers. The paper
concludes that post-crisis banking regulations, including the 2013
rule, contributed to the reductions in turnover, trade size, frequency
of block trades, and the willingness of dealers to commit capital.
---------------------------------------------------------------------------

    \881\ See Hendrik Bessembinder et al., Capital Commitment and
Illiquidity in Corporate Bonds, 73 J. Fin. 1615 (2018). For a more
detailed discussion of the paper's limitations and caveats, see SEC
Report 2017, supra note 774, at 101-104.
---------------------------------------------------------------------------

    Another paper \882\ examines the cost of immediacy in corporate
bonds, using index exclusions as a setting in which uninformed traders
exogenously demand immediacy. The paper finds that the cost of
immediacy has more than doubled and that dealers revert back to target
inventory far more quickly after the 2007-2008 financial crisis. The
paper finds that this post-crisis dealer behavior is most severe for
bank dealers and concludes that such changes are consistent with the
effects of the Volcker Rule.
---------------------------------------------------------------------------

    \882\ See Jens Dick-Nielsen and Marco Rossi, The Cost of
Immediacy for Corporate Bonds, 32 Rev. Fin. Stud 1 (2019). For a
more detailed discussion, see SEC Report 2017, supra note 774, at
112-13.
---------------------------------------------------------------------------

    Research on changes in liquidity around the post-crisis reforms,
including the 2013 rule, presents two seemingly contradictory results:
On the one hand, price-based measures of liquidity (such as the bid-ask
spread) have improved; on the other hand, measures of dealer liquidity
supply have significantly worsened.\883\ A few studies seek to
reconcile these two effects. One paper \884\ focuses on dealers'
willingness to provide liquidity in certain types of bonds out of
inventory. The paper finds that, when transacting in riskier and less
liquid bonds, dealers are significantly more likely to offset trades on
the same day instead of committing capital overnight. Specifically, the
paper documents that dealers offset approximately 75% of trades in the
lowest-rated, least-actively-traded bonds, but only 55% of trades in
the highest-credit-quality, most-actively-traded bonds. In addition,
liquidity provision out of inventory involves risk to the dealer--a
risk that is priced in higher transaction costs. As a result, a decline
in transaction costs in observed trades may be a reflection of the
decline in dealers' willingness to take certain groups of bonds into
inventory.
---------------------------------------------------------------------------

    \883\ See, e.g., SEC Report 2017, supra note 774, at 100-105.
    \884\ See Michael Goldstein and Edith Hotchkiss, Providing
Liquidity in an Illiquid Market: Dealer Behavior in U.S. Corporate
Bonds, J. Fin. Econ. (2019) (in press) (accepted manuscript). See
also, e.g., SEC Report 2017, supra note 774, at 106-107.
---------------------------------------------------------------------------

    Another study \885\ finds that, after the post-crisis banking
regulations, including the 2013 rule, customer provision of liquidity
has increased and, as a result, the paper posits that bid-ask spread
measures will necessarily underestimate the cost of dealer liquidity
provision. The paper estimates that, for a subset of large liquidity
demanding customer trades in which dealers provide liquidity from their
inventory, customers pay between 35% and 65% higher spreads after the
crisis than before the crisis.\886\ The paper concludes that a large
portion of liquidity provision has moved from dealers to large asset
managers and that the effect is consistent with the effects of tighter
banking regulations.
---------------------------------------------------------------------------

    \885\ See Jaewon Choi and Yesol Huh, Customer Liquidity
Provision: Implications for Corporate Bond Transaction Costs, (Aug.
1, 2019) (working paper), last accessed 8/27/2019). For a more
detailed discussion, see, e.g., SEC Report 2017, supra note 774, at
117.
    \886\ In contrast, Bessembinder et al. (2016) focuses on dealer-
to-customer principal trades and finds the average transaction cost,
particularly for small trades (less than $100,000) and large trades
(over $1,000,000), is lowest in the pre-crisis and regulation
periods. As the SEC stated elsewhere, the difference between these
two results may stem from different proxies for transaction costs
and the measurement of principal trading activity.
---------------------------------------------------------------------------

    A recent paper \887\ focuses on the effects of the underwriting
exemption of the 2013 rule on trading by affected dealers.
Specifically, the paper examines changes in the trading and liquidity
of newly issued bonds that affected dealers have underwritten relative
to bonds that the dealers have not underwritten around the
implementation and conformance of the 2013 rule. This empirical design
accounts for potentially confounding dealer effects (as dealers trade
in bonds that they both underwrite and bonds that they do not) and bond
effects (as both underwriters and non-underwriters trade in a given
bond), and isolates the effects of the underwriting exemption in the
2013 rule from the effects of other bank regulations during the
implementation period of the 2013 rule. The paper estimates that dealer
markups have increased by between 42 and 43 basis points for fast
roundtrip trades (15 minutes or less) after April 2014, but finds that
the effect is transitional and disappears after August of 2015.
However, the paper estimates that the adverse effects on dealer markups
for slower roundtrip trades of between 15 minutes and 1 day--trades
that involve dealers absorbing trades into inventory--are both
economically significant and persist past the

[[Page 62051]]

implementation period (a range of 27-43 bps increase between April 2014
and July 2015, and a range of 18-35 basis point effect after July
2015).\888\ To rule out the selection explanation (that dealers post-
2013 rule simply pre-arrange more trades so the non-prearranged trades
become costlier), the paper tests changes in short-term, non-inventory
trades. The paper finds an increase in such trades around the effective
date of the 2013 rule, but no differences when conditioning on dealer
underwriting activity, and concludes that endogenous selection of time
in inventory cannot explain the above results. Moreover, the paper
finds that nonbanking dealers enjoy a significant increase in market
share after the conformance period, while bank-affiliated dealers lose
market share. Finally, the paper concludes that the 2013 rule increased
dealer trading risk on short round-trip trades (15 minutes or less),
estimating that the standard deviation of covered dealers' markups on
corporate bonds has risen by between 0.09 and 0.1.
---------------------------------------------------------------------------

    \887\ See Meraj Allahrakha et al., The Effects of the Volcker
Rule on Corporate Bond Trading: Evidence from the Underwriting
Exemption (Off. of Fin. Research Working Paper 19-02, 2019)
available at https://www.financialresearch.gov/working-papers/files/OFRwp-19-02_the-effects-of-the-volcker-rule-on-corporate-bond-trading.pdf, last accessed 8/9/2019.
    \888\ The paper also finds an increase of between 8% and 14% in
dealer markups on trades around the 60-day cutoff for the rebuttable
presumption in the 2013 rule. The paper acknowledges that this
result could be consistent with dealers conducting profitable
proprietary trades and holding positions past the 60-day rebuttable
presumption window but is cautious in interpreting the result given
the methodological limitations of its empirical design and very
small sample size that does not allow conclusive inference.
---------------------------------------------------------------------------

    These results are subject to three primary caveats. First, the
paper relies on a relatively narrow measure of risk (the standard
deviation of dealer profits at the bond-month level). Unlike other
research discussed in this section, the paper does not examine changes
in the overall volume of trading activity, measures of downside risk at
the individual banking entity level, or commonality of risk exposures
among affected and unaffected dealers. Second, some of the paper's
tests are affected by small sample sizes, limiting inference related to
transitional and permanent effects of the 2013 rule in certain trades
(including the 15 minute-1 day subsample and the 60-90 day subsample).
Third, the paper recognizes that these results are specific to dealer
provision of liquidity in the corporate bond market, and may not extend
to trading by affected firms in other asset classes.
    Other research helps inform the SEC's understanding of the effects
of section 13 of the BHC Act and the 2013 rule on liquidity in times of
stress. Specifically, there is growing evidence that liquidity
provision in times of stress may be adversely affected by post-crisis
reforms in general and the Volcker Rule in particular. Two studies
directly test the effects of the Volcker Rule on market making by
dealers in times of stress. One of the papers \889\ examines liquidity
during corporate bond downgrades that result in selling by certain
institutions. The paper suggests that dealers affected by the Volcker
Rule decreased market making in newly downgraded bonds, and that
unaffected dealers have not fully offset this decline. Moreover, the
paper rules out the alternative explanation that these changes are
attributable to other financial reforms, finding that the same effects
are present for dealers affected by the Volcker Rule but not
constrained by Basel III and Comprehensive Capital Analysis and Review
(CCAR) regulations. The paper isolates the effect in a relatively small
sample of bonds experiencing relatively large stress events (under
normal aggregate conditions). This methodological design reflects the
common tradeoff between a narrower empirical setting that enables
causal inference, and a larger sample that is less amenable to causal
interpretations.\890\
---------------------------------------------------------------------------

    \889\ See Jack Bao et al., The Volcker Rule and Corporate Bond
Market Making in Times of Stress, 130 J. Fin. Econ. 95 (2018).
    \890\ For a fulsome discussion of this and other issues and
limitations, see SEC Report 2017, supra note 774, at 109-11.
---------------------------------------------------------------------------

    A related study \891\ compares liquidity during times of stress
before and after the crisis, and defines times of stress on the basis
of extreme increases in market-wide volatility (measured by the VIX
index), bond yield drops, and credit rating downgrades from investment
grade to speculative grade. While the study does not find that price-
based liquidity measures decreased around idiosyncratic shocks, the
study does find that the price impact of large trades surrounding
market-wide shocks has increased after the post-crisis financial
reforms relative to the pre-crisis period.\892\
---------------------------------------------------------------------------

    \891\ See Mike Anderson & Ren[eacute] Stulz, Is Post-Crisis Bond
Liquidity Lower? (Dice Ctr. Working Paper 2017-09, 2017) last
accessed 6/3/2019.
    \892\ Consistent with these results, Goldstein and Hotchkiss
(2019) finds that on days with large VIX increases, dealers tend to
offset trades more quickly even for highly rated bonds that they
normally would take into inventory. For a more detailed discussion,
see SEC Report 2017, supra note 774, at 114-15.
---------------------------------------------------------------------------

    A recent report by the International Organization of Securities
Commissions (IOSCO)'s Committee on Emerging Risks examined changes in
bond market liquidity focusing on stressed conditions.\893\ The report
notes that the most significant effect of post-crisis financial reforms
and reduction in dealer risk appetite is the decline in the capacity of
dealers to intermediate transactions on a principal basis, combined
with a drastic increase in the size of the market. The report concludes
that such effects mean the lack of liquidity in times of stress is
likely to be more acute than in past episodes of stressed conditions.
---------------------------------------------------------------------------

    \893\ See OICU-IOSCO, 2019, Liquidity in Corporate Bond Markets
Under Stressed Conditions, FR079/2019, May. Available at https://www.iosco.org/library/pubdocs/pdf/IOSCOPD634.pdf, last accessed 7/1/
2019.
---------------------------------------------------------------------------

    One of the important results identified in this literature is the
finding that nonbank dealers may step in but may not fully offset the
decline in the liquidity provision of bank dealers caused by section 13
of the BHC Act and the 2013 rule.\894\ New research suggests that the
fundamental mechanism behind this result may be the effect of other
post-crisis regulations on the ability of bank dealers to provide
funding liquidity to nonbank intermediaries.\895\ Specifically, the
paper examines the interplay between post-crisis bank regulations,
including the Volcker Rule, the supplementary leverage ratio, the
liquidity coverage ratio, and the net stable funding ratio, and their
effects on the ability of nonbank intermediaries to arbitrage away
mispricing. The paper finds that the profitability of classic arbitrage
trades (on-the-run/off-the-run, Treasury-interest swap, CDS-bond basis,
and single name-index CDS arbitrage trades) is significantly lower
under the supplementary leverage ratio, liquidity coverage ratio, and
net stable funding ratio components of Basel III compared with Basel
II. In addition, using a differences-in-differences estimation, the
paper finds that levered hedge funds relying on prime brokers that are
identified in the paper as globally systemically important banks
experience lower abnormal returns and a decline in assets under
management. The paper concludes that the effects of post-crisis
regulations affect not only bank intermediation but also the ability of
private funds to rely on banks for funding liquidity supporting
arbitrage strategies. The paper notes that the supplementary leverage
ratio and the net stable funding ratio disincentivize

[[Page 62052]]

low margin activities and a reliance on short-term funding, such as
repo, and that the liquidity coverage ratio incentivizes holdings of
more liquid securities. The paper concludes that Basel III is the
regulation with the biggest effect on the profitability of trades
exploiting arbitrage opportunities.\896\
---------------------------------------------------------------------------

    \894\ As discussed above, when examining informed trading of
advisor banks in options on the stocks of client firms, Lowry et al.
(2018) finds that informed trading by hedge funds increases
simultaneously with a decrease in informed trading by banks around
the enactment of section 13 of the BHC Act. See Michelle Lowry et
al., Informed Trading By Advisor Banks: Evidence from Options
Holdings, 32 Rev. Fin. Stud 605 (2018).
    \895\ See Boyarchenko, Eisenbach, Gupta, Shachar, and Van
Tassel, 2018, ``Bank Intermediated Arbitrage,'' Federal Reserve Bank
of New York Staff Report No. 858, last accessed 6/3/2019.
    \896\ These findings are also consistent with another paper that
finds an exogenous increase in the leverage ratio constraint in the
UK to have reduced repo market liquidity--an effect especially
pronounced in transactions between dealers and small customers. See
Antonis Kotidis and Neeltje Horen, Repo Market Functioning: The Role
of Capital Regulation (2018) (working paper) last accessed June 3,
2019.
---------------------------------------------------------------------------

    Post-crisis regulations may also be having effects on the co-
movement \897\ in liquidity metrics across markets. A recent paper
\898\ exploring this issue posits two channels for this increased co-
movement in liquidity. First, liquidity supply is capital intensive,
and absorbing trades into inventory in one risky asset class may use up
the capital capacity of a dealer to provide liquidity in other assets.
Basel III and liquidity requirements for banks may aggravate this
effect. Second, bank dealers may face uncertainty about their ability
to rely on the market making exemption in the 2013 rule, as the
distinctions between prohibited proprietary trading and permissible
market making may often be unclear. As discussed above, prior studies
suggest that the 2013 rule may have reduced the inventory capacity of
bank dealers. Empirically, the paper documents that co-movement among
measures of illiquidity of stock, bond, and CDS markets has risen
significantly after the 2007-2008 financial crisis, particularly during
the regulatory implementation period. For example, the regulatory
period is characterized by a much larger fraction of firms exhibiting
positive pairwise correlations between measures of illiquidity. The
paper concludes that the 2013 rule and the tightening of capital and
liquidity regulations reduced the inventory capacity of market makers,
resulting in higher co-movement in liquidity across various financial
markets. Importantly, the paper argues that these results are not
consistent with increased electronic trading as that would have
resulted in a reduced reliance on market makers and an increased
reliance on customers, which should have reduced (instead of increased)
co-movement in liquidity across markets.
---------------------------------------------------------------------------

    \897\ Co-movement in two variables generally refers to a
positive correlation of changes in the two variables over time. For
example, co-movement in returns refers to a pattern of positive
correlation in returns among different securities or asset classes.
Similarly, co-movement in liquidity metrics suggests a positive
correlation of changes in liquidity metrics. See, e.g., Nicholas
Barberis et al., Co-movement, 75 J. Fin. Econ. 283 (2005).
    \898\ See Xinjie Wang et al., Do Post-Crisis Regulations Affect
Market Liquidity? Evidence from the Co-Movement of Stock, Bond, and
CDS Illiquidity (2018) (working paper) last accessed 6/3/2019.
---------------------------------------------------------------------------

    With respect to liquidity in the dealer-centric, single-name CDS
market, the SEC elsewhere found that, while dealer-customer activity
and various trading activity metrics have generally remained stable,
interdealer trading, trade sizes, number of quotes, and quoted spreads
for certain illiquid borrowers have worsened since 2010.\899\ In
addition, a recent paper \900\ seeks to tie financial reforms to trends
in liquidity in the single-name CDS markets. Specifically, the paper
finds that the sample period (2010 through 2016) saw a decline in
interdealer trading, a decrease in net dealer inventories, and a
decline in customer transaction volume. In addition, bid-ask spreads in
later years are more heavily dependent on individual dealer inventories
rather than aggregate inventories of all dealers. Notably, the paper
does not estimate the optimal volume of trading activity. Overall, the
paper concludes that increased costs of market making have affected
liquidity provision in the single-name CDS market.
---------------------------------------------------------------------------

    \899\ See SEC Report 2017, supra note 774.
    \900\ See Mark Paddrik and Stathis Tompaidis, Market Making
Costs and Liquidity: Evidence from CDS Markets (Off. of Fin.
Research Working Paper 19-01, 2019) available at https://www.financialresearch.gov/working-papers/files/OFRwp-19-01_Market-Making-Costs-and-Liquidity-Evidence-from-CDS-Markets.pdf, last
accessed 7/5/2019.
---------------------------------------------------------------------------

    While these studies are necessarily limited in scope, methodology,
and measurement, their results may indicate that section 13 of the BHC
Act and the 2013 rule may have reduced dealer provision of liquidity,
particularly in times of stress.\901\ There is little empirical
evidence concerning whether customers will continue to provide
liquidity in times of severe market stress, possibly since such
empirical settings are scarce in the post-crisis period. One recent
paper builds a theoretical model \902\ that suggests that constraints
on dealer balance sheets may benefit customers and reduce transaction
costs as they can induce dealers to invest in technology designed to
match customers to each other. However, this model does not explicitly
examine dealer behavior in times of stress. In addition, the results
rely on strong modeling assumptions. The model assumes that only bank
dealers are able to develop technology to match customers and assumes
away the role of an inter-dealer market or competition among dealers in
the interdealer market. If these assumptions are violated, it is
unclear whether the results will continue to hold. For example, if
nonbank dealers (as well as bank dealers) can develop customer matching
technology, constraining dealer balance sheets may not be necessary for
the development of technology matching customers to other customers or
the disintermediation of trading, with its resulting welfare
improvements. Similarly, in the presence of an interdealer market,
constraining dealer balance sheets may benefit customers by
facilitating customer-to-customer trading but may also reduce the
ability of dealers to demand liquidity from other dealers.
---------------------------------------------------------------------------

    \901\ See, e.g., supra notes 881, 887, 889, and 891.
    \902\ See Gideon Saar et al., From Market Making to Matchmaking:
Does Bank Regulation Harm Market Liquidity? (May 22, 2019) (working
paper) last accessed June 3, 2019.
---------------------------------------------------------------------------

    Moreover, as discussed above, existing research suggests that non-
dealer institutions may be constrained in their ability to secure
funding from prime brokers that are affected by post-crisis
regulations, limiting the ability of non-dealers to arbitrage away
mispricings. It is even less clear whether customers would be willing
and able to secure funding liquidity and stand on the buy side of
customer sells during severe market stress across asset markets.
    Finally, the agencies also received comment that end-users are
increasingly finding that their bank counterparties have reduced short-
term lending and repo activity, while other end-users are experiencing
higher discounts to posted collateral as a result of the 2013
rule.\903\ The SEC is informed by research on the effects of the
constraints dealers face as a result of post-crisis regulations and
liquidity provision.\904\ One particular study on this issue \905\
finds that dealer balance sheet constraints have broad market-wide
effects on bond liquidity beyond the liquidity of bonds with a
particular credit rating, sector, or issue size. The paper finds that,
prior to the crisis, bonds were more liquid when they were traded by
more levered dealers, dealers with higher return on assets and lower
vulnerability

[[Page 62053]]

(measured by conditional value-at-risk),\906\ dealers with lower risk-
weighted assets, and dealers with relatively low reliance on repo.
However, during the rule implementation period (post-2014) these
results have reversed, and bonds are more liquid when they are traded
by less-levered dealers, dealers with lower return on assets, dealers
with higher risk-weighted assets, and dealers with more reliance on
repo funding. Finally, unlike the pre-crisis period, during the rule
implementation period (post-2014), dealers with more reliance on repo
funding, with higher trading revenues, with larger maturity mismatches,
with higher measures of vulnerability, and with fewer assets held as
loans are less likely to accommodate customer order flow and are more
likely to access the interdealer market instead. Though these results
do not speak to dealer behavior in times of stress, they are based on a
substantially larger sample compared with the discussed above work
showing liquidity declines in times of stress. Overall, while the paper
does not delineate the effects of the Volcker Rule from other post-
crisis regulations (such as the supplemental leverage ratio), the
paper's findings indicate that tightening of dealer balance sheet
constraints due to the package of post-crisis financial regulations may
adversely affect the ability of affected dealers to intermediate
customer trading in bond markets.
---------------------------------------------------------------------------

    \903\ See Coalition for Derivatives End Users.
    \904\ For a more general model of the links between repo market
frictions and liquidity in underlying cash markets see, e.g., Yesol
Huh and Sebastian Infante, Bond Market Intermediation and the Role
of Repo (Oct. 22, 2018) (working paper) last accessed 6/3/2019.
    \905\ See Tobias Adrian et al., Dealer Balance Sheets and Bond
Liquidity Provision, 89 J. Monetary Econ. 92 (2017).
     See also SEC Report 2017, supra note 774, at 115-16.
    \906\ See Tobias Adrian and Markus Brunnermeier, CoVar, 106 Am.
Econ. Rev. 1705 (2016).
---------------------------------------------------------------------------

    The SEC also recognizes that the effects of the 2013 rule on the
ability and willingness of banks to engage in repo activity may be
compounded by other post-crisis reforms. For example, one study \907\
focuses on the effects of the liquidity coverage ratio, exploiting
cross-country differences in the implementation of the rule. The paper
finds that, as a result of the liquidity coverage ratio, U.S. dealers
reduced their reliance on repo in funding high-quality liquid assets by
more, and increased the maturity of lower-quality-collateral repos by
more, than did foreign dealers.
---------------------------------------------------------------------------

    \907\ See Marco Macchiavelli and Luke Pettit, Liquidity
Regulation and Financial Intermediaries (Jul. 29, 2019) (working
paper) last accessed 8/29/2019.
---------------------------------------------------------------------------

    Importantly, reduced ability and willingness to engage in repo
activity are likely to have downstream effects on customers and market
quality. For example, a paper \908\ recently showed that dealers'
ability to rely on repos to finance bond inventory has an effect on
bid-ask spreads and bond transaction costs; that dealers with less
access to funding liquidity are less likely to provide liquidity on a
principal basis and are more likely to trade on an agency basis
instead; and that funding liquidity has causal effects on bond market
liquidity.
---------------------------------------------------------------------------

    \908\ See Marco Macchiavelli and Xing Zhou, Funding Liquidity
and Market Liquidity: The Broker-Dealer Perspective (Jul. 17, 2019)
(working paper) last accessed 8/29/2019.
---------------------------------------------------------------------------

    As discussed above, corporate bond dealers, particularly bank-
affiliated dealers, may have, on aggregate, reduced their capital
commitment post-crisis--a result that is consistent with a reduction in
liquidity provision in corporate bonds because of the 2013 rule. In
addition, the 2013 rule may have resulted in many corporate bond
dealers shifting from trading in a principal capacity to agency
trading. Moreover, corporate bond dealers may decrease liquidity
provision during certain times of stress in general (e.g., during a
financial crisis) \909\ and after the 2013 rule in particular, as
discussed above. Nonbank dealers and non-dealer intermediaries may not
have fully offset the shortfall in liquidity provision, partly because
of their reliance on funding from financial institutions affected by
post-crisis financial reforms.
---------------------------------------------------------------------------

    \909\ Dealers provide less liquidity to clients and peripheral
dealers during stress times; during the peak of the crisis, core
dealers charged higher spreads to peripheral dealers and clients but
lower spreads to dealers with whom they had strong ties. See Marco
Di Maggio et al., The Value of Trading Relationships in Turbulent
Times, 124 J. Fin. Econ. 266 (2017). See also Jaewon Choi and Or
Shachar, Did Liquidity Providers Become Liquidity Seekers? (Oct.,
2013), New York Fed Staff Report No. 650.
---------------------------------------------------------------------------

    The SEC recognizes that the effects of the 2013 rule on the
activities of banking entities and conflicts of interest may flow
through to SEC-registered dealers and investment advisers affiliated
with banks and bank holding companies directly (if banks and holding
companies transact through their dealer affiliates) and indirectly
(e.g., through effects on capital requirements, profitability,
compliance systems, and policies and procedures), and may have an
effect on securities markets. As discussed in the proposal,\910\ the
presence and magnitude of spillover effects across different types of
financial institutions vary over time and may be more significant in
times of stress.\911\
---------------------------------------------------------------------------

    \910\ See 83 FR at 33534.
    \911\ See, e.g., Monica Billio et al., Econometric Measures of
Connectedness and Systemic Risk in the Finance and Insurance
Sectors, 104 J. Fin. Econ. 535 (2012). See also Zeno Adams et al.,
Spillover Effects Among Financial Institutions: A State-Dependent
Sensitivity Value at Risk Approach (SDSVar), 49 J. Fin. &
Quantitative Analysis 575 (2014). See also Adrian and Brunnermeier
(2016) supra note 906.
---------------------------------------------------------------------------

iv. Compliance Burdens, Profitability, and Competitive Effects
    In the proposal, the SEC recognized that the scope and breadth of
the compliance obligations impose costs on banking entities, which may
be particularly important for smaller entities.\912\ The SEC noted
commenters' estimates that banking entities may have added as many as
2,500 pages of policies, procedures, mandates, and controls per
institution for the purposes of compliance with the 2013 rule, which
need to be monitored and updated on an ongoing basis, and that some
banking entities may spend, on average, more than 10,000 hours on
training each year. In terms of ongoing costs, in the proposal the SEC
noted a market participant's estimate that some banking entities may
have 15 regularly meeting committees and forums, with as many as 50
participants per institution dedicated to compliance with the 2013
rule.
---------------------------------------------------------------------------

    \912\ See, e.g., 83 FR at 33550.
---------------------------------------------------------------------------

    In connection with the proposal, the agencies have received a
number of comments on the compliance burdens of the 2013 rule. Some
commenters presented trends in bank profitability, trading revenue, and
loan growth, arguing that the proposed amendments are unnecessary.\913\
Others indicated that the Volcker Rule may reduce bank profits due to
the elimination of proprietary trading but that lost profits are not
costs but intended regulatory effects of section 13 of the BHC
Act.\914\
---------------------------------------------------------------------------

    \913\ See, e.g., Volcker Alliance and AFR.
    \914\ See, e.g., Occupy the SEC.

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

[[Page 62054]]

    In response to those comments, the SEC continues to note that the
scope of this economic analysis is limited to SEC registrants, and
securities markets and their participants. Importantly, trends in
profitability are not informative of the direct causal effect on
profitability or compliance burdens of section 13 of the BHC Act or of
the 2013 rule, since there is no data about the amount of revenue or
compliance burdens that would have occurred in the absence of the 2013
rule. Moreover, the agencies have received a number of comments
pointing to large and significant burdens of section 13 of the BHC Act
and various components of the agencies' 2013 rule. For example, one
commenter estimated that proprietary trading requirements related to
RENTD involved annual costs of as much as about $513 million; that the
metrics-related policies and procedures requirements involved initial
burdens of approximately $41.5 million; that total compliance
expenditures of affected entities (including with respect to covered
funds) totaled between $402 million and $541 million; and that covered
funds requirements involved a cost of between $152 million and $690
million.\915\ Another commenter estimated that, for at least one
banking entity, sorting counterparties into customers and non-customers
for the purposes of calculating RENTD requires dozens of employees
spending thousands of hours in initial and ongoing burdens.\916\
Another commenter stated that simplifying covered funds requirements
would eliminate thousands of unnecessary hours in compliance burdens
related to activities that do not raise the concerns intended to be
addressed by section 13 of the BHC Act.\917\ One trade organization
indicated that duplicative examinations drastically increase burdens on
registrants, estimating that in 2016 members of the organization spent
in aggregate over 50,000 hours responding to inquiries and examinations
related to section 13 of the BHC Act.\918\
---------------------------------------------------------------------------

    \915\ See Data Boiler, citing its own analysis as well as SIA
Partners Briefing Note, July 2015, ``Volcker Implementation,''
available at http://en.finance.sia-partners.com/sites/default/files/post/sia_partners_-_briefing_note_volcker_coveredfunds_blog_version.pdf, last accessed
6/4/2019.
    \916\ See CCMC.
    \917\ See SFIG.
    \918\ See SIFMA.
---------------------------------------------------------------------------

    Moreover, the SEC notes that risk-averse market participants are
compensated for bearing greater systematic \919\ risks with higher
expected returns.\920\ If capital markets have a high degree of
efficiency and arbitrage opportunities are generally scarce, greater
profitability may simply be indicative of greater risks taken on by
banking entities. Setting aside the challenges of causal inference
discussed above, trends in bank profitability may reflect not only
compliance burdens of the 2013 rule, but also the effects of the 2013
rule on banking entity risk exposures from permissible activities. That
is, banking entities may have become more willing to take risk through
engaging in activities permitted by the 2013 rule. For more discussion
of the existing evidence on the effects of the 2013 rule on the
activities of banking entities, see the preceding sections of the
economic baseline.
---------------------------------------------------------------------------

    \919\ The term ``systematic risk'' generally refers to the
variability of returns due to macroeconomic factors that affect all
risky assets and, thus, cannot be eliminated by diversification. See
Frank Reilly & Keith Brown, Investment Analysis & Portfolio
Management, 1025 (9th ed. 2009). See also Bodie, supra note 840, at
G-12.
    \920\ See supra note 840.
---------------------------------------------------------------------------

    The agencies also received a number of comments concerning the need
to tailor regulations to banking entities on the basis of risk profile
in order to balance the intended regulatory goals with compliance
burdens and competitive effects. Specifically, a number of commenters
supported tailoring the 2013 rule to more effectively accomplish the
underlying goals of section 13 of the BHC Act, reduce unnecessary
compliance burdens, particularly on smaller and mid-sized banking
entities and entities with small trading books, and more effectively
allocate supervisory resources to prudential goals.\921\
---------------------------------------------------------------------------

    \921\ See, e.g., IIB; CCMC; CREFC; CCMR; Covington; Capital One
et al. and Credit Suisse.
---------------------------------------------------------------------------

    The SEC continues to believe that the compliance regime under the
2013 rule and related burdens reduce the profitability of permissible
activities by bank-affiliated dealers and investment advisers and may
be passed along to customers or clients in the form of reduced
provision of services or higher service costs.\922\ Moreover, the SEC
continues to believe that the extensive compliance program under the
2013 rule detracts resources of some banking entities and their
compliance departments and supervisors from other compliance matters,
risk management, and supervision. Finally, the SEC continues to believe
that prescriptive compliance requirements may not optimally reflect the
organizational structures, governance mechanisms, or risk management
practices of complex, innovative, and global banking entities.
---------------------------------------------------------------------------

    \922\ See 83 FR at 33550.
---------------------------------------------------------------------------

    In the sections that follow the SEC discusses rule provisions of
the 2013 rule, how each amendment in the final rule changes the
economic effects of the regulatory requirements, and the anticipated
costs and benefits of the amendments.
c. Affected Participants
    The SEC-regulated entities directly affected by the final rule
include broker-dealers, security-based swap dealers, and investment
advisers.
i. Broker-Dealers \923\
---------------------------------------------------------------------------

    \923\ These estimates differ from the estimates in the proposal
and in the EGRRCPA Conforming Amendments Adopting Release, as these
estimates rely on more recent data and information about both U.S.
and global trading assets and liabilities of bank holding companies.
This analysis is based on data from Reporting Form FR Y-9C for
domestic holding companies on a consolidated basis and Report of
Condition and Income for banks regulated by the Board, FDIC, and OCC
for the most recent available four-quarter average, as well as data
from S&P Market Intelligence LLC on the estimated amount of global
trading activity of U.S. and non-U.S. bank holding companies.
Broker-dealer bank affiliations were obtained from the Federal
Financial Institutions Examination Council's (FFIEC) National
Information Center (NIC). Broker-dealer assets and holdings were
obtained from FOCUS Report data for Q4 2018.
---------------------------------------------------------------------------

    Under the 2013 rule, some of the largest SEC-regulated broker-
dealers are banking entities because they are affiliated with banks or
bank holding companies. Table 1 reports the number, total assets, and
holdings of broker-dealers by the broker-dealer's bank affiliation.

[[Page 62055]]

    While the 199 bank-affiliated broker-dealers subject to the 2013
rule (affected broker-dealers) are greatly outnumbered by the 3,595
broker-dealers that are either bank broker-dealers exempt under section
203 of EGRRCPA or nonbank broker-dealers, the affected broker-dealers
dominate other broker-dealers in terms of total assets (72.7% of total
broker-dealer assets) and aggregate holdings (66.5% of total broker-
dealer holdings).

                        Table 1--Broker-Dealer Count, Assets, and Holdings by Affiliation
----------------------------------------------------------------------------------------------------------------
                                                                                                     Holdings
         Broker-dealer bank affiliation               Number       Total assets,  Holdings, $mln    (altern.),
                                                                    $mln \924\         \925\        $mln \926\
----------------------------------------------------------------------------------------------------------------
Bank broker-dealers affected by the final rule               199       3,142,780         761,532         567,387
 \927\..........................................
All other broker-dealers \928\..................           3,595       1,179,805         382,451         225,675
                                                 ---------------------------------------------------------------
    Total.......................................           3,794       4,322,586       1,143,983         793,062
----------------------------------------------------------------------------------------------------------------

    Some of the amendments to the 2013 rule that the agencies are
adopting differentiate banking entities on the basis of their
consolidated trading assets and liabilities.\929\ Table 2 reports
affected broker-dealer counts, assets, and holdings by consolidated
trading assets and liabilities of the (top-level) parent firm. The SEC
estimates that 163 broker-dealer affiliates of firms with less than $20
billion in consolidated trading assets and liabilities account for
20.4% of bank-affiliated broker-dealer assets and 17.8% of holdings (or
7% using the alternative measure of holdings).\930\
---------------------------------------------------------------------------

    \924\ Broker-dealer total assets are based on FOCUS report data
for ``Total Assets.''
    \925\ Broker-dealer holdings are based on FOCUS report data for
securities and spot commodities owned at market value, including
bankers' acceptances, certificates of deposit and commercial paper,
state and municipal government obligations, corporate obligations,
stocks and warrants, options, arbitrage, other securities, U.S. and
Canadian government obligations, and spot commodities.
    \926\ This alternative measure excludes U.S. and Canadian
government obligations and spot commodities.
    \927\ This category includes all bank-affiliated broker-dealers
except those exempted by section 203 of EGRRCPA.
    \928\ This category includes both bank affiliated broker-dealers
subject to section 203 of EGRRCPA and broker-dealers that are not
affiliated with banks or holding companies.
    \929\ See, e.g., 2013 rule Sec.  __.20(d)(1).
    \930\ See supra note 926.
    \931\ This analysis excludes SEC-registered broker-dealers
subject to section 203 of EGRRCPA.
    \932\ Consolidated trading assets and liabilities are estimated
using information reported in form FR Y-9C data and from S&P Market
Intelligence LLC on the estimated amount of global trading activity
provided for U.S. and non-U.S. firms. These estimates exclude from
the definition of consolidated trading assets and liabilities
government, agency, and GSE securities. U.S. trading assets and
liabilities are calculated on the basis of the most recent four-
quarter average, except for foreign firms without an intermediate
holding company, for which the amount of trading activity for the
nonbank and edge subsidiaries does not exclude securities of
government-sponsored enterprises. For top-tier bank holding
companies, top-tier independent depositary institutions, and foreign
parents with U.S. activity, Ginnie Mae securities are included in
the calculation of trading assets and liabilities because of data
limitations. (It is not possible to exclude Ginnie Mae securities
without also excluding Fannie Mae and Freddie Mac securities.)

             Table 2--Broker-Dealer Counts, Assets, and Holdings by Consolidated Trading Assets and Liabilities of the Banking Entity \931\
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                  Total assets,                                                  Holdings
 Consolidated trading assets and liabilities \932\     Number          $mln         Percent     Holdings, $mln    Percent    (altern.), $mln    Percent
--------------------------------------------------------------------------------------------------------------------------------------------------------
>=50bln............................................         28          2,152,225         68            555,787         73            510,325         90
20bln-50bln........................................          8            349,716         11             70,054          9             17,611          3
10bln-20bln........................................          9            198,895          6             49,797          7             13,301          2
5bln-10bln.........................................         24            261,622          8             55,316          7             14,295          3
1bln-5bln..........................................         33             66,583          2             18,319          2              4,998          1
<=1bln.............................................         97            113,740          4             12,259          2              6,857          1
                                                    ----------------------------------------------------------------------------------------------------
    Total..........................................        199          3,142,780        100            761,532        100            567,387        100
--------------------------------------------------------------------------------------------------------------------------------------------------------

ii. Security-Based Swap Dealers
    The final rule may also affect bank-affiliated SBSDs. As compliance
with SBSD registration requirements is not yet required, there are
currently no registered SBSDs. However, the SEC has previously
estimated that as many as 50 entities may potentially register as
security-based swap dealers and that as many as 16 of these entities
may already be SEC-registered broker-dealers.\933\ Similarly, the SEC
previously estimated that between 0 and 5 entities may register as
Major Security-Based Swap Participants (MSBSPs).\934\ On the basis of
the analysis of TIW transaction and positions data on single-name
credit-default swaps, the SEC believes that all entities that may
register with the SEC as SBSDs are bank-affiliated firms, including
those that are SEC-registered broker-dealers. Therefore, the SEC
estimates that, in addition to the bank-affiliated SBSDs that are
already registered as broker-dealers and included in the discussion
above, as many as 34 other bank-affiliated SBSDs may be affected by
these amendments. Similarly, on the basis of the analysis of TIW data,
the SEC estimates that none of the entities that may register with the
SEC as MSBSPs are affected by the final rule.
---------------------------------------------------------------------------

    \933\ See Capital, Margin, Segregation Adopting Release, 84 FR
at 43960.
    \934\ Id.
---------------------------------------------------------------------------

    Importantly, compliance with capital and other substantive
requirements for SBSDs under Title VII of the Dodd-Frank Act is not yet
required.\935\ The SEC recognizes that firms may choose to move
security-based swap trading activity into (or out of) an affiliated
bank or an affiliated broker-dealer instead of registering as a
standalone SBSD, if bank or broker-dealer capital and other regulatory
requirements are less (or more) costly than those that may be imposed
on SBSDs under Title VII. As a result, the above figures may

[[Page 62056]]

overestimate or underestimate the number of SBSDs that are not broker-
dealers and that may become SEC-registered entities affected by the
final rule. Quantitative cost estimates are provided separately for
affected broker-dealers and potential SBSDs.
---------------------------------------------------------------------------

    \935\ Id.
---------------------------------------------------------------------------

iii. Private Funds and Private Fund Advisers \936\
---------------------------------------------------------------------------

    \936\ These estimates are calculated from Form ADV data as of
March 31, 2019. An investment adviser is defined as a ``private fund
adviser'' if it indicates that it is an adviser to any private fund
on Form ADV Item 7.B. An investment adviser is defined as a ``bank-
affiliated RIA'' if it indicates on Form ADV Item 6.A.(7) that it is
actively engaged in business as a bank, or it indicates on Form ADV
Item 7.A.(8) that it has a ``related person'' that is a banking or
thrift institution. For purposes of Form ADV, a ``related person''
is any advisory affiliate and any person that is under common
control with the adviser. The definition of ``control'' for purposes
of Form ADV, which is used in identifying related persons on the
form, differs from the definition of ``control'' under the BHC Act.
In addition, this analysis does not exclude SEC-registered
investment advisers affiliated with banks that have consolidated
total assets less than or equal to $10 billion and trading assets
and liabilities less than or equal to 5% of total assets. Thus,
these figures may overestimate or underestimate the number of bank-
affiliated RIAs.
---------------------------------------------------------------------------

    This section focuses on RIAs advising private funds. Using Form ADV
data, Table 3 reports the number of RIAs advising private funds by fund
types, as those types are defined in Form ADV. Table 4 reports the
number and gross assets of private funds advised by RIAs and separately
reports these statistics for bank-affiliated RIAs. As can be seen from
Table 3, the two largest categories of private funds advised by RIAs
are hedge funds and private equity funds.
    Bank-affiliated RIAs advise a total of 4,316 private funds with
approximately $2 trillion in gross assets. Per Form ADV data, bank-
affiliated RIAs' gross private fund assets under management are
concentrated in hedge funds and private equity funds. On the basis of
this data, bank-affiliated RIAs advise 929 hedge funds with
approximately $668 billion in gross assets and 1,420 private equity
funds with approximately $395 billion in assets. While bank-affiliated
RIAs are subject to all of section 13's restrictions, because RIAs do
not typically engage in proprietary trading, the SEC continues to
believe that they will not be affected by the final rule as it relates
to proprietary trading.

 Table 3--SEC-Registered Investment Advisers Advising Private Funds, by
                             Fund Type \937\
------------------------------------------------------------------------
                                                               Bank-
                Fund type                     All RIA       affiliated
                                                                RIA
------------------------------------------------------------------------
Hedge Funds.............................           2,656             154
Private Equity Funds....................           1,644              98
Real Estate Funds.......................             526              52
Securitized Asset Funds.................             220              45
Liquidity Funds.........................              46              16
Venture Capital Funds...................             193               8
Other Private Funds.....................           1,066             146
                                         -------------------------------
    Total Private Fund Advisers.........           4,756             296
------------------------------------------------------------------------


    Table 4--The Number and Gross Assets of Private Funds Advised by SEC-Registered Investment Advisers \938\
----------------------------------------------------------------------------------------------------------------
                                                      Number of private funds           Gross assets, $bln
                                                 ---------------------------------------------------------------
                    Fund type                                          Bank-                           Bank-
                                                      All RIA     affiliated RIA      All RIA     affiliated RIA
----------------------------------------------------------------------------------------------------------------
Hedge Funds.....................................          10,431             929           7,160             668
Private Equity Funds............................          14,775           1,420           3,446             395
Real Estate Funds...............................           3,472             320             646             100
Securitized Asset Funds.........................           1,814             358             661             129
Liquidity Funds.................................              83              30             297             195
Venture Capital Funds...........................           1,201              43             136               3
Other Private Funds.............................           4,460           1,217           1,396             474
                                                 ---------------------------------------------------------------
    Total Private Funds.........................          36,230           4,316          13,741           1,964
----------------------------------------------------------------------------------------------------------------

    In addition,  for an additional period of 2 years until July 21,
2021, the banking agencies will not treat qualifying foreign excluded
funds that meet the conditions included in the policy statement
discussed above as banking entities or attribute their activities and
investments to the banking entity that sponsors the fund or otherwise
may control the fund under the circumstances set forth in the policy
statement.\939\
---------------------------------------------------------------------------

    \937\ This table includes only the advisers that list private
funds on Section 7.B.(1) of Form ADV. The number of advisers in the
``Any Private Fund'' row is not the sum of the rows that follow,
since an adviser may advise multiple types of private funds. Each
listed private fund type (e.g., real estate fund, liquidity fund) is
defined in Form ADV, and those definitions are the same for purposes
of the SEC's Form PF.
    \938\ Gross assets include uncalled capital commitments on Form
ADV.
    \939\ See ``Statement regarding Treatment of Certain Foreign
Funds under the Rules Implementing Section 13 of the Bank Holding
Company Act,'' July 19, 2019, available at https://www.occ.gov/news-issuances/news-releases/2019/nr-ia-2019-79a.pdf, last accessed July
19, 2019.
---------------------------------------------------------------------------

iv. Registered Investment Companies
    The potential that a registered investment company (RIC) or a
business development company (BDC) would be treated as a banking entity
where the fund's sponsor is a banking entity and holds 25% or more of
the RIC or BDC's voting securities after a seeding period also forms
part of the baseline. On the basis of Commission filings and public
data, the SEC estimates that, as of year-end 2018, there were
approximately

[[Page 62057]]

15,700 RICs \940\ and 104 BDCs. Although RICs and BDCs are generally
not banking entities themselves subject to the 2013 rule, they may be
indirectly affected by the 2013 rule and the final rule, for example,
if their sponsors or advisers are banking entities. For instance, bank-
affiliated RIAs or their affiliates may reduce their level of
investment in the funds they advise, or potentially close those funds,
to avoid those funds becoming banking entities themselves.
---------------------------------------------------------------------------

    \940\ This estimate includes open-end companies, exchange-traded
funds, closed-end funds, and non-insurance unit investment trusts
and does not include fund of funds. The inclusion of fund of funds
increases this estimate to approximately 17,200.
---------------------------------------------------------------------------

v. Entities Reporting Metrics to the SEC \941\
---------------------------------------------------------------------------

    \941\ The estimates in this section are based on Appendix A
information provided by reporters to the SEC under the 2013 rule at
the holding company level for April 2018 through March 2019, based
on the most complete filing for each reporting period. Appendix A
records for a particular trading desk are reported to the SEC if a
trading desk books activity into the SEC registrant.
---------------------------------------------------------------------------

    The regulatory reporting requirements of the 2013 rule with respect
to bank-affiliated broker-dealers, SBSDs, and RIAs are described in
section V.F.2.a above. As discussed below, the final rule increases the
threshold for entities subject to metrics reporting from the $10
billion under the 2013 rule to $20 billion in trading assets and
liabilities. Moreover, the final amendments that link the trading desk
definition to the market risk capital rule have an effect on the volume
of reporting to the SEC and corresponding burdens.
    The agencies have received a number of comments opposing the
proposed amendments to metrics reporting and challenging the agencies'
assessment of the proposed amendments.\942\ For example, one commenter
indicated that the SEC's assessment of the overall streamlining effects
of the amendments to metrics reporting and recordkeeping will not be
supported by a full-fledged cost-benefit analysis.\943\ Another
commenter stated that the proposal presented no analysis showing that
the benefits of eliminating some metrics outweigh the costs of imposing
new metrics.\944\ A number of commenters indicated that the agencies
should not adopt any of the proposed amendments to metrics reporting as
they would result in a significant net increase in metrics data.\945\
One commenter estimated that the proposed requirements would require
its member institutions to report hundreds of thousands of additional
data points each month.\946\ One commenter indicated that the extended
reporting timeframe for metrics submission is insufficient and frequent
resubmissions are likely to persist.\947\ In response to these comments
and to enable a quantification of the economic effects of the metrics
amendments on the volume and timeliness of metrics reporting, the SEC
is updating the economic baseline with summary information about the
current volume and resubmission statistics by different groups of
Appendix A  filers.
---------------------------------------------------------------------------

    \942\ See, e.g., ABA; Credit Suisse; CCMR; FSF, Public Citizen
and SIFMA.
    \943\ See SIFMA Annex C.
    \944\ See CCMR.
    \945\ See, e.g., CCMC and FSF.
    \946\ See FSF.
    \947\ See SIFMA Annex C.
    \948\ For the purposes of this analysis, each record is one line
of the matrix reported to the SEC, with the value filled out by the
reporting entity, on a monthly basis, for all its related trading
desks. The total number of records also includes the header, body,
and footer. Each submission is the full data matrix reported by the
reporting entity to the SEC for any specific reporting month.

   Table 5--Volume of Metrics Records Submitted to the SEC, by Trading
                      Assets and Liabilities \948\
------------------------------------------------------------------------
                                             Number of        Records
      Trading assets & liabilities           reporters       submitted
------------------------------------------------------------------------
>50bln..................................               8      40,771,825
20bln-50bln.............................               4       7,357,794
<20bln..................................               6      10,440,677
                                         -------------------------------
    Total...............................              18      58,570,296
------------------------------------------------------------------------


             Table 6--Trading Desks Reporting Metrics to the SEC, by Trading Assets and Liabilities
----------------------------------------------------------------------------------------------------------------
                                                                                      Average         Average
                                                                      Average        number of       number of
                  Trading assets & liabilities                      number  of      records per    records  per
                                                                       desks        submission         desk
----------------------------------------------------------------------------------------------------------------
>50bln..........................................................              56         450,921           7,588
20bln-50bln.....................................................              43         195,010           5,172
<20bln..........................................................              38         216,433           7,093
----------------------------------------------------------------------------------------------------------------


                 Table 7--Time Delays and Resubmissions of Metrics Records Submitted to the SEC
----------------------------------------------------------------------------------------------------------------
                                                                                    Percent of      Percent of
                                                   Total number     Percent of        records         records
          Trading assets & liabilities             of submitted     records not     resubmitted     resubmitted
                                                      records       resubmitted        once            twice
----------------------------------------------------------------------------------------------------------------
                                    Panel A. Resubmissions of Initial Records
----------------------------------------------------------------------------------------------------------------
>50bln..........................................      40,785,033              34              56              10
20bln-50bln.....................................       6,908,332              61              39               0
<20bln..........................................      10,441,265              96               4               0
----------------------------------------------------------------------------------------------------------------


[[Page 62058]]


 
                                                                                                   Average delay
                                                   Total records                   Average delay    in initial
                                                  submitted late    Percent of      in initial      submissions
          Trading assets & liabilities               (initial      late initial     submissions       (days,
                                                    submission)     submissions    (days, simple    weighted by
                                                                                     average)      record count)
----------------------------------------------------------------------------------------------------------------
                                 Panel B. Delayed Submission of Initial Records
----------------------------------------------------------------------------------------------------------------
>50bln..........................................       4,771,713              12               2               2
20bln-50bln.....................................       4,020,778              58              32              32
<20bln..........................................      10,437,647           99.97              46              42
----------------------------------------------------------------------------------------------------------------

    The SEC notes two important caveats relevant for the interpretation
of these statistics. First, direct attribution of specific trading
activity by a trading desk to an SEC registrant or group of registrants
is not feasible, since the trading desk may book transactions into
multiple legal entities, including both those registered with the SEC
as well as those that are not registered. As a result, the scope of
activity reported in this section is likely to overestimate the records
and reporting by legal entities registered with the SEC. Second, the
SEC does not receive reporting from trading desks that do not transact
on behalf of SEC-registered entities. Therefore, these estimates may
significantly underestimate the overall volume of metrics reporting by
all banking entities (including those that are not registered with the
SEC) related to the 2013 rule.
3. Economic Effects
a. Treatment of Entities Based on the Size of Trading Assets and
Liabilities
    As proposed, the agencies are adopting a categorization of banking
entities into three groups on the basis of the size of their trading
activity. Under the final rule, banking entities with significant
trading assets and liabilities (Group A entities) are required to
comply with a streamlined but comprehensive version of the 2013 rule's
compliance program requirements, as discussed below. Banking entities
with moderate trading assets and liabilities (Group B entities) are
subject to reduced requirements and an even more tailored approach in
light of their smaller trading activities. The burdens are further
reduced for banking entities with limited trading assets and
liabilities (Group C entities), for which the amendments establish a
presumption of compliance, which can be rebutted by the agencies. The
sections that follow discuss the economic effects of each of the
amendments on these groups of entities.
i. Costs and Benefits
    First, banking entities with significant trading assets and
liabilities are defined as those that have, together with affiliates
and subsidiaries, trading assets and liabilities (excluding trading
assets and liabilities attributable to trading activities permitted
pursuant to Sec.  __.6(a)(1) and (2) of subpart B) the average gross
sum of which, over the previous consecutive four quarters, as measured
as of the last day of each of the four previous calendar quarters,
equals or exceeds $20 billion.\949\ This $20 billion threshold is
higher than the threshold that the agencies proposed in the proposal.
Accordingly, more banking entities may qualify as Group B entities
rather than Group A entities (as compared to those that would have
qualified under the proposal's lower threshold), which will reduce
compliance burdens for more banking entities relative to the
proposal.\950\ The agencies received comments that a higher than the
proposed $10 billion trading assets and liabilities threshold would
provide Group B banking entities that are near or approaching $10
billion threshold with flexibility to have moderate growth over time
and to manage their business without triggering the more stringent
compliance requirements imposed on Group A banking entities.\951\ In
addition, some commenters stated that potential fluctuations resulting
from customer-driven trades, quarter-end activity, and market and
foreign exchange volatility may cause banking entities that are near or
approaching the $10 billion threshold to exceed this threshold.\952\
The SEC recognizes that fluctuations in customer demand or market
events may cause these banking entities to exceed the $10 billion
threshold temporarily or permanently, which could trigger a more
enhanced compliance regime and expose these banking entities to higher
compliance costs.\953\ Thus, a $20 billion threshold accounts for such
fluctuations and provides banking entities that are near or approaching
$10 billion in trading assets and liabilities with more certainty
regarding their compliance burdens.
---------------------------------------------------------------------------

    \949\ With respect to a banking entity that is a foreign banking
organization or a subsidiary of a foreign banking organization, this
threshold for having significant trading assets and liabilities
applies according to the trading assets and liabilities of the
combined U.S. operations of the top-tier foreign banking
organization (including all subsidiaries, affiliates, branches, and
agencies of the foreign banking organization operating, located, or
organized in the United States).
    \950\ The final rule defines banking entities with moderate
trading assets and liabilities as those that are neither banking
entities with significant trading assets and liabilities nor banking
entities with limited trading assets and liabilities.
    \951\ See, e.g., Capital One et al.; ABA; BPI; and Custody
Banks.
    \952\ See, e.g., Custody Banks and BPI.
    \953\ See supra note 123.
---------------------------------------------------------------------------

    Some commenters stated that changing the threshold from $10 to $20
billion would have minimal effect on the number of banking entities
that would remain categorized as having significant trading assets and
liabilities.\954\ The SEC estimates that there are 66 broker-dealers
with approximately 16% of all broker-dealer holdings (or 6% based on
the alternative measure) that would qualify as Group B entities with
the adopted $20 billion threshold--compared to 57 broker-dealers with
between 9% and 4% of all broker-dealer holdings that would have
qualified under the proposed threshold value. Thus, relative to the
proposal, 15 additional broker-dealers will experience the cost
reduction because of reduced compliance burdens.
---------------------------------------------------------------------------

    \954\ See, e.g., ABA; Custody Banks; New England Council;
Capital One et al.; SIFMA; State Street and BPI.
---------------------------------------------------------------------------

    Second, as in the proposal, the agencies are defining a banking
entity with limited trading assets and liabilities as a banking entity
that has, together with its affiliates and subsidiaries on a
consolidated basis, trading assets and liabilities (excluding trading
assets and liabilities attributable to trading activities permitted
pursuant to Sec.  __.6(a)(1) and (2) of subpart B) the average gross
sum of which, over the previous consecutive four quarters, as measured
as of the last day of each of the four previous calendar quarters, is

[[Page 62059]]

less than $1 billion. However, in the proposal, the agencies proposed
this threshold to be calculated on the worldwide consolidated basis for
both foreign and domestic registrants. Unlike in the proposal, with
respect to a banking entity that is a foreign banking organization or a
subsidiary of a foreign banking organization, this threshold will be
applied on the basis of the combined U.S. operations of the top-tier
foreign banking organization (including all subsidiaries, affiliates,
branches, and agencies of the foreign banking organization operating,
located, or organized in the United States).
    The SEC continues to recognize that the 2013 rule may have resulted
in significant compliance burdens for banking entities that do not have
significant U.S. operations, even though such entities may not pose
substantial risks to the U.S. financial system because of their limited
presence in the U.S. The SEC estimates that the adopted definition of
limited trading assets and liabilities will allow 97 broker-dealers to
reduce compliance costs related to the 2013 rule as a result of the
final rule's presumption of compliance. In contrast, if the final rule
adopted the proposed calculation of limited trading assets and
liabilities, some foreign broker-dealers would not qualify as those
affiliated with entities with limited trading assets and liabilities,
even though the entities these broker-dealers are affiliated with may
have very limited activity in the U.S.
    Third, in the final rule the calculation of thresholds for limited
and significant trading assets and liabilities will exclude--in
addition to the proposed exclusion of trading assets and liabilities
involving obligations of, or guaranteed by, the United States, or any
agency of the United States--trading assets and liabilities involving
obligations, participations, or other instruments of, or issued or
guaranteed by, government-sponsored enterprises listed in Sec. 
__.6(a)(2). Some commenters stated that the calculation of trading
assets and liabilities should exclude financial instruments that are
not regulated under the 2013 rule.\955\ The SEC recognizes that
inclusion of trading assets and liabilities involving obligations of,
participations by, or other instruments of, or issued or guaranteed by,
government-sponsored enterprises in the calculation of trading assets
and liabilities may inadvertently scope in entities whose trading
assets and liabilities primarily consist of financial instruments that
are excluded from the prohibition on proprietary trading under the 2013
rule.\956\ Accordingly, the final rule will better align the
application of the tiered compliance regime with trading activities
that are subject to the proprietary trading prohibitions. The SEC
estimates that the exclusion of the aforementioned trading assets and
liabilities from the calculation of the $1 billion and $20 billion
thresholds will not change the assignment of banking entities into the
tiered compliance groups.
---------------------------------------------------------------------------

    \955\ See, e.g., KeyCorp; BMO and Capital One et al.
    \956\ See Sec.  __.6(a)(2).
---------------------------------------------------------------------------

    The SEC continues to believe that the primary effect of these
amendments for SEC registrants is the reduced compliance burdens, as
discussed in more detail in later sections. To the extent that the
compliance costs are currently passed along to customers and
counterparties, some of the cost reductions for these entities
associated with the final rule may flow through to counterparties and
clients in the form of reduced transaction costs or a greater
willingness to engage in activity, including intermediation that
facilitates risk-sharing.
    The SEC notes that, from above, Group B and Group C broker-dealers
currently account for approximately 7% to 18% of total bank broker-
dealer holdings and that, to the extent that holdings reflect risk
exposure resulting from trading activity, current trading activity by
Group B and Group C entities may represent lower risks than the risks
posed by Group A entities' trading activities addressed in the 2013
rule. In addition, the SEC continues to recognize that some Group B and
Group C entities that currently exhibit low levels of trading activity
because of the costs of compliance may respond to the final rule by
increasing their trading assets and liabilities while still remaining
under the $20 billion or $1 billion threshold, as applicable. Increases
in aggregate risk exposure by Group B and Group C entities may be
magnified if trading activity becomes more highly correlated among such
entities, or dampened if trading activity becomes less correlated among
such entities. Since it is difficult to estimate the number of Group B
and Group C entities that may increase the riskiness of their
activities and the degree to which their trading activity would be
correlated, the implications of this effect for aggregate risk and
capital market activity are unclear.
    The shifts in risk exposure may have two competing effects. On the
one hand, if Group B and Group C entities are able to bear risk at a
lower cost than their customers, increased risk exposures could promote
secondary market trading activity and capital formation in primary
markets and increase access to capital for issuers, benefitting issuers
and investors. On the other hand, Group B and Group C firms may be
incentivized to increase their risk exposures, resulting in more
aggregate risk in the banking sector, greater market fragility, and
exacerbated conflicts of interest between banking entities and their
customers. This may ultimately adversely affect issuers and investors.
However, the SEC continues to recognize that the amendments are focused
on tailoring the compliance regime based on the amount of trading
activity engaged in by each banking entity, and all banking entities
would still be subject to the statutory prohibitions related to such
activities. Thus, the potential risk of increased market fragility and
the severity of conflicts of interest effects is mitigated.
    In response to the final rule, it is possible that trading activity
that was once consolidated within a small number of unaffiliated
banking entities may become fragmented among a larger number of
unaffiliated banking entities that each manage down their trading books
under the $20 billion and $1 billion trading assets and liabilities
thresholds to enjoy reduced hedging compliance and documentation
requirements and a less costly compliance and reporting regime
described in sections V.F.3.c, V.F.3.d, V.F.3.g, and V.F.3.h. The
extent to which banking entities may seek to manage down their trading
books will depend on a number of factors, such as the size and
complexity of each banking entity's trading activities and
organizational structure, along with those of its affiliated entities,
as well as forms of potential restructuring and the magnitude of
expected compliance savings from such restructuring relative to the
cost of restructuring. The SEC anticipates that the incentives to
manage the trading book under the $20 billion or $1 billion threshold,
as applicable, may be strongest for those holding companies that are
near or just above the thresholds. Such management of the trading book
may reduce the size of trading activity of some banking entities and
reduce the number of banking entities subject to more stringent
hedging, compliance, and reporting requirements. At the same time, if
the amendments incentivize banking entities to have smaller trading
books, they may mitigate moral hazard and reduce market impacts from
the failure of a given banking entity.

[[Page 62060]]

ii. Efficiency, Competition, and Capital Formation
    The 2013 rule imposes compliance burdens that may be particularly
significant for smaller market participants. Moreover, such compliance
burdens may be passed along to counterparties and customers in the form
of higher costs, reduced capital formation, or a reduced willingness to
transact. For example, in the proposal, the SEC cited one commenter's
estimate that the funding cost for an average non-financial firm may
have increased by as much as $30 million after the 2013 rule's
implementation.\957\ At the same time, and as discussed in section
V.F.2, the SEC continues to recognize that the 2013 rule may have
yielded important qualitative benefits, such as reducing certain types
of risks in the financial system and mitigating potential incentive
conflicts that could be posed by certain types of proprietary trading
by dealers, as well as enhancing oversight and supervision.
---------------------------------------------------------------------------

    \957\ See 83 FR at 33526.
---------------------------------------------------------------------------

    On one hand, as a result of the amendments, Group B and Group C
entities might enjoy a competitive advantage relative to similarly
situated Group A and Group B entities respectively. As noted, firms
that are near to the $20 billion threshold may actively manage their
trading book to avoid triggering stricter requirements, and some firms
above the threshold may seek to manage down the trading activity to
qualify for streamlined treatment under the amendments. As a result,
the amendments may result in greater competition between Group B and
Group A entities around the $20 billion threshold, and similarly,
between Group B and Group C entities around the $1 billion threshold,
to the extent that Group C and Group B entities will increase their
trading activity without reaching the $1 and $20 billion thresholds
respectively. On the other hand, to the extent that the risk exposure
of Group B and Group C entities increases as they compete with Group A
and Group B entities, respectively, investors may demand additional
compensation for bearing financial risk. A higher required rate of
return and higher cost of capital could therefore offset potential
competitive advantages for Group B and Group C entities.
    In addition, the adopted methods for the calculation of limited and
significant trading assets and liabilities may result in lower
compliance costs for foreign banking entities relative to the domestic
banking entities, increasing the competitive advantage of foreign Group
B and C entities.
    As in the proposal, the SEC recognizes that cost savings to Group B
and Group C entities related to the compliance requirements and
requirements described in sections V.F.3.g and V.F.3.h may be partially
or fully passed along to clients and counterparties. To the extent that
hedging documentation and compliance requirements for Group B and Group
C entities are currently resulting in a reduced willingness to make
markets or underwrite securities, the amendments may facilitate trading
activity and risk-sharing, as well as capital formation and reduced
costs of access to capital. Again, the SEC notes that the amendments do
not eliminate statutory prohibitions under section 13 of the BHC but
create a simplified compliance regime for banking entities that do not
have significant trading assets and liabilities. Thus, the statutory
prohibitions on proprietary trading and covered funds activities will
continue to apply to all affected entities, including Group B and Group
C entities.
iii. Alternatives
    Alternative approaches were considered. For example, the rule could
have used other values for thresholds for total consolidated trading
assets and liabilities in the definition of entities with significant
trading assets and liabilities. As noted in the discussion of the
economic baseline, using different thresholds would affect the scope of
application of compliance requirements and requirements described in
sections V.F.3.g and V.F.3.h by changing the number and size of
affected broker-dealers. For instance, using the proposed $10 billion
threshold or a lower threshold, such as $5 billion, in the definition
of significant trading assets and liabilities would scope a larger
number of entities into Group A, as compared to the final rule's $20
billion threshold, thereby subjecting a larger share of the dealer and
investment adviser industries to six-pillar compliance obligations.
However, the SEC continues to recognize that trading activity is
heavily concentrated in the right tail of the distribution and that
using a lower threshold would not significantly increase the volume of
trading assets and liabilities scoped into the Group A regime.\958\ For
example, Table 2 shows that 57 bank-affiliated broker-dealers that have
between $1 and $10 billion in consolidated trading assets and
liabilities and are subject to section 13 of the BHC Act account for
only approximately 10% of bank-affiliated broker-dealer assets and
between approximately 4% and 9% of holdings. In addition, 33 broker-
dealer affiliates of firms that have between $1 and $5 billion in
consolidated trading assets and liabilities and are subject to section
13 of the BHC Act account for only approximately 2% of bank-affiliated
broker-dealer assets and between approximately 1% and 2% of
holdings.\959\ At the same time, with a lower threshold, more banking
entities would face higher compliance burdens and related costs.
Therefore, as discussed in section IV.A.1.b, the agencies decided
against this alternative.
---------------------------------------------------------------------------

    \958\ Some commenters supported this view. See, e.g., Capital
One et al.
    \959\ In addition, one commenter stated that firms with $20
billion or more in trading assets and liabilities represented
approximately 94.80% of total reported U.S. trading assets and
liabilities and firms with $5 billion or less in trading assets and
liabilities represented approximately 1.32% of total reported U.S.
trading assets and liabilities. See BPI.
---------------------------------------------------------------------------

    A different threshold for the definition of banking entities with
limited trading assets and liabilities was also considered. As pointed
out by some commenters, a higher threshold, such as $5 billion, would
allow small and mid-size banking entities to have moderate growth over
time without triggering more costly compliance requirements.\960\ As
shown in Table 2, 33 more broker-dealers would qualify for presumed
compliance under this alternative. However, as discussed in section
IV.A.1.b, the agencies continue to believe that banking entities with
$1 billion or less in trading assets and liabilities differ from
banking entities with between $1 and $5 billion in trading assets and
liabilities in their business models and risk exposures, and that a $1
billion threshold appropriately accounts for the risks posed by Group B
and Group C entities; therefore, the agencies are not adopting this
alternative.
---------------------------------------------------------------------------

    \960\ See, e.g., ABA.
---------------------------------------------------------------------------

    An alternative of splitting banking entities into only two groups
according to their trading assets and liabilities--those with
significant trading assets and liabilities and those without, i.e.
joining the limited and moderate trading assets and liabilities groups
was also considered.\961\ This alternative could have reduced
compliance burdens for Group B entities if the threshold was set at $20
billion. But, if the threshold for this alternative would have been set
at $1 billion, the compliance burdens for Group B entities would have
been

[[Page 62061]]

higher than their compliance costs under the final rule. As shown in
Table 2, Group B broker-dealers represent approximately 16% of total
assets of bank-affiliated broker-dealers and approximately 16% of their
holdings, while Group C broker-dealers account for only 4% of total
assets of bank-affiliated broker-dealers and 2% of their holdings. The
SEC continues to believe that Groups B and C differ in their business
models (e.g., level of trading activity) and the risks posed to the
U.S. financial system. For these reasons, the agencies decided not to
adopt this alternative.
---------------------------------------------------------------------------

    \961\ This alternative approach was also suggested by some
commenters. See, e.g., Capital One et al.
---------------------------------------------------------------------------

    A percentage-based threshold for determining whether a banking
entity has significant trading assets and liabilities was also
considered. For example, the amendment could have relied exclusively on
a threshold where banking entities are considered to be entities with
significant trading assets and liabilities if the firm's total
consolidated trading assets and liabilities are above a certain
percentage (for example, 10% or 25%) of the firm's total consolidated
assets. Under this alternative, a greater number of entities could have
benefited from lower compliance costs and a streamlined regime for
Group B entities. In addition, as pointed out by a commenter, this
alternative could address risk for individual banking entities since it
would base the threshold on the materiality of trading activity to the
entity's business.\962\ However, under this approach, even firms in the
extreme right tail of the trading asset distribution could be
considered without significant trading assets and liabilities if they
are also in the extreme right tail of the total assets distribution.
Thus, without placing an additional limit on total assets within such
regime, entities with the largest trading books could have been scoped
into the Group B regime if they also had a sufficiently large amount of
total consolidated assets, while entities with significantly smaller
trading books could be categorized as Group A entities if they had
fewer assets overall. Thus, the SEC believes that this alternative
would not have appropriately accounted for the size of banking
entities' trading activity.
---------------------------------------------------------------------------

    \962\ See, e.g., KeyCorp.
---------------------------------------------------------------------------

    In addition, a threshold based on total assets could have been
adopted. It is possible that losses on small trading portfolios can be
amplified through their effect on non-trading assets held by a banking
entity. To that extent, a threshold based on total assets may be useful
in potentially capturing both direct and indirect losses that originate
from trading activity of a holding company.\963\ However, such
threshold may not be as meaningful as a threshold based on trading
assets and liabilities when applied in the context of section 13 of the
BHC Act. A threshold based on total assets would scope in entities
merely on the basis of their balance sheet size, even though they may
have little or no trading activity of the type that section 13 of the
BHC Act is intended to address. Therefore, the agencies decided against
this alternative.
---------------------------------------------------------------------------

    \963\ Some commenters supported this view. See, e.g., Data
Boiler.
---------------------------------------------------------------------------

    Thresholds based on the level of total revenues from permitted
trading activities could have been adopted. To the extent that revenues
could be a proxy for the structure of a banking entity's business and
the focus of its operations, this alternative may apply more stringent
compliance requirements to those entities that focus their business the
most on covered activities. However, revenues from trading activity
fluctuate over time, rising during economic booms and deteriorating
during crises and liquidity freezes. As a result, under the
alternative, a banking entity that is scoped into the regulatory regime
during normal times may be scoped out during a time of market stress
because of a decrease in the revenues from permitted activities. That
is, under such alternative, the weakest compliance regime may be
applied to banking entities with the largest trading books in times of
acute market stress, when the performance of trading desks is
deteriorating and the underlying requirements of the 2013 rule may be
the most valuable.
    Finally, the agencies could have excluded from the definition of
entities with significant trading assets and liabilities those entities
that may be affiliated with a firm with over $20 billion in
consolidated trading assets and liabilities but that are operated
separately and independently and are not consolidated with the parent
company that have total trading assets and liabilities (excluding
trading assets and liabilities involving obligations of or guaranteed
by the United States or any agency of the United States) under $20
billion. As shown in Table 8 below, the SEC estimates that there are 17
broker-dealers that have holdings of less than $20 billion and are
affiliated with bank holding companies that have trading assets and
liabilities in excess of $20 billion. The SEC does not have data on how
many of these 17 broker-dealers are operated separately and
independently and are not consolidated with affiliated entities with
significant trading assets and liabilities. However, the SEC notes
that, at a maximum, this alternative could decrease the scope of
application of the Group A regime for 17 broker-dealers.

   Table 8--Broker-Dealer Assets and Holdings, by Gross Trading Assets and Liabilities Threshold of Affiliated
                                                Banking Entities
----------------------------------------------------------------------------------------------------------------
                                                                                                     Holdings
              Type of broker-dealer                   Number       Total assets,  Holdings, $mln    (altern.),
                                                                       $mln                            $mln
----------------------------------------------------------------------------------------------------------------
Holdings >=$20bln and affiliated with firms with              19       2,225,989         594,513         514,360
 gross trading assets and liabilities >=$20bln..
Holdings <$20bln and affiliated with firms with               17         275,951          31,328          13,576
 gross trading assets and liabilities >=$20bln..
Affiliated with firms with gross trading assets              163         640,840         135,691          39,451
 and liabilities <$20bln \964\..................
                                                 ---------------------------------------------------------------
    Total.......................................             199       3,142,780         761,532         567,387
----------------------------------------------------------------------------------------------------------------

    Some commenters indicated that this alternative may be beneficial
for banking entities.\965\ The SEC recognizes that this alternative
would increase the number of entities able to avail themselves of the
reduced compliance, documentation, and metrics reporting requirements,
potentially resulting in cost reductions flowing through to

[[Page 62062]]

customers and counterparties. At the same time, this alternative would
permit more trading activities by entities affiliated with firms that
have gross trading assets and liabilities in excess of $20 billion. In
addition, it could encourage such firms to fragment their trading
activity, for instance, across multiple dealers, and operate them
separately and independently, thereby relieving such firms of the
requirement to comply with the hedging, compliance, and reporting
regime of the 2013 rule. This alternative may, therefore, reduce the
regulatory oversight and compliance benefits of the full hedging,
documentation, reporting, and compliance requirements for Group A
banking entities. The feasibility and costs of such fragmentation would
depend, in part, on the organizational complexity of a firm's trading
activity, the architecture of trading systems, the location and
skillsets of personnel across various dealers affiliated with such
entities, and current inter-affiliate hedging and risk mitigation
practices.
---------------------------------------------------------------------------

    \965\ See, e.g., JBA.
---------------------------------------------------------------------------

    Some commenters suggested that periodic adjustment to thresholds to
account for inflation should be adopted.\966\ This alternative would
account for changing market conditions in the absence of any changes in
a banking entity's business and level of trading activities. In an
environment with a moderate level of inflation, Group B and Group C
banking entities that are situated just below the thresholds may reduce
their level of activity to avoid triggering a more costly compliance
regime. However, the agencies do not believe that the additional
complexity associated with inflation-indexing the thresholds in the
final rule is necessary in light of the other changes to the thresholds
and calculation methodologies described above. Therefore, the agencies
decided against this alternative.
---------------------------------------------------------------------------

    \964\ This category excludes SEC-registered broker-dealers
affiliated with banks that have consolidated total assets less than
or equal to $10 billion and trading assets and liabilities less than
or equal to 5% of total assets, as well as firms for which bank
trading assets and liabilities data was not available.
    \966\ See, e.g., BPI and Capital One et al.
---------------------------------------------------------------------------

b. Proprietary Trading
    Under section 13 of the BHC act and the 2013 rule, proprietary
trading is defined as engaging as principal for the ``trading account''
of a banking entity.\967\ Thus, the definition of the trading account
determines the trading activity that falls within the scope of the
statutory prohibitions and the compliance regime in the 2013 rule
associated with such activity. The definition of trading account in the
2013 rule has three prongs, including the dealer prong. The final
amendments introduce certain changes to the definition of trading
account; however, these amendments do not remove or modify the dealer
prong. In addition, the amendments introduce new exclusions from the
trading account and a new definition of the trading desk.
---------------------------------------------------------------------------

    \967\ See 2013 rule Sec.  __.3(b).
---------------------------------------------------------------------------

i. Trading Account
(1) Costs and Benefits
    Under the final rule, the definition of ``trading account''
continues to include purchases and sales of financial instruments by
banking entities engaged in the business of a dealer, swap dealer, or
security-based swap dealer outside of the United States, to the extent
these instruments are purchased or sold in connection with the
activities of such business.\968\ Thus, the SEC expects that most (if
not substantially all) trading activity by SEC-regulated dealers that
are banking entities will continue to be captured by the dealer prong
of a banking entity, notwithstanding any of the changes made to the
definition of the trading account.
---------------------------------------------------------------------------

    \968\ See 2013 rule Sec.  __.3(b)(1)(iii).
---------------------------------------------------------------------------

    Some commenters pointed out that not all of dealers' trading
activity is conducted in a dealer capacity.\969\ The SEC recognizes the
possibility that some dealers engage in transaction activity that, by
itself, would not trigger a dealer registration requirement.\970\ Under
the baseline, such activity may be scoped into the ``trading account''
definition by the short-term prong or the market risk capital prong.
Thus, as discussed below, the SEC believes that only a small subset of
trading activity by dealers may be affected by the changes to the
definition of the trading account.
---------------------------------------------------------------------------

    \969\ See, e.g., SIFMA and BPI.
    \970\ See 79 FR at 5549 (``The Agencies believe the scope of the
dealer prong is appropriate because, as noted in the proposal,
positions held by a registered dealer in connection with its dealing
activity are generally held for sale to customers upon request or
otherwise support the firm's trading activities (e.g., by hedging
its dealing positions), which is indicative of short term
intent.'').
---------------------------------------------------------------------------

    The agencies are adopting three changes to the definition of the
trading account. First, the applicability of the short-term prong and
the market risk capital prong is changed under the final rule. In
particular, for dealers that are subject to the market risk capital
prong, trading activity outside of the dealer prong will be scoped into
the trading account only if it is a covered position for the purposes
of the market risk capital rule. That is, if the activity is not
captured by the dealer prong or the market risk capital prong, it would
be scoped out from the definition of the trading account under the
final rule. This is in contrast to the 2013 rule, under which, for
banking entities that are subject to the market risk capital prong,
trading activity that is not captured by the dealer prong or the market
risk capital prong could still be captured by the short-term
prong.\971\ Thus, under the 2013 rule, bank dealers that are subject to
the market risk capital prong have to apply three prongs: The dealer
prong, the market risk capital prong, and the short-term prong. Under
the final rule, these same entities will apply only two prongs: The
dealer prong and the market-risk capital prong. To the extent that
dealers subject to the market risk capital prong have trading
activities that are not captured by the dealer prong currently
experience organizational inefficiencies or duplicative costs as a
result of being subject to both short-term and market risk capital
prongs, this amendment may benefit such dealers by decreasing their
compliance costs, as discussed in section V.F.3.g, and decreasing the
regulatory complexity, consequently increasing operational efficiency.
The SEC expects that these benefits are likely to be greater for
banking entities that are not subject to the dealer prong, although, as
noted above, the SEC does not analyze those potential benefits here.
---------------------------------------------------------------------------

    \971\ As noted in section IV.B.1.a.iii, the scope of activities
captured by the short-term intent prong substantially overlaps with
the scope of activities captured by the market risk capital prong.
---------------------------------------------------------------------------

    In addition, to the extent that the definition of trading account
in the 2013 rule involves position-by-position analysis of financial
instruments which may be costly, and to the extent that the costs of
such analysis discourage dealers that are subject to the market risk
capital prong from conducting activities that could be scoped in by the
short-term intent prong, this amendment may promote trading activities
that would not be captured by the dealer prong or the market risk
capital prong. On the one hand, such trading activities may allow
dealers that are subject to the market risk capital rule to manage
their business more efficiently. On the other hand, to the extent that,
under the final rule, trading activity that is not captured by either
the dealer prong or the market risk capital prong would have been
captured by the short-term intent prong, and to the extent that this
activity exposes dealers to additional risks, this amendment may
increase risk exposure of dealers that are subject to the market risk
capital rule. The SEC does not have information about the amount of
trading activity of SEC-registered broker-dealers

[[Page 62063]]

that is not captured by the dealer prong or the market risk capital
prong and about the prevalence of the current application of the market
risk capital prong and the short-term prong under the 2013 rule. As
shown in Table 9 below, the SEC estimates that there are 100 broker-
dealers that in aggregate hold between 98% and 99% of holdings by
broker-dealers affected by the final rule that are subject to the
market risk capital rule and may be affected by this amendment. The SEC
continues to believe that the largest share of dealers' trading
activity will continue to be captured by the dealer prong. Thus, the
SEC expects that the effects of this amendment on SEC-regulated dealers
will be modest.

                                  Table 9--Market Risk Capital Rule Application
----------------------------------------------------------------------------------------------------------------
                                                     Number of     Total assets,                     Holdings
      Market risk capital rule application        broker-dealers       $mln          Holdings        (altern.)
----------------------------------------------------------------------------------------------------------------
Subject to the market risk capital rule.........             100       3,002,834         749,867         562,515
Not subject to the market risk capital rule.....              99         139,946          11,665           4,872
                                                 ---------------------------------------------------------------
    Total.......................................             199       3,142,780         761,532         567,387
----------------------------------------------------------------------------------------------------------------

    The second change to the definition of trading account affects
banking entities that are not subject to the market risk capital rule
and cannot apply the market risk capital prong under the 2013 rule.
Under the final rule, these entities will be able to elect to apply the
market risk capital prong instead of the short-term prong to determine
the scope of the banking entity's trading account. This amendment will
affect those dealers that have trading activity that is not captured by
the dealer prong and instead captured by the short-term prong. To the
extent that the market risk capital prong is less costly to comply
with, relative to the short-term prong, this amendment may benefit
dealers that are not subject to the market risk capital rule and have
trading activity that is not captured by the dealer prong by providing
them with flexibility to apply the prong that is more cost-effective.
This amendment may particularly benefit foreign banking entities that
are not subject to the market risk capital rule but are applying a
different market risk framework, to the extent that this framework is
similar to the market risk capital rule. To the extent that foreign
dealers with frameworks similar to the framework of the market risk
capital rule are currently experiencing inefficiencies because they
cannot apply the market risk capital prong of the trading account
definition, this amendment may reduce the compliance costs of these
dealers. The SEC estimates that, at most, 99 broker-dealers that are
not subject to the market risk capital rule may be affected by this
amendment, to the extent that they have trading activity that is
captured by the short-term prong under the 2013 rule. However, the SEC
continues to believe that the largest share of dealers' trading
activity will continue to be captured by the dealer prong. Thus, the
SEC expects that the effects of this amendment for dealers will be
modest.
    The third amendment to the trading account definition will
eliminate the 60-day rebuttable presumption in the short-term prong and
instead establish a new rebuttable presumption that financial
instruments held for 60 days or more are not within the short-term
prong. Many commenters supported the proposed rule's elimination of the
60-day rebuttable presumption,\972\ and some commenters suggested that
the agencies should presume, for banking entities not subject to the
market risk capital rule, that financial instruments held for longer
than 60 days, or that have an original maturity or remaining maturity
upon acquisition, of fewer than 60 days to their stated maturities, are
not for the banking entity's trading account.\973\ As recognized in
section IV.B.1.a.iv, the agencies have found that the rebuttable
presumption has captured many activities that should not be included in
the definition of proprietary trading. In addition, as stated by some
commenters, the presumption may be difficult to rebut.\974\ Therefore,
the SEC believes that the reversal of the presumption in the 2013 rule
would reduce the compliance burdens for dealers that conduct trading
activity that is not otherwise captured by the dealer prong or the
market risk capital prong. To the extent that the compliance burdens
related to the rebuttable presumption of the 2013 rule limit dealers'
ability to conduct customer-accommodating transactions or liquidity
management activities, the cost reductions of the amendment may flow
through to customers and counterparties and increase operational
efficiency of dealers. The SEC estimates that this amendment may affect
99 broker-dealers--the broker-dealers that are not subject to the
market risk capital rule--which on aggregate have 1.5% of broker-dealer
holdings. However, the SEC expects that the largest share of dealing
activity subject to SEC oversight will continue to be captured by the
dealer prong. Thus, the SEC expects that the effects of this amendment
for dealers will be modest.
---------------------------------------------------------------------------

    \972\ See, e.g., State Street; Chatham; BPI; FSF; CCMR and CFA.
    \973\ See, e.g., ABA; Arvest; BPI; SIFMA and IIB.
    \974\ See, e.g., State Street; Chatham; BPI; FSF; CCMR and CFA.
---------------------------------------------------------------------------

(2) Efficiency, Competition, and Capital Formation
    To the extent that the compliance related to the rebuttable
presumption of the 2013 rule limits dealers' ability to conduct
customer-accommodating transactions, or liquidity management or risk
management activities that are covered by the short-term prong, the
amendments to the definition of trading account may facilitate such
activities, which could, in turn, promote capital formation. In
addition, to the degree that the amendments to the trading account may
provide banking entities with more flexibility to underwrite, market
make, and hedge, and to the extent these activities facilitate capital
formation, these amendments may improve allocative efficiency. To the
extent that the amendments to the short-term prong reduce compliance
costs and to the extent that the short-term prong primarily applies to
smaller dealers (i.e., those not covered by the market risk capital
prong), the amendments to the trading account definition may improve
the competitive position of smaller dealers. However, the SEC notes
that the largest share of dealing activity subject to SEC oversight is
already captured by the dealer prong; and, therefore, the above
economic effects of the amendments to the definition of the trading
account on SEC-regulated entities, including the effects on efficiency,
competition, and capital formation, may be de minimis.

[[Page 62064]]

(3) Alternatives
    As an alternative to the short-term prong, the agencies proposed
replacing the short-term prong in the 2013 rule with an accounting
prong that would have included within the definition of ``trading
account'' any account used by a banking entity to purchase or sell one
or more financial instruments that are recorded at fair value on a
recurring basis under applicable accounting standards.\975\ As the
agencies noted when they proposed this alternative, the accounting
prong was designed to provide more certainty and clarity about which
financial instruments should be included in the trading account due to
the fact that banking entities should know which positions are recorded
at fair value on their balance sheets.\976\ In addition, as pointed out
by some commenters,\977\ this alternative could deter noncompliance and
facilitate the agencies' supervision. However, a large number of
commenters stated that the proposed accounting prong would
inadvertently scope in activities that are not 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. For example,
some commenters pointed out that longer term positions, such as
available-for-sale debt securities,\978\ certain long-term
investments,\979\ static hedging of long term investments,\980\
traditional asset-liability management activities,\981\ derivative
transactions entered into for any purpose and duration,\982\ long-term
holdings of commercial mortgage-backed securities; \983\ would be
scoped in under this alternative. Although some of these instruments
are held for less than 60 days and may fall under the short-term prong
of the trading account under the 2013 rule, these instruments, in
general, are not held for trading purposes, i.e., they are not held
principally for the purpose of selling in the near term; rather, the
majority of the aforementioned instruments are held for
investment.\984\ Since this alternative would include all instruments
reported at fair value, regardless of the purpose with which these
instruments are bought or sold and regardless of the period during
which these instruments are held (short-term or long-term), the scope
of the trading account would be significantly greater under this
alternative than the scope of the trading account in the 2013 rule.
Given that many of the instruments that would be captured by the
accounting prong are not held principally for the purpose of selling in
the near term, the agencies are not adopting this alternative. The SEC
also notes that if this alternative had been adopted, the effect on
SEC-regulated dealers would have been limited because the majority of
dealer trading activity falls under the dealer prong.
---------------------------------------------------------------------------

    \975\ See proposed rule Sec.  __.3(b)(3); 83 FR at 33447-48.
    \976\ See id.
    \977\ See, e.g., Better Markets.
    \978\ See, e.g., BPI and SIFMA.
    \979\ See, e.g., Capital One et al.; BPI; SIFMA; and CCMR.
    \980\ See, e.g., BPI and ISDA.
    \981\ See, e.g., KeyCorp; BPI; Capital One et al.; FSF and
Goldman Sachs.
    \982\ See e.g., ISDA and BPI.
    \983\ See MBA.
    \984\ See, e.g., FASB defines available-for-sale securities as
investments that are not classified as trading securities nor as
held-to-maturity securities and states that cash flows from these
investments should be classified as cash flows from investing
activities. See ``Statement of Financial Accounting Standards No.
115'', FASB.
---------------------------------------------------------------------------

    The agencies also proposed, but are not adopting, including a
reservation of authority allowing for a determination, on a case-by-
case basis, with appropriate notice and response procedures, that any
purchase or sale of one or more financial instruments by a banking
entity for which it is the primary financial regulatory agency either
is or is not for the trading account. While the SEC continues to
recognize that the use of objective factors to define proprietary
trading is intended to provide bright lines that simplify compliance,
the SEC also recognizes that this approach may, in some circumstances,
produce results that are either underinclusive or overinclusive with
respect to the definition of proprietary trading. The SEC continues to
believe that the reservation of authority may add uncertainty for
banking entities about whether a particular transaction could be deemed
as a proprietary trade by the regulatory agency, which may affect the
banking entity's decision to engage in transactions that are not
included in the definition of the trading account under the 2013 rule.
As discussed in the proposal, notice and response procedures related to
the reservation of authority provision would cost as much as $19,877
for SEC-registered broker-dealers, and $5,006 for entities that may
choose to register with the SEC as SBSDs.\985\
---------------------------------------------------------------------------

    \985\ See 83 FR 33432.
---------------------------------------------------------------------------

    The agencies proposed but are not adopting the revision of the
market risk capital prong to apply to the activities of FBOs to take
into account the different market risk frameworks FBOs may have in
their home countries.\986\ This alternative may better align foreign
banking entities' compliance with the 2013 rule and compliance with
market risk regulations of their home counties, increasing
organizational efficiency and potentially decreasing compliance costs
for such banking entities. However, as suggested by some commenters,
under this alternative, positions that are not held for short-term
trading would be captured in some foreign market risk capital
frameworks.\987\ Therefore, the agencies decided against this
alternative and instead are adopting a more flexible approach, under
which foreign banking entities would be able to apply the market risk
capital prong if they choose to do so.\988\
---------------------------------------------------------------------------

    \986\ See proposed rule Sec.  __. 3(b)(1)(ii); 83 FR at 33447.
    \987\ See, e.g., IIB.
    \988\ See section IV.B.1.a.v.
---------------------------------------------------------------------------

    As an alternative, the agencies could have modified the dealer
prong of the trading account definition to include only near-term
trading, e.g., positions held for less than 60, 90, or 120 days. This
alternative would likely narrow the scope of application of the
substantive proprietary trading prohibitions to a smaller portion of a
banking entity's activities. Under this alternative, bank-affiliated
dealers would be able to amass large trading positions at the near-term
definition boundary (e.g., for 61, 91, or 121 days) to take advantage
of a directional market view, to profit from mispricing in an
instrument, or to collect a liquidity premium in a particular
instrument. This may significantly increase the risk exposure of bank-
affiliated dealers. However, as this alternative could stimulate an
increase in potentially impermissible proprietary trading by these
dealers, the volume of trading activity in certain instruments and
liquidity in certain markets may increase. The SEC also notes that the
temporal thresholds necessary to implement such a short-term trading
alternative would be difficult to quantify and may have to vary by
product, asset class, and aggregate market conditions, among other
factors. For instance, the markets for large cap equities and
investment grade corporate bonds have different structures, types of
participants, latency of trading, and liquidity levels. Therefore, an
appropriate horizon for short-term positions will likely vary across
these markets. Similarly, the ability to transact quickly differs under
strong macroeconomic conditions and in times of stress. A meaningful
implementation of this alternative would likely require calibrating and

[[Page 62065]]

recalibrating complex thresholds to exempt non-near-term proprietary
trading and so could introduce additional uncertainty and increase the
compliance burdens on SEC-regulated banking entities.
    As another alternative, the agencies could have categorically
excluded financial instruments of dealers purchased in a non-dealing
capacity, such as financial instruments purchased for long-term
investment purposes. Some commenters pointed out that it is not always
clear whether such instruments are scoped in the dealer prong and that
banking entities may engage in costly and time-consuming position-by-
position analysis to confirm that a long-term investment is captured in
the trading account.\989\ As discussed in section IV.B.1.a.vi, the
agencies continue to believe that only the activities that are done in
connection with activities that would require the banking entity to be
licensed or registered are covered by the dealer prong. For example, if
a banking entity purchases or sells a financial instrument in
connection with activities that do not require registration as a
dealer, this activity would not be covered by the dealer prong.
However, this activity could still be included in the trading account
under the short-term prong or the market risk capital prong, as
applicable.\990\
---------------------------------------------------------------------------

    \989\ See, e.g., SIFMA and BPI.
    \990\ See 79 FR 5549.
---------------------------------------------------------------------------

ii. Exclusions From Proprietary Trading
    The agencies are adopting the proposed expansion of the liquidity
management exclusion, as well as an exclusion for trading errors and
subsequent correcting transactions, certain matched derivative
transactions, certain trades related to hedging mortgage servicing
rights or mortgage servicing assets, and transactions in instruments
not included in the definition of trading asset or trading liability
under the applicable reporting form for a banking entity.
(1) Costs and Benefits
Exclusion for Liquidity Management Activities
    The agencies are adopting the proposed expansion of the liquidity
management exclusion substantially as proposed, but with a modification
to permit the use of non-deliverable cross-currency swaps. Thus,
liquidity management exclusion would apply not only to securities, but
also to foreign exchange forwards and foreign exchange swaps (each as
defined in the Commodity Exchange Act), and to cross-currency swaps
(both physically- and cash-settled) that are traded for the purpose of
liquidity management in accordance with a documented liquidity
management plan. On the one hand, under this amendment, SEC-regulated
banking entities would face lower burdens and enjoy greater flexibility
in currency-risk management as part of their overall liquidity
management plans. In the proposal, the SEC recognized that the
liquidity management exclusion in the 2013 rule may be narrow and that
the trading account definition may scope in routine asset-liability
management and commercial-banking related activities. In their response
to the proposal, some commenters supported that view and stated that
the 2013 rule may be restricting liquidity-risk management by banking
entities.\991\ Therefore, the SEC continues to believe that, to the
degree that these effects constrain activities of dealers, this
amendment could facilitate more efficient risk management, greater
secondary market activity, and more capital formation in primary
markets.
---------------------------------------------------------------------------

    \991\ See, e.g., ISDA; Goldman Sachs and SIFMA.
---------------------------------------------------------------------------

    Some commenters indicated that this amendment may make it easier to
trade in currency markets for speculative purposes under the guise of
legitimate liquidity management.\992\ The SEC continues to recognize
that this liquidity-management amendment may lead to currency
derivatives exposures, including potentially very large exposures,
being scoped out of the trading account definition and the ensuing
substantive prohibitions of the 2013 rule, which may increase the risk
exposures of banking entities and reduce the effectiveness of
regulatory oversight. However, the SEC continues to believe that the
conditions maintained in the exemption, including the requirement to
conduct liquidity management in accordance with a documented liquidity
management plan, will limit these adverse effects.
---------------------------------------------------------------------------

    \992\ See Volcker Alliance and Data Boiler.
---------------------------------------------------------------------------

Exclusion for Error Trades
    The agencies are also adopting an exclusion for trading errors and
subsequent correcting transactions from the definition of proprietary
trading. The 2013 rule excludes from the proprietary trading
prohibition certain excluded clearing activities by banking entities
that are members of clearing agencies, derivatives clearing
organizations, or designated financial market utilities. Specifically,
such excluded clearing activities are defined to include, among others,
any purchase or sale necessary to correct error trades made by, or on
behalf of, customers with respect to customer transactions that are
cleared, provided the purchase or sale is conducted in accordance with
certain regulations, rules, or procedures.\993\ Accordingly, the
exclusion for error trades under the 2013 rule is applicable only to
clearing members with respect to cleared customer transactions.\994\
---------------------------------------------------------------------------

    \993\ See 2013 rule Sec.  __.3(e)(7).
    \994\ Id.

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

[[Page 62066]]

    This amendment primarily benefits dealers that are not clearing
members with respect to all customer trades and dealers that are
clearing members with respect to customer trades that are not cleared,
since under the 2013 rule error trades of these dealers are not
considered excluded clearing activity. Table 10 reports information
about broker-dealer count, assets, and holdings, by affiliation and
clearing type.

                      Table 10--Broker-Dealer Assets and Holdings, By Clearing Status \995\
----------------------------------------------------------------------------------------------------------------
                                                                                                     Holdings
 Broker-dealers subject to section 13 of the BHC      Number       Total assets,  Holdings, $mln    (altern.),
                       Act                                             $mln                            $mln
----------------------------------------------------------------------------------------------------------------
Clear or carry (or both)........................              76       3,101,936         755,975         562,649
Other...........................................             123          40,844           5,557           4,738
                                                 ---------------------------------------------------------------
    Total.......................................             199       3,142,780         761,532         567,387
----------------------------------------------------------------------------------------------------------------

    Since correcting error trades is not conducted for the purpose of
profiting from short-term price movements, as also pointed out by some
commenters,\996\ this amendment is likely to facilitate valuable
customer-facing activities and promote effective risk management by
dealers. As discussed in section IV.B.1.b.ii, the agencies continue to
believe that banking entities generally should monitor and manage their
error trade account because doing so would help prevent personnel from
using these accounts for proprietary trading. Some commenters stated
that banking entities could still make profits while relying on the
error trade exclusion.\997\ To the degree that this may happen, banking
entities could become incentivized to use error trade exclusion to
conduct proprietary trading. However, some commenters noted that bona
fide trade error activity is separately managed and classified as an
operational loss when there is a loss event or a near miss when error
activity results in a gain.\998\ The SEC agrees with the commenters'
view and believes that existing requirements and operational risk
management practices would be sufficient to deter participants from
using the error trade exclusion to obfuscate impermissible proprietary
trades.
---------------------------------------------------------------------------

    \995\ Broker-dealers clearing or carrying customer accounts (or
both) are identified using FOCUS filings. Broadly, broker-dealers
that are clearing or carrying firms directly carry customer
accounts, maintain custody of the assets, and clear trades. Other
broker-dealers may accept customer orders but do not maintain
custody of assets. This analysis excludes SEC-registered broker-
dealers affiliated with banks that have consolidated total assets
less than or equal to $10 billion and trading assets and liabilities
less than or equal to 5% of total assets, as well as firms for which
bank trading assets and liabilities data was not available.
    \996\ See, e.g., BPI; FSF and BB&T.
    \997\ See, e.g., Data Boiler; CAP and Public Citizen.
    \998\ See, e.g., ABA; BB&T; BPI and Capital One et al.
---------------------------------------------------------------------------

Exclusion for Customer-Driven Swaps and Customer-Driven Security-Based
Swaps
    In addition, the agencies are adopting an exclusion for
transactions in which banking entities contemporaneously enter into a
customer-driven swap or security-based swap and a matched swap or
security-based swap if (i) the banking entity retains no more than
minimal price risk; and (ii) the banking entity is not a registered
dealer, swap dealer, or security-based swap dealer. The SEC continues
to recognize that loan-related swaps and customer accommodation back-
to-back derivatives facilitate lending transactions as a customer
service and are not designed to profit from speculative price
movements.\999\ Some commenters indicated that such customer
accommodation loan-related swaps transactions may reduce the risk of
banking entities and borrowers, and encourage the extension of credit,
commonly for smaller and medium-size banking entities that engage in
trading in connection with loans and other extensions of customer
credit. Some commenters stated that this amendment increases the scope
of permissible trading activity. The SEC notes that under the final
rule this exclusion is not available to banking entities that are
subject to the market risk or the dealer prong, reducing such risks.
Therefore, the SEC believes that the effects of this amendment
discussed above on SEC-regulated entities would be de minimis.
---------------------------------------------------------------------------

    \999\ Commenters agreed with this view. See, e.g., Covington;
Credit Suisse; SIFMA; Chatham and ABA.
---------------------------------------------------------------------------

Exclusion for Hedges of Mortgage Servicing Rights or Mortgage Servicing
Assets
    The agencies are adopting an exclusion for transactions involving
any purchase or sale of one or more financial instrument that the
banking entity uses to hedge mortgage servicing rights or mortgage
servicing assets in accordance with a documented hedging strategy. This
amendment will provide more clarity to banking entities that are
subject to the short-term prong that intangibles, including servicing
assets, are not included in the definition of proprietary trading.
Because under the market risk capital prong, intangibles, including
servicing assets, are explicitly excluded from the definition of
``covered position,'' the exclusion will provide additional certainty
to dealers that do not apply the market risk capital prong. To the
extent that dealers that do not apply the market risk capital prong
currently experience uncertainty as to whether the aforementioned
financial instruments are included in the trading account and to the
extent that this uncertainty impedes transactions involving these types
of financial instruments, the amendment may facilitate permitted
trading activity in these financial instruments. In addition, to the
extent that these exclusions facilitate more efficient risk management,
dealers that are not subject to the market risk capital rule may
benefit from this amendment.\1000\
---------------------------------------------------------------------------

    \1000\ The SEC estimates that there are 99 SEC-registered
broker-dealers that are not subject to the market risk capital rule,
which on aggregate hold approximately 1.5% of broker-dealer
holdings.
---------------------------------------------------------------------------

Exclusion for Financial Instruments That Are Not Trading Assets or
Trading Liabilities
    In addition to the above exclusions, the agencies are adopting an
exclusion for purchases or sales of financial instruments that do not
meet the definition of trading assets or trading liabilities under the
applicable reporting form for a banking entity as of January 1, 2020.
Similar to the exclusion for hedges of mortgage servicing rights or
assets, this exclusion is intended to clarify the scope of the
prohibition on proprietary trading and to provide parity between
banking entities that apply the market risk capital prong and banking
entities that apply the short-

[[Page 62067]]

term intent prong by scoping out of the rule positions that would not
be captured by the market risk capital prong. In addition, this
amendment will exclude financial instruments purchased by a dealer in
its dealing capacity that are not trading assets or liabilities.
Therefore, the SEC believes that this amendment will benefit dealers,
to the extent that the 2013 rule's dealer prong is overinclusive
because it scopes in financial instruments acquired in dealer capacity,
regardless of their purpose (i.e. both for trading and non-trading
purposes). To the extent that this aspect of the 2013 rule leads to
inefficiencies or increases costs at the dealer level, the SEC expects
that the final rule will promote dealers' organizational efficiency by
narrowing the scope of the dealer prong to financial instruments that
are considered trading assets and liabilities.
    To the extent that some financial instruments that are not trading
assets or liabilities are currently scoped-into the rule by the short-
term prong due to the fact that they are held for less than 60 days,
this amendment may decrease the scope of the trading account. For
example, some fair value financial instruments that are not trading
assets or liabilities, such as available-for-sale securities or
derivatives not reported as trading, may be held for less than 60 days
and therefore be presumed to be for the trading account under the 2013
rule. However, under the 2013 rule, banking entities could rebut this
presumption by demonstrating that such instruments are not purchased or
sold principally for the purpose of selling in the near term.\1001\ In
addition, the SEC notes that dealers, in general, hold primarily
trading assets and trading liabilities due to the nature of their
business. The SEC does not have data or information about what fraction
of dealers' financial instruments that are not defined as trading
assets or liabilities under the applicable banking agency reporting
forms is currently being scoped-into the trading account by the short-
term prong in the 2013 rule. This is because only non-trading fair
value instruments held for fewer than 60 days are likely to be scoped
into the trading account via the short-term prong under the 2013 rule,
rather than all such financial instruments, and the data disaggregated
by maturity of non-trading fair value instruments is not available.
However, the SEC reiterates that only a small subset of trading
activity by dealers may be affected by this exclusion, as majority of
financial instruments purchased or sold by dealers are trading assets
and liabilities. For this reason and the reasons discussed above, the
SEC expects that this amendment will not substantially affect the scope
of the trading account for banking entities that are dealers.
---------------------------------------------------------------------------

    \1001\ As discussed above, the final rule eliminates the 60-day
rebuttable presumption in the short-term prong and instead
establishes a new rebuttable presumption that financial instruments
held for 60 days or more are not within the short-term prong.
---------------------------------------------------------------------------

(2) Efficiency, Competition, and Capital Formation
    To the degree that the 2013 rule may be restricting liquidity-risk
management by banking entities, and to the extent that this affects
their trading activity, the liquidity management amendment could
facilitate more efficient risk management, greater secondary market
activity, and more capital formation in primary markets. Similarly, to
the extent that corrections for bona-fide errors and exclusions for
customer-driven swaps and customer-driven security-based swaps and
transactions related to mortgage servicing rights facilitate customer-
driven transactions and increase banking entities' willingness to
conduct such transactions, these exclusions could facilitate more
efficient risk management and promote capital formation and secondary
market activity. In addition, to the degree that the exclusions from
proprietary trading may provide banking entities with more flexibility
to manage risks, and to the extent these activities facilitate capital
formation, these amendments may improve allocative efficiency.
    To the extent that these amendments may increase the ability of
dealers that are banking entities to hedge risks related to customer
transactions, the competitive position of dealers that are banking
entities may improve relative to nonbanking dealers. In addition, to
the extent that these amendments reduce compliance costs of dealers
that are banking entities and to the extent that these compliance costs
are currently passed onto customers and counterparties, the reduction
in costs related to the exclusions from proprietary trading may result
in more competitive prices set by dealers that are banking entities,
improving their competitive position further.
(3) Alternatives
    The agencies could have taken the approach of expanding the
liquidity management exclusion to exclude additional trading
activities. For example, the agencies could exclude transactions in
other derivatives, such as derivatives related to government
securities, derivatives on foreign sovereign debt,\1002\ instruments
that qualify for certain treatment under the liquidity coverage ratio
or section 165 of the Dodd-Frank Act, or transactions executed by SEC-
registered dealers on behalf of their asset management customers.\1003\
---------------------------------------------------------------------------

    \1002\ Some commenters indicated that all derivatives should be
excluded in the liquidity management exclusion. See, e.g., FSF;
Capital One et al.; IIB and JBA.
    \1003\ See, e.g., Capital One et al. and ABA.
---------------------------------------------------------------------------

    The 2013 rule exempts all trading in domestic government
obligations and trading in foreign government obligations under certain
conditions; however, derivatives referencing such obligations that are
intended to manage risks--including derivatives portfolios that can
replicate the payoffs and risks of such government obligations--are not
excluded from the trading account. Therefore, existing requirements
reduce the flexibility of banking entities to engage in asset-liability
management and result in a different treatment of two groups of
financial instruments that have similar risks and payoffs. Excluding
derivatives transactions on government obligations from the trading
account definition could reduce costs to market participants and
provide greater flexibility in their asset-liability management. This
alternative could also result in increased volume of trading in markets
for derivatives on government obligations, such as Treasury futures.
The SEC recognizes, nonetheless, that derivatives portfolios that
reference an obligation, including Treasuries, can be structured to
magnify the economic exposure to fluctuations in the price of the
reference obligation. Moreover, derivatives transactions involve
counterparty credit risk not present in transactions in reference
obligations themselves. Since the alternative would exclude all
derivatives transactions on government obligations, and not just those
that are intended to mitigate risk, this alternative could permit
banking entities to increase their exposure to counterparty, interest
rate, and liquidity risk. For the reasons discussed in section
IV.B.1.i, the agencies decided not to expand the liquidity management
exclusion further.
    The agencies also considered mandating the use of a separately-
managed trade error account for the purposes of this amendment. This
alternative could deter banking entities from using the error trade
exclusion to obfuscate impermissible proprietary trades. However, as
indicated by the commenters, this approach may result in duplicative
systems and additional

[[Page 62068]]

compliance costs.\1004\ The agencies agree with these commenters and,
therefore, are not adopting this alternative.
---------------------------------------------------------------------------

    \1004\ See, e.g., ABA; Credit Suisse; JBA and SIFMA.
---------------------------------------------------------------------------

iii. Trading Desk Definition
    The final rule adopts a multi-factor definition of the trading desk
that is substantially similar to the definition included in the request
for comment in the proposal, except that the reference to incentive
compensation has been removed from the first prong. The definition of
trading desk includes a new second prong that aligns the definition
with the market risk capital rule. Specifically, for a banking entity
that is subject to the market risk capital rule, the trading desk
established for purposes of the market risk capital rule must be the
same unit of organization that is established as a trading desk for
purposes of the regulations implementing section 13 of the BHC Act.
(1) Costs and Benefits
    The SEC continues to recognize that the definition of trading desk
is an important component of the implementation of the 2013 rule in
that certain requirements, such as those applicable to the underwriting
and market making exemptions, and the metrics-reporting requirements,
apply at the trading desk level of organization. Under the 2013 rule, a
trading desk is defined as the smallest discrete unit of organization
of a banking entity that purchases or sells financial instruments for
the trading account of the banking entity or an affiliate thereof. Some
commenters asserted that the smallest discrete unit language of the
2013 rule was subjective, ambiguous, or could be interpreted in
different ways.\1005\ Thus, the SEC continues to believe that SEC-
regulated banking entities may currently experience substantial
compliance costs related to the trading desk designation for the
purposes of compliance with section 13 of the BHC Act. Accordingly, the
SEC believes that the adopted definition of the trading desk may
provide more certainty to SEC-regulated banking entities regarding
trading desk designations and will reduce their compliance burdens, as
the multi-factor definition better aligns with other operational,
management, and compliance purposes,\1006\ which typically depend on
the type of trading activity, asset class, product line offered, and
individual banking entity's structure. Among the metrics submissions
from 18 entities received by the SEC, the SEC estimates that the
average number of desks reported per entity is approximately 51.\1007\
To the extent that the trading desk designations under the final rule
will be less granular than those under the 2013 rule, and to the extent
that establishing a large number of desks is more costly, this
amendment will reduce compliance costs for dealers that are banking
entities.
---------------------------------------------------------------------------

    \1005\ See, e.g., ABA and CCMC.
    \1006\ This was also supported by commenters. See, e.g., ABA;
JBA; FSF; Goldman; ISDA; SIFMA and CCMC.
    \1007\ See section V.0.
---------------------------------------------------------------------------

    As seen in Table 9, the SEC estimates that 100 broker-dealers with
between 98% and 99% of holdings are currently subject to the market
risk capital rule and would be able to align their trading desks for
the purposes of the Volcker Rule and the market risk capital rule. The
SEC continues to believe that such alignment will reduce organizational
complexity, consequently reducing compliance burdens for these banking
entities.\1008\ The SEC also estimates that 99 broker-dealers are not
currently subject to the market risk capital rule--these broker-dealers
will be able to establish trading desks on the basis of the multi-
factor definition. To the extent that the current operational,
management, or compliance structure of these entities may not perfectly
align with the adopted multi-factor definition of the trading desk,
these entities may experience one-time setup costs related to the
reorganization of trading activity in order to satisfy the multi-factor
definition. The SEC does not have information or data about the costs
of this reorganization. However, the SEC believes that these
reorganization costs will be offset by a reduction in ongoing
compliance costs, which will be reduced as a result of the amended
definition of the trading desk for dealers that are not subject to the
market risk capital rule, to the extent that the trading desk
designations under the final rule will be less granular than those
under the 2013 rule and will better align with criteria used to
establish trading desks for operational and management purposes.
---------------------------------------------------------------------------

    \1008\ See id.
---------------------------------------------------------------------------

(2) Efficiency, Competition, and Capital Formation
    To the extent that the reduction in compliance costs stemming from
this amendment facilitates permitted trading activity by banking
entities, capital formation may increase. To the extent that the
reduced compliance costs stemming from this amendment flow through to
customers and counterparties, bank-affiliated dealers may become more
competitive with nonbanking dealers. The amendment to the definition of
the trading desk does not change the information available to market
participants, and the SEC does not believe that these amendments are
likely to have an effect on informational efficiency. To the degree
that this amendment facilitates capital formation, allocative
efficiency may improve.
(3) Alternatives
    The agencies could have adopted an amendment that would allow
trading desks to be set completely at the discretion of banking
entities.\1009\ This would provide banking entities greater flexibility
in determining their own optimal organizational structure and allow
banking entities organized with various degrees of complexity to
reflect their organizational structure in the trading desk definition.
This alternative could reduce operational costs from fragmentation of
trading activity and compliance program requirements, as well as enable
more streamlined metrics reporting. However, under this alternative, a
banking entity may be able to aggregate impermissible proprietary
trading with permissible activity (e.g., underwriting, market making,
or hedging) into the same trading desk and consequently take
speculative positions under the guise of permitted activities. To the
extent that this alternative would allow banking entities to use a
highly aggregated definition of a trading desk, it may increase risk
exposures of banking entities and the conflicts of interest that the
prohibitions of section 13 of the BHC Act aimed to address.\1010\ The
SEC does not have data on operating and compliance costs that arise
because of the fragmentation of trading activity by SEC-regulated
banking entities, or data on their organizational complexity, and the
extent of variation therein. For the reasons discussed in section
IV.B.1.c, the agencies are not adopting this definition.
---------------------------------------------------------------------------

    \1009\ This alternative was also suggested by a commenter. See
JBA.
    \1010\ See, e.g., Volcker Alliance.
---------------------------------------------------------------------------

c. Permitted Underwriting and Market Making
    Underwriting and market making are customer-oriented financial
services that are essential to capital formation and market liquidity,
and the risks and profit sources related to these activities are
distinct from those related to impermissible proprietary trading.
Moreover, as discussed above, market liquidity can be important to
investors

[[Page 62069]]

as it may enable investors to exit (in a timely manner and at an
acceptable price) from their positions in instruments, products, and
portfolios. At the same time, excessive risk exposure by banking
entities can, of course, adversely affect markets and, therefore,
investors.
    Under the final rule, banking entities with covered activities are
presumed compliant with the RENTD requirements of the exemption for
underwriting and market making-related activities if the banking entity
establishes and implements, maintains, and enforces certain internal
limits that are designed not to exceed RENTD, taking into account the
liquidity, maturity, and depth of the market for the relevant type of
security or financial instrument. These internal limits are subject to
supervisory review and oversight on an ongoing basis.
    For Group A entities, these limits are required to be established
either within the entity's internal compliance program or under the
presumption of compliance within the exemptions for permitted
underwriting and market making related activities. Under the final
rule, Group B entities are not required to establish a separate
compliance program for underwriting and market making requirements,
including the internal limits for RENTD. However, in order to be
presumed compliant with the RENTD requirements under the exemptions for
underwriting and market making-related activities, banking entities are
required to establish and enforce limits designed not to exceed RENTD,
as well as authorization procedures for limit breaches and increases
for each trading desk as described below.
    With respect to limit increases and breaches, banking entities are
required to maintain and make available upon request records regarding
any limit that is exceeded and any temporary or permanent increase to
any limit. Unlike the proposal, the final rule does not include the
requirement of prompt reporting of breaches or limit increases but
requires that banking entities keep and provide such records to the
agencies upon request. However, consistent with the requirements under
the 2013 rule, the final rule includes certain requirements for the
continued availability of the presumption of compliance in the event of
limit increases or breaches. Specifically, the presumption of
compliance will continue to remain available in the event of a breach
or limit increase only if (i) the banking entity takes prompt action to
bring the trading desk into compliance; and (ii) establishes and
complies with a set of written authorization procedures, including
escalation procedures that require review and approval of any trade
that exceeds a trading desk's limits, demonstrable analysis of the
basis for any temporary or permanent increase to a trading desk's
limits, and independent review of such demonstrable analysis and
approval.
i. Costs and Benefits
    This section discusses the expected benefits of the final rule and
how regulatory oversight of internal limits may reduce such benefits;
potential costs related to deterioration of risk management practices
and increased risk exposures of banking entities, including with
respect to the removal of the demonstrability requirement; aspects of
the final rule and baseline that mitigate these costs; and factors
likely to affect the overall balance of these economic effects.
    The primary expected benefits of the final rule are threefold.
First, the agencies have received comments that the 2013 rule has
created significant costs and uncertainty about some banking entities'
ability to rely on the exemption for underwriting and market making-
related activities,\1011\ and the economic baseline discusses existing
research on the baseline effects of the 2013 rule on market quality,
trading, and client facilitation activities. The SEC believes that the
final rule may provide SEC-regulated banking entities with beneficial
flexibility and certainty in conducting permissible underwriting and
market making-related activities. Second, consistent with commenter
views,\1012\ the SEC recognizes that banking entities may already
routinely establish and monitor internally set risk and position limits
for purposes of meeting capital requirements and internal risk
management. Thus, to the degree that some banking entities already
establish limits that meet the requirements under the final rule, the
presumption allows the reliance on internal limits in accordance with a
banking entity's risk management function that may already be used to
meet other regulatory requirements. Therefore, the amendment may
prevent unnecessary duplication of risk-management compliance
procedures for the purposes of complying with multiple regulations and
may reduce compliance costs for SEC-regulated banking entities. Third,
to the extent that the uncertainty and compliance burdens related to
the RENTD requirements are currently impeding otherwise profitable
permissible underwriting and market making by dealers,\1013\ the
amendments may increase banking entities' profits and the volume of
dealer underwriting and market making activity. The SEC notes that the
returns and risks arising from banking entity activity may flow through
to investors and that investors in securities markets may benefit from
market liquidity as it enables exit from investment positions.
---------------------------------------------------------------------------

    \1011\ See, e.g., ABA; Credit Suisse; State Street and BB&T.
    \1012\ See JBA.
    \1013\ See section V.F.2.
---------------------------------------------------------------------------

    Since the 2013 rule requires oversight of internal limits and
authorization policies and procedures related to internal limit
increases or breaches, this aspect of the final rule is unlikely to
result in new compliance burdens for SEC registrants. In addition, the
SEC has received comment that some banking entities may already have
escalation and recordkeeping procedures when limits are breached or
changed.\1014\ The SEC continues to believe that agency oversight of
internal limits for the purposes of compliance with the final rule may
help support the benefits and costs of the substantive prohibitions of
section 13 of the BHC Act. The agencies have also received comment that
the amendments may allow the agencies to challenge the limit approval
and exception process but not the nexus between RENTD and limits.\1015\
As discussed above, sections __.4(c)(1)(i)-(ii) of the final rule
require that such limits must be designed not to exceed RENTD.
---------------------------------------------------------------------------

    \1014\ See JBA.
    \1015\ See, e.g., Better Markets.
---------------------------------------------------------------------------

    In the proposal, the SEC noted that some entities may be able to
maintain positions that are larger than RENTD and increase risk
exposures arising out of trading activities, thus reducing the economic
effects of section 13 of the BHC Act and the 2013 rule. The agencies
have received comment that limits may be designed to exceed RENTD and
banking entities may frequently exceed limits and that introducing the
presumption may lead to a deterioration of risk management practices
and increase risk taking by banking entity dealers.\1016\ However, as
discussed above, under the final rule internal limits need to be tied
to RENTD, such that if the banking entity complies with the limits it
will not maintain positions that are larger than RENTD. The SEC also
notes that breaches and changes to internal limits may reflect banking
entities' close

[[Page 62070]]

monitoring of market conditions and tailoring such limits, valuable for
both internal risk management and supervision and oversight over
banking entities. The agencies have received comment that some banking
entities may change the way they set internal limits in response to the
final rule, for instance, by selecting higher initial limits to avoid
breaches or increases for the purposes of section 13 of the BHC
Act.\1017\ The SEC recognizes these possible effects from entities
changing their internal limit setting practices and notes that this
effect may reduce the value of closely tailored and dynamically
adjusted internal limits for internal oversight and agency supervision.
Moreover, the SEC notes that this effect may lead some banking entities
to take on greater trading risks. Nevertheless, to satisfy the
presumption of compliance, such trading activity must conducted within
risk and position limits designed not to exceed RENTD, and thus be
consistent with section 13(d)(1)(B) of the BHC Act. The SEC also notes
that the final rule contains recordkeeping obligations concerning any
exceeded limits or temporary or permanent increases to limits, which
may facilitate agency oversight but impose new burdens on banking
entities. As discussed in section V.B, this aspect of the final rule
may increase initial burdens \1018\ by $8,870 \1019\ for SEC-registered
banking entities and ongoing burdens for SEC-registered broker-dealers
by approximately $227,278 per year and for SBSDs by approximately
$38,831 per year.\1020\
---------------------------------------------------------------------------

    \1016\ See, e.g., Volcker Alliance; Better Markets; NAFCU and
Public Citizen.
    \1017\ See, e.g., Capital One et al.; Better Markets; and State
Street.
    \1018\ For the purposes of the burden estimates in this release,
the SEC is assuming the cost of $423 per hour for an attorney, from
SIFMA's ``Management & Professional Earnings in the Securities
Industry 2013,'' modified to account for an 1,800-hour work year,
multiplied by 5.35 to account for bonuses, firm size, employee
benefits, and overhead, and adjusted for inflation as of June 2019.
    \1019\ Initial reporting and recordkeeping burdens: 0.5 hours x
0.18 dealer weight x [199 broker-dealers + 34 SBSDs not already
registered as broker-dealers] x Attorney at $423 per hour = $8,870.
    \1020\ Ongoing burdens for broker-dealers: [10 hours
recordkeeping + 5 hours reporting] x 0.18 dealer weight x 199 x
Attorney at $423 per hour = $227,278.
    Ongoing burdens for SBSDs: [10 hours recordkeeping + 5 hours
reporting] x 0.18 dealer weight x 34 SBSDs not already registered as
broker-dealers x Attorney at $423 per hour = $38,831.
---------------------------------------------------------------------------

    The final rule also eliminates the requirements of the market
making exemption related to the demonstrable analysis of historical
customer demand, current inventory of financial instruments, and market
and other factors concerning financial instruments in which the trading
desk makes a market, including though block trades. Some commenters
indicated that this aspect of the amendments gives banking entities
greater discretion to establish higher risk and inventory limits in
excess of RENTD \1021\ and that banking entities should be required to
demonstrate the analysis behind their RENTD forecasts and compare ex-
ante forecasts with ex-post realizations.\1022\ However, the agencies
also received comment that RENTD can significantly deviate from
historically observed levels, particularly in times of severe market
stress, and internal limits designed to not to exceed RENTD may be
based on current or forward looking customer inquiries, anticipated
volatility shocks, and other forward looking information about market
conditions and the evolving risks of a particular desk.\1023\ The SEC
also notes that, under the final rule, the presumption of compliance
requires risk and position limits to be designed not to exceed RENTD
and that the agencies may rebut the presumption as discussed above.
---------------------------------------------------------------------------

    \1021\ See Volcker Alliance.
    \1022\ See Data Boiler.
    \1023\ See, e.g., FSF.
---------------------------------------------------------------------------

    Four key aspects of the final rule are aimed at mitigating these
risks and costs. First, the internal limits, including any changes to
limits, used to establish the presumption of compliance are subject to
rebuttal procedures discussed above, and the final rule requires that
the internal limits are designed not to exceed RENTD and take into
account the liquidity, maturity, and depth of the market for the
relevant type of security or financial instrument. Second, the
presumption of compliance is conditional on the banking entity's prompt
action to bring the trading desk into compliance if a limit is
exceeded. Third, banking entities are required to establish and comply
with a robust set of internal policies and procedures, requiring review
of limits, demonstrable analysis of a basis for any limit increase, and
independent review of such analysis and approval. Fourth, the economic
effects of the presumption of compliance interact with the effects of
the amended trading desk definition, which the SEC believes will allow
the agencies to better oversee trading activity across a given banking
entity's trading desks and across groups of banking entities to
determine whether the internal limits are appropriately designed not to
exceed RENTD.
    The SEC also notes that the final rule tailors compliance
obligations of banking entities for purposes of the exemptions for
underwriting and market making-related activities. The economic effects
of the final amendments related to compliance are discussed in section
V.F.3.g.
    The SEC continues to believe that the overall economic effect of
these amendments will depend on how banking entities choose to comply
with the substantive prohibitions in section 13 of the BHC Act and the
2013 rule as amended. Specifically, banking entities are likely to
weigh the unmet demand for and profitability of client facilitation
activity against the potential costs of establishing and maintaining
appropriate internal limits.\1024\ The SEC does not have data on the
volume of trading activity that does not occur because of the costs
associated with complying with the RENTD requirement or data on the
profitability of such trading activity for SEC-regulated banking
entities. The SEC is not aware of any such data, and commenters did not
provide data enabling such quantification.\1025\
---------------------------------------------------------------------------

    \1024\ See, e.g., 83 FR at 33532.
    \1025\ The SEC observes that, as shown in Table 1, broker-
dealers affected by the final rule have total assets of
approximately $3.14 trillion and holdings of approximately $761.53
billion. If the final amendments increase affected broker-dealer
holdings by even 0.01%, the economic impact of the final rule may
exceed $100 million.
---------------------------------------------------------------------------

ii. Efficiency, Competition, and Capital Formation
    The SEC believes that the final rule may reduce the costs of
relying on the exemptions for underwriting and market making-related
activities, which may facilitate the activities related to these
exemptions. The evolution in market structure in some asset classes
(e.g., equities) has transformed the role of traditional dealers vis-
[agrave]-vis other participants, particularly as it relates to high-
frequency trading and electronic platforms. However, dealers continue
to play a central role in less liquid markets, such as corporate bond
and over-the-counter (OTC) derivatives markets. While it is difficult
to establish causality, corporate bond dealers, particularly bank-
affiliated dealers, have, on aggregate, significantly reduced their
capital commitment post-crisis.\1026\ Corporate bond dealers are
increasingly shifting from trading in a principal capacity to agency
trading. To the extent that this change cannot be explained by enhanced
ability of dealers to manage corporate bond inventory, electronic
trading, post-crisis changes in dealer risk tolerance and macro factors
(effects

[[Page 62071]]

which themselves need not be fully independent of the effect of section
13 of the BHC Act and the 2013 rule), such effects may point to a
reduced supply of liquidity by dealers. Moreover, corporate bond
dealers decrease liquidity provision in times of stress after the 2013
rule.\1027\ In dealer-centric single-name CDS markets, interdealer
trade activity, trade sizes, quoting activity, and quoted spreads for
illiquid underliers have deteriorated since 2010, but dealer-customer
activity and various trading activity metrics have remained
stable.\1028\
---------------------------------------------------------------------------

    \1026\ See, e.g., FRB's ``Staff Q2 2017 Report on Corporate Bond
Market Liquidity.'' See also section V.F.2 above.
    \1027\ See section V.F.2. above.
    \1028\ For a literature review and data, see SEC Report 2017,
supra note 774.
---------------------------------------------------------------------------

    Because of the methodological challenges described earlier in this
analysis, the SEC cannot quantify potential effects of the 2013 rule in
general--and the RENTD, underwriting, and market making provisions of
the 2013 rule in particular--on capital formation and market liquidity.
The SEC also recognizes, as discussed above, that these provisions may
not be currently affecting all securities markets, asset classes, and
products uniformly. If, because of uncertainty and the costs of relying
on exemptions for market making-related activity and risk-mitigating
hedging, dealers currently limit their market making and hedging
activity in certain products, the final rule may facilitate market
making. Because secondary market liquidity can affect the willingness
to invest in primary markets, and access to liquidity in these markets
can enable market participants to mitigate undesirable risk exposures,
the amendments may increase trading activity and capital formation in
some segments of the market.
    While section 13 of the BHC Act and the 2013 rule, as amended,
prohibit banking entities from engaging in proprietary trading, some
trading desks may attempt to use certain elements of the final RENTD
amendments to circumvent those restrictions, which may reduce the
economic effects of the 2013 rule outlined in the economic baseline.
However, under the final rule, internal limits and policies and
procedures regarding breaches and limit increases and other aspects of
banking entities' compliance with section 13 of the BHC Act remain
subject to the full scope of agency oversight and supervision, and the
presumption of compliance is rebuttable.
    The SEC continues to recognize that proprietary trading by banking
entities may increase the risk exposures of banking entities, may give
rise to economic inefficiency because of implicitly subsidized risk
exposures of banking entities, and may increase market fragility and
conflicts of interest between banking entities and their
customers.\1029\ However, the SEC also recognizes the comments and
research discussed above concerning the unintended effects of the 2013
rule on valuable underwriting and market making activities, and the
nuanced effects of section 13 of the BHC Act and the 2013 rule on the
overall volume and structure of banking entity risk exposures.
---------------------------------------------------------------------------

    \1029\ See 83 FR at 33533.
---------------------------------------------------------------------------

    The SEC continues to believe that, where the final rule increases
the scope of permissible activities or decreases the risk of detection
of proprietary trading, its effect on informational efficiency stems
from a balance of two effects.\1030\ On the one hand, where proprietary
trading strategies are based on superior analysis and prediction
models, their enhanced ability to trade on such information may make
securities markets more informationally efficient. While such
proprietary trading strategies can be executed by dealers that are not
affiliated with banking entities and therefore unaffected by the
prohibitions on proprietary trading, their ability to do so may be
constrained by their limited access to capital and a lack of scale
needed to profit from such strategies. On the other hand, if superior
information is obtained by an entity from its customer-facing
activities and as a result of conflicts of interest, and if such
conflicts are recognized by other market participants, proprietary
trading may make other market participants less willing to transact
with banks or participate in securities markets, potentially reducing
informational efficiency.
---------------------------------------------------------------------------

    \1030\ See 83 FR at 33534.
---------------------------------------------------------------------------

iii. Alternatives: Prompt Notice, Thresholds
    The agencies could have adopted a prompt notice requirement for
limit breaches and limit changes, such as internal limit increases, for
all or a subgroup of banking entities. Prompt notification of breaches
and changes to internal limits under the alternative may provide more
immediate information to agencies about limit breaches and changes
supporting oversight.\1031\ The agencies have received comment that
such prompt notice may be especially beneficial for the oversight of
smaller and mid-size banking entities with less sophisticated internal
controls that may be more susceptible to risks from rogue
trading.\1032\
---------------------------------------------------------------------------

    \1031\ See, e.g., Data Boiler.
    \1032\ See, e.g., CFA.
---------------------------------------------------------------------------

    However, consistent with the views of a number of commenters,\1033\
the SEC believes that the prompt notice requirement would have imposed
considerable costs on registrants. Such information may duplicate
metrics reporting for Group A entities and other information provided
to the agencies in the ordinary course of prudential supervision.\1034\
Further, such costs would likely be most significant for Group B and
Group C entities that do not engage in significant trading activity and
which may face more difficulties absorbing reporting costs,\1035\ as
well as for non-U.S. banking entities with large non-U.S.
operations.\1036\ In addition, internal limit increases or breaches may
reflect changes in market conditions and not changes in a banking
entity strategy or risk tolerance, and smaller and mid-size banks may
currently be setting internal limits considerably below RENTD.\1037\
Finally, to the degree that market participants may interpret the
prompt reporting requirement as an enhanced regulatory focus on the
number of times an entity has breached RENTD, traders may become less
willing to request limit increases to accommodate customer demand;
\1038\ alternatively, entities may set higher internal limits to avoid
breaches or increases.\1039\
---------------------------------------------------------------------------

    \1033\ See, e.g., ABA; Committee on Capital Markets; Credit
Suisse; GFMA; FSF; JBA and BB&T.
    \1034\ See, e.g., FSF; SIFMA; ABA; CREFC; GFMA; Goldman Sachs;
Real Estate Associations and ISDA.
    \1035\ See, e.g., Capital One et al.
    \1036\ See, e.g., JBA and IIB.
    \1037\ See BOK.
    \1038\ See, e.g., CCMC.
    \1039\ See, e.g., Capital One et al.; Better Markets; MBA and
State Street.
---------------------------------------------------------------------------

    The final rule balances these considerations by imposing
recordkeeping requirements that enable the agencies to access books and
records concerning internal limit increases and breaches in the course
of other supervision, inspections, and examinations; require prompt
action to bring the trading desk back in compliance in the event of a
breach; and impose requirements concerning policies and procedures for
escalation, for demonstrable analysis of the basis for internal limit
increases, and for independent review for such analysis and approval.
    The agencies could have also adopted the internal limit approach,
but with more or less flexibility provided to banking entities in
setting internal limits. For example, the agencies could have specified
that a desk's internal

[[Page 62072]]

limits can reflect risk appetite, risk capacity, and business strategy,
so long as that desk holds itself out as a market maker; the agencies
could have also permitted limits based on absolute value of profit and
loss (in the case of an underwriting desk).\1040\ The agencies could
have also adopted an approach under which the internal limits necessary
for the presumption of compliance are developed in collaboration with
onsite supervisors or prudential examiners.\1041\ The agencies could
have also adopted an approach under which all or Group B and Group C
banking entities would be able to rely on the presumption of compliance
if their internal limits were appropriate to the activities of the desk
subject to other existing bank regulations, supervisory review, and
oversight by the appropriate agency.\1042\ Finally, the agencies could
have adopted an approach under which the presumption of compliance is
available for activity-based internal limits, such as those based on
notional size and inventory turnover.\1043\ Alternatives that would
provide banking entities with greater flexibility in setting internal
limits would bolster the ability of market makers and underwriters to
proactively adjust their risk exposures to changing market conditions
and potentially accommodate a greater volume of customer demand. At the
same time, such alternatives may also allow banking entities to engage
in a greater degree of trading activity while relying on the
presumption of compliance.
---------------------------------------------------------------------------

    \1040\ See JBA.
    \1041\ See, e.g., FSF and SIFMA.
    \1042\ See Capital One et al.
    \1043\ See BB&T.
---------------------------------------------------------------------------

    Similarly, one commenter suggested an approach that more
prescriptively specifies how banking entities should set and adjust
internal limits and what factors they should consider.\1044\ Another
commenter stated that such a one-size-fits all approach ignores
differences in the business models of banking entities and desks.\1045\
The SEC believes that, while this alternative may decrease the trading
activity of banking entities, it would not appropriately tailor the
2013 rule to the differences in organization, operation, and risks of
various banking entities and their trading desks; may hamper client
facilitation activity when market conditions are in flux; and may have
the unintended effect of banking entities delegating certain risk
management functions to the agencies. As discussed above, the final
rule specifies that internal limits must be designed not to exceed
RENTD and that internal limits of banking entities are subject to
ongoing regulatory oversight by the agencies.
---------------------------------------------------------------------------

    \1044\ See Better Markets.
    \1045\ See Committee on Capital Markets.
---------------------------------------------------------------------------

    The agencies could have adopted an approach under which
underwriting and market making requirements are tailored to banking
entities on the basis of different thresholds. For example, the
agencies could have instead relied on the trading assets and
liabilities threshold for market making compliance (as in the final
rule), but applied a different threshold for underwriting compliance,
such as on the basis of the volume or profitability of past
underwriting activity. This alternative would have tailored the
compliance requirements for SEC-regulated banking entities with respect
to underwriting activities. However, the volume and profitability of
underwriting activity is highly cyclical and is likely to decline in
weak macroeconomic conditions. As a result, under the alternative, SEC-
regulated banking entities would face lower limits with respect to
underwriting activity during times of economic stress when covered
trading activity related to underwriting may pose the highest risk of
loss. The alternative may also limit banking entities in their ability
to engage in underwriting during economic weakness when economic
activity and capital formation are in decline.
    One commenter suggested that the agencies interpret the
underwriting exemption broadly to accommodate any activity that assists
persons or entities in accessing the capital markets or raising
capital, as well as any activities done in connection with a capital
raise.\1046\ Under such an approach, an underwriter's hedging of
unsold, contingent, or forward underwriting allotments would be
permissible under the underwriting exemption. To the degree that
banking entities are unable to engage in such activities in reliance on
the hedging or other exemptions under the 2013 rule, this alternative
may increase the ability of some banking entities to hedge some of the
risks related to underwriting and their willingness to engage in
underwriting activity. Moreover, a broad underwriting exemption would
eliminate the need to categorize the underwritten instruments, which
may be difficult to do in some foreign markets with respect to loans,
repos, securities loans, financial instruments, or derivatives. At the
same time, the SEC believes that banking entities may currently be able
to engage in hedging related to underwriting activity under the rule,
such as in reliance on the hedging exemption.
---------------------------------------------------------------------------

    \1046\ See, e.g., ISDA.
---------------------------------------------------------------------------

d. Permitted Risk-Mitigating Hedging
i. Costs and Benefits
    As discussed in the proposal,\1047\ hedging is an essential tool
for risk mitigation and can enhance a banking entity's provision of
client-facing services, such as market making and underwriting, as well
as facilitate financial stability. In recognition of the important role
that this activity can play as part of a banking entity's overall
operations, the agencies are adopting a number of changes that
streamline and clarify the 2013 rule's exemption for risk-mitigating
hedging activities to reduce unnecessary compliance burdens and
uncertainty some banking entities face concerning their ability to rely
on the hedging exemption.
---------------------------------------------------------------------------

    \1047\ See, e.g., 83 FR at 33535.
---------------------------------------------------------------------------

    First, the final rule simplifies the requirements of the risk-
mitigating hedging exemption for banking entities that do not have
significant trading assets and liabilities. The amendment removes the
requirement to have a specific risk-mitigating hedging compliance
program, as well as the documentation requirements and certain hedging
activity requirements for such entities. As a result, these banking
entities are subject to the following requirements: (1) The hedging
activity, at the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate one or more specific,
identifiable risks, including market risk, counterparty or other credit
risk, currency or foreign exchange risk, interest rate risk, commodity
price risk, basis risk, or similar risks, arising in connection with
and related to identified positions, contracts, or other holdings of
the banking entity, based upon the facts and circumstances of the
identified underlying and hedging positions, contracts or other
holdings and the risks and liquidity thereof; and (2) the hedging
activity is subject, as appropriate, to ongoing recalibration by the
banking entity to ensure that the hedging activity satisfies these
requirements and is not prohibited proprietary trading.
    As discussed in the proposal,\1048\ banking entities without
significant trading assets and liabilities may be less likely to engage
in large or complicated trading activities and hedging strategies. The
agencies have received comment supporting such reduced compliance

[[Page 62073]]

requirements for banking entities that do not have significant trading
assets and liabilities.\1049\ One commenter stated that reduced
compliance requirements for risk-mitigating hedging by Group B and
Group C banking entities would not affect the safety and soundness of
banking entities or financial stability and pointed to the importance
of robust monitoring and banking entity risk management in the context
of risk-mitigating hedging.\1050\ Another commenter opposed this aspect
of the amendments and stated that, absent proprietary trading intent,
ensuring that hedging does not increase banking entities' risks at
inception of the hedge and that trading personnel are not compensated
for doing so is not complex.\1051\
---------------------------------------------------------------------------

    \1048\ See, e.g., 83 FR at 33536.
    \1049\ See, e.g., Credit Suisse and BB&T.
    \1050\ See BB&T.
    \1051\ See Better Markets.
---------------------------------------------------------------------------

    The SEC continues to believe that compliance with the 2013 rule,
including compliance with the requirements of Sec.  __.5(b)(2), imposes
disproportionate costs on banking entities without significant trading
assets and liabilities.\1052\ The SEC continues to note that, as
quantified in the economic baseline, Group B and Group C broker-dealers
represent a very small fraction of total assets and holdings in the
broker-dealer industry. In addition, fixed compliance costs represent
disproportionately greater burdens for smaller entities as they may
face greater difficulty absorbing such costs into revenue. Importantly,
the final rule does not waive the substantive proprietary trading
prohibitions in section 13 of the BHC Act for any banking entity,
including for any Group B or Group C banking entity. Instead, the SEC
continues to believe that the amendment reduces the costs of relying on
the hedging exemption and, thus, the costs of engaging in hedging
activities for Group B and Group C entities. To the extent that the
removal of these requirements may reduce the costs of risk-mitigating
hedging activity, Group B and Group C entities may increase their
intermediation activity while also growing their trading assets and
liabilities.
---------------------------------------------------------------------------

    \1052\ See, e.g., 83 FR at 33536.
---------------------------------------------------------------------------

    Second, the final rule reduces documentation requirements for Group
A entities. In particular, the final rule removes the documentation
requirements for some risk-mitigating hedging activity. More
specifically, the activity is not subject to the documentation
requirement if (1) the financial instrument used for hedging is
identified on a written list of pre-approved financial instruments
commonly used by the trading desk for the specific type of hedging
activity; and (2) at the time the financial instrument is purchased or
sold the hedging activity (including the purchase or sale of the
financial instrument) complies with written, pre-approved hedging
limits for the trading desk purchasing or selling the financial
instrument for hedging activities undertaken for one or more other
trading desks.
    The agencies received comment that this and other final amendments
to the risk-mitigating hedging exemption may lead banking entities to
engage in less planning, documentation, and testing in their hedging
activities, may reduce the effectiveness of agency oversight, and may
weaken the proprietary trading prohibitions of the 2013 rule.\1053\
Other commenters supported the revisions, but stated that enhanced
documentation requirements for the hedging exemption, as a whole, are
unnecessary given the robust compliance framework under the 2013 rule
and amendments, and supported the complete elimination of the
documentation requirements for all banking entities.\1054\
---------------------------------------------------------------------------

    \1053\ See, e.g., Better Markets; Data Boiler and Bean.
    \1054\ See, e.g., ABA; FSF; CREFC; BPI and SIFMA.
---------------------------------------------------------------------------

    Consistent with the views of some commenters,\1055\ the economic
effects with respect to internal limits for the purposes of hedging
with pre-approved instruments may be similar to the effects of internal
limits for the purposes the underwriting and market making exemptions
discussed above. The SEC recognizes that the economic effects of this
aspect of the final rule depend on the prevalence of hedging activities
in each registrant, their organizational structure, business model, and
complexity of risk exposures. However, the SEC continues to believe
that the flexibility to choose between providing documentation
regarding risk-mitigating hedging transactions and establishing hedging
limits for pre-approved instruments may be beneficial for Group A
entities, as it will allow these entities to tailor their compliance
programs to their specific organizational structure and existing
policies and procedures.\1056\ At the same time, the SEC believes that
the remaining documentation requirements for Group A entities being
adopted will facilitate effective internal risk management and agency
oversight.
---------------------------------------------------------------------------

    \1055\ See, e.g., Credit Suisse.
    \1056\ See, e.g., 83 FR at 33536.
---------------------------------------------------------------------------

    Third, the final rule eliminates the requirement that the risk-
mitigating hedging activity must demonstrably reduce or otherwise
significantly mitigate one or more specific identifiable risks at the
inception of the hedge. Additionally, the demonstrability requirement
is also removed from the requirement to continually review, monitor,
and manage the banking entity's existing hedging activity. Banking
entities will continue to be subject to the requirement that the risk-
mitigating hedging activity be designed to reduce or otherwise
significantly mitigate one or more specific, identifiable risks, as
well as to the requirement that the hedging activity be subject to
continuing review, monitoring and management by the banking entity to
confirm that such activity is designed to reduce or otherwise
significantly mitigate the specific, identifiable risks that develop
over time from the risk-mitigating hedging.
    Consistent with the views of a number of commenters,\1057\ the SEC
believes that the removal of the demonstrability requirement may
benefit banking entity dealers, as it decreases uncertainty about the
ability to rely on the risk-mitigating hedging exemption and may reduce
the compliance costs of engaging in permitted hedging activities. The
SEC continues to recognize that some SEC-regulated banking entities may
respond to this aspect of the final rule by accumulating positions that
increase the banking entity's risk exposure through adjustments (or
lack thereof) to otherwise permissible hedging portfolios.\1058\ The
SEC also recognizes concerns raised by commenters that some banking
entities may forecast changes in correlations and construct hedging
portfolios such that they leave the entity exposed to directional
market movements.\1059\ The SEC continues to recognize that this may
result in increased risks from the trading activity of some banking
entities.\1060\ However, the final rule's requirement concerning
ongoing recalibration may mitigate these adverse effects. In addition,
as discussed in greater detail in the economic baseline, the SEC
recognizes that trading activity is only one form of activity conducted
by banking entities that can increase risk exposure, and that market,
credit, and liquidity risks of the banking book as well as the degree
to which banking book risks are hedged by tradeable assets all
contribute to the overall risk of a banking entity or group of banking
entities. As a result, the SEC

[[Page 62074]]

recognizes that, to the degree that some banking entities may respond
to the final rule by increasing risk exposures arising out of trading
activity, these effects may be partly offset by changes in the risks
these banking entities take in the normal course of their banking
activity or more complete hedging of their banking and trading risks
through trading portfolios. Moreover, the SEC believes that this aspect
of the final rules may not only benefit banking entities by alleviating
compliance burdens related to risk management, but may also benefit
clients and counterparties by enabling greater trading activity and
liquidity provision by dealers that are banking entities. Furthermore,
the SEC reiterates that the returns and risks arising from the activity
of banking entities may flow through to banking entity's investors and
that investors in securities markets may benefit from greater liquidity
as it enables exit from investment positions.
---------------------------------------------------------------------------

    \1057\ See, e.g., ABA; Credit Suisse and SIFMA.
    \1058\ See 83 FR at 33535. See also, e.g., Better Markets; Bean;
Data Boiler and CFA.
    \1059\ See, e.g., Public Citizen.
    \1060\ See, e.g., 83 FR at 33536.
---------------------------------------------------------------------------

    Finally, the final rule removes the requirement to perform the
correlation analysis. The SEC continues to recognize that a correlation
analysis based on returns may be prohibitively complex for some asset
classes and that a correlation coefficient may not always serve as a
meaningful or predictive risk metric.\1061\ The agencies received
comment that permitting additional time to provide correlation analysis
would better address time-related challenges; \1062\ that requiring
statistical tests of randomness to the observed returns on the hedged
positions may serve to duly constrain hedging; \1063\ and that there
should be no regulation-related delays when hedging if banking entities
rely on documented and stable risk relationships.\1064\ The SEC notes
that time costs are only one of the issues in the correlation
requirement and that banking entities may not be able to rely on
documented and stable risk relationships in quickly evolving market
conditions. Although in some instances correlation analysis of past
returns may be helpful in evaluating whether a hedging transaction was
effective in offsetting the risks intended to be mitigated, the SEC
continues to recognize that correlation analysis may not be an
effective tool for such evaluation in other instances. For example,
correlations across assets and asset classes evolve over time and may
exhibit jumps at times of idiosyncratic or systematic stress. In such
circumstances, historical correlations among the returns on assets or
asset classes may not be representative of the way in which they will
affect portfolio risk going forward. Moreover, the SEC notes that asset
return correlations may not be informative when financial instruments
are traded infrequently, if the prices used to construct asset returns
are non-binding indicative quotes (and not actual execution prices).
Additionally, the hedging activity, even if properly designed to reduce
risk, may not be practicable if costly delays or compliance
complexities result from a requirement to undertake a correlation
analysis.\1065\ These costs and delays may be most acute in times of
market stress and during spikes in volatility, during which customers
and other dealers may demand greater liquidity. The SEC continues to
believe that the removal of the correlation analysis requirement may
provide dealers with greater flexibility in selecting and executing
risk-mitigating hedging activities.\1066\
---------------------------------------------------------------------------

    \1061\ See 83 FR at 33535. See also, e.g., ABA; Credit Suisse;
JBA; SIFMA and CREFC.
    \1062\ See, e.g., Better Markets.
    \1063\ Id.
    \1064\ Id.
    \1065\ See, e.g., SIFMA.
    \1066\ See, e.g., 83 FR at 33535.
---------------------------------------------------------------------------

    The SEC received comments that the elimination of the correlation
analysis may impede supervisory review, enable some banking entities to
disguise proprietary trades as hedges, or result in permissible over-
or under-hedging due to changes in asset correlations over time.\1067\
Other commenters indicated that correlation analysis is highly
automated and forces banking entities to be more purposeful in hedging
activities.\1068\ The SEC recognizes these concerns and continues to
recognize that the removal of the correlation analysis requirement
involves the tensions of the effects discussed above.\1069\ The SEC
continues to recognize that, to the extent that some banking entities
may respond to this aspect of the final rule by engaging in more
trading activities that leave them exposed to directional market
movements while relying on the risk-mitigating hedging exemption, this
aspect of the final rule may increase risk taking and conflicts of
interest between banking entities and their customers. However, the SEC
believes that the final rule's requirement concerning ongoing
recalibration by the banking entity to ensure that the hedging activity
satisfies the requirements above and is not prohibited proprietary
trading may mitigate these concerns. In addition, similar to the
discussion above, the SEC continues to recognize that changes in the
overall risk of banking entities reflect both changes in the risk of
trading activities and their banking activities. Importantly, the SEC
continues to believe that the requirement to engage in correlation
analysis may have slowed the timing of hedging activities by some
banking entities and may not be beneficial for prudent risk management
or practical under some circumstances. Moreover, the SEC continues to
believe that potential increases in permitted risk-mitigating hedging
may benefit clients, customers, and counterparties by increasing
trading activity and capital formation by banking entities,
particularly in times of market stress and during spikes in volatility.
Finally, under the final rule, banking entities remain subject to the
full scope of agency oversight over trading activities in reliance on
the hedging exemption.
---------------------------------------------------------------------------

    \1067\ See, e.g., AFR; Bean; NAFCU; Public Citizen; Volcker
Alliance; Better Markets and Systemic Risk Council.
    \1068\ See, e.g., AFR and Data Boiler.
    \1069\ See 83 FR at 33536.
---------------------------------------------------------------------------

    As discussed above, the SEC estimates burden reductions, per firm,
as a result of the final rule. The final amendments to Sec.  __.5(c)
may result in ongoing cost savings for SEC-registered broker-dealers
\1070\ estimated at $1,295,903.\1071\ Additionally, the final rule will
result in lower ongoing costs for potential SBSD registrants relative
to the costs that they would incur under the 2013 rule's regime if they
were to choose to register with the SEC--this cost reduction is
estimated to reach up to $51,775.\1072\ However, the SEC recognizes
that compliance with SBSD registration

[[Page 62075]]

requirements is not yet required and that there are currently no
registered SBSDs.
---------------------------------------------------------------------------

    \1070\ The SEC continues to believe that the burden reduction
for SEC-regulated entities will be a fraction of the burden
reduction for the holding company as a whole. In the proposal, the
SEC attributed 18% of the reductions in holding company (parent)
burdens to the dealer affiliates, on the basis of the average weight
of broker-dealer assets in holding company assets. The SEC received
no comment on this estimate and continues to rely on this figure in
estimates of compliance burden reductions for SEC registrants.
However, the SEC recognizes that compliance burdens may be borne
disproportionately by dealer affiliates because of their role in
trading for the holding company. As a result, some dealers may
currently be bearing a larger fraction of holding company compliance
burdens related to section 13 of the BHC Act. To this extent, the
estimates of compliance burden savings may underestimate the
magnitude of the benefits enjoyed by SEC registrants under the final
amendments.
    \1071\ Ongoing recordkeeping burden reduction for broker-
dealers: (100 hours per firm x 0.18 weight x (Attorney at $423 per
hour) x 199 firms)-(80 hours per firm x 0.18 weight x (Attorney at
$423 per hour) x 36 firms affiliated with Group A entities) =
$1,515,186-$219,283 = $1,295,903.
    \1072\ Recordkeeping burden reduction for entities that may
register as SBSDs: (100-80) hours per firm x 0.18 weight x (Attorney
at $423 per hour) x 34 SBSDs not already registered as broker-
dealers = $51,775. This estimate assumes all SBSDs are Group A
entities and will still be subject to these ongoing recordkeeping
obligations.
---------------------------------------------------------------------------

ii. Efficiency, Competition, and Capital Formation
    The primary efficiency, competition, and capital formation effects
of the risk-mitigating hedging amendments stem from competition and
capital formation. The final hedging amendments provide greater relief
with respect to the requirements of the exemption for hedging activity
to Group B and Group C entities relative to Group A entities. Since the
fixed costs of relying on such exemptions may be more significant for
entities with smaller trading books, the final hedging amendments may
permit Group B entities just below the $20 billion threshold to more
effectively compete with Group A entities just above the threshold.
    The final hedging amendments may also influence the volume of
hedging activity and capital formation. To the extent that some
registrants currently experience significant compliance costs related
to the hedging exemption, these costs may constrain the amount of risk-
mitigating hedging they currently engage in. The ability to hedge
underlying risks at a low cost can facilitate the willingness of SEC-
regulated entities to commit capital and take on underlying risk
exposures. Because the final rule may reduce costs of relying on the
hedging exemption, these entities may become more incentivized to
engage in risk-mitigating hedging activity, which may in turn
contribute to greater capital formation.
    These amendments to risk-mitigating hedging do not change the
amount or type of information available to market participants, and the
SEC does not believe that the final rule is likely to have an effect on
informational efficiency. To the degree that these amendments may
enable some banking entities to more easily rely on the hedging
exemption, and to the extent that hedging supports extension of credit
and other capital formation, these amendments may somewhat improve
allocative efficiency.
iii. Alternatives
    The agencies could have adopted an approach that would exclude from
the proprietary trading prohibition or allow all or a subset of banking
entities (such as Group B and Group C entities) to rely on the
presumption of compliance with respect to hedging activity accounted
for under hedge accounting principles.\1073\ The agencies could have
also adopted an approach excluding trading activity of non-U.S. banking
entities accounted for under hedge accounting rules in their home
jurisdictions.\1074\ The SEC believes that such alternatives would
effectively replace the compliance and documentation obligations for
permitted risk-mitigating hedging in the 2013 rule as amended in this
final rule with the compliance obligations necessary for an entity to
qualify for hedge accounting treatment. For example, banking entities
must generally document the hedge relationship, including hedge
objectives, risks being hedged, hedged item and the financial
instrument used in the hedge, demonstrate that the hedge is highly
effective, and recognize any ineffectiveness in profits and
losses.\1075\ As a result, some commenters \1076\ indicated that such
approaches may reduce compliance duplication and further reduce
uncertainty regarding the ability of some banking entities to rely on
the risk-mitigating hedging exemption with respect to certain hedging
transactions.
---------------------------------------------------------------------------

    \1073\ See, e.g., Capital One et al., JBA, ABA and KeyCorp.
    \1074\ See JBA.
    \1075\ See FASB, Derivatives and Hedging (Topic 815) (Aug.
2017). See also International Financial Reporting Standard
(``IFRS'') 9 (Financial Instruments). See also Capital One et al.
    \1076\ See Capital One et al. and JBA.
---------------------------------------------------------------------------

    However, the SEC also recognizes commenter concerns that the
compliance and effectiveness testing for the purposes of hedge
accounting are designed for the purposes of transparent and informative
financial statements and are not designed to distinguish between
prohibited proprietary trading and permissible risk-mitigating hedging
for the purposes of section 13 of the BHC Act.\1077\ Moreover,
international accounting standards may not involve the same level of
compliance, documentation, and effectiveness testing as either the U.S.
hedge accounting standards or the compliance program for the hedging
exemption of the 2013 rule. As a result, the SEC continues to believe
that the final rule implements the purposes of section 13 of the BHC
Act while reducing compliance burdens on most affected registrants.
---------------------------------------------------------------------------

    \1077\ See, e.g., Data Boiler.
---------------------------------------------------------------------------

    As another alternative, the agencies could have adopted an
approach, under which compliance with the risk-mitigating hedging
exemption is applied on the basis of analysis of the trading desk's
activities as a whole and not on a trade-by-trade basis.\1078\ In a
related vein, the agencies could have adopted an approach that allows
portfolio hedging that is not contemporaneous with the inception of the
position being hedged and that does not occur at the desk to which the
risk is booked, so long as the hedging exposure remains within
permitted internal limits applicable to each desk and to the banking
entity as a whole.\1079\ The SEC believes that such alternatives would
have the effect of enabling firm-wide macro hedges of a banking
entity's risk exposures by centralized risk management desks, which may
involve fewer transaction costs and reduce the burden of demonstrating
compliance with the hedging exemption for each trade. However, such an
approach may make it more difficult for the agencies and banking
entities to oversee compliance with the hedging exemption and
distinguish between transactions reasonably designed at their inception
to hedge specific risks and impermissible proprietary trades intended
to profit from asset mispricing or directional changes in the value of
assets or asset classes.
---------------------------------------------------------------------------

    \1078\ See, e.g., Credit Suisse and CCMC.
    \1079\ Id.
---------------------------------------------------------------------------

    As discussed above, the agencies could have also eliminated all
enhanced documentation requirements for Group A banking entities and
all other conditions of the hedging exemption not expressly required by
the statute.\1080\ The SEC believes that, relative to the final rule,
such an alternative would further reduce compliance burdens on Group A
banking entities and uncertainty regarding their ability to rely on the
hedging exemption and may increase the volume of risk-mitigating
hedging by Group A banking entities. However, the elimination of
enhanced documentation requirements as a whole and other conditions of
the exemption may also reduce the effectiveness of internal risk
management and agency oversight of Group A entities and may result in
increased trading activity by Group A entities in reliance on the
hedging exemption. This risk may be particularly acute given the size
and complexity of trading activity of Group A entities and their role
in the dealer industry and in the U.S. financial system as a whole.
---------------------------------------------------------------------------

    \1080\ See, e.g., ABA; FSF; CREFC; BPI and SIFMA.
---------------------------------------------------------------------------

    The agencies could have adopted an explicit exclusion from the
proprietary trading prohibition for hedges of corporate debt issuances.
Specifically, the agencies have received comment that financial
institutions may routinely hedge debt securities issued for corporate
purposes with interest rate swaps, which fall into the trading account
under the 60-day rebuttable

[[Page 62076]]

presumption of the 2013 rule.\1081\ As discussed above, the final rule
modifies the short-term prong of the trading account definition,
reducing the likelihood that such activity would fall in to the trading
account and require the reliance on the hedging exemption. As a result,
the SEC believes that the final rule may enable valuable and routine
hedging of corporate debt issued by banking entities subject to the
short-term prong without the costs of complying with the risk-
mitigating hedging exemption.
---------------------------------------------------------------------------

    \1081\ See KeyCorp.
---------------------------------------------------------------------------

e. Exemption for Foreign Trading
i. Costs and Benefits
    Foreign banking entities seeking to rely on the exemption for
trading outside of the United States under the 2013 rule face a complex
set of compliance requirements that may result in significant burdens
and implementation inefficiencies, which may have reduced cross-border
trading activity and liquidity between U.S. and non-U.S.
entities.\1082\ In particular, agencies have received comment from some
market participants that compliance with the financing prong may be
difficult for some non-U.S. banking entities because of the fungibility
of some forms of financing.\1083\ In addition, the SEC continues to
recognize that satisfying the U.S counterparty prong is burdensome for
foreign banking entities and may have led some foreign banking entities
to reduce the range of counterparties with which they engage in trading
activity.\1084\ The final rule removes the financing and counterparty
prongs.
---------------------------------------------------------------------------

    \1082\ See, e.g., JBA; HSBC; ABA; ISDA; Credit Suisse; Committee
on Capital Markets and IIB.
    \1083\ See, e.g., EBF (citing 83 FR at 33468-69).
    \1084\ See, e.g., 83 FR at 33537.
---------------------------------------------------------------------------

    Under the final rule, financing for a transaction relying on the
foreign trading exemption can be provided by U.S. branches or
affiliates of foreign banking entities, including U.S. branches or
affiliates that are SEC-registered dealers. Foreign banking entities
may benefit from the final rule because of the greater flexibility
afforded to how they are permitted to finance their transaction
activity in reliance on the foreign trading exemption. The agencies
have also received comment supporting the focus of the exemption on the
location of the principal risk and the location in which decision
making behind the trading occurs.\1085\ At the same time, the agencies
have received comment that the proposed amendments to the exemption may
increase the vulnerability of the U.S. financial system to proprietary
trading losses of foreign banking entities.\1086\ However, for the
reasons noted below, the SEC does not believe that the amendments will,
on balance, increase vulnerability in the manner described by
commenters. Specifically, the SEC continues to recognize that some of
the economic exposure and risks of proprietary trading by foreign
banking entities may flow not just to the foreign banking entities, but
to U.S.-located entities financing the transactions, e.g., through
margin loans.\1087\ However, potential adverse effects on vulnerability
may be mitigated by two primary factors. First, the SEC notes that the
final rule retains the condition that any purchases or sales by a
foreign banking entity, including any hedging trades, are not accounted
for as principal directly or on a consolidated basis by any U.S. branch
or affiliate of the foreign banking entity. Thus, under the final rule,
the principal risk of proprietary trading by non-U.S. banking entities
will remain outside of the United States. Moreover, U.S. banking
entities providing financing to their foreign banking entity affiliates
are likely to be separately subject to a full range of capital, margin,
and other obligations unrelated to section 13 of the BHC Act, which may
reduce risks to the U.S. branches and affiliates of foreign banking
entities. The SEC believes that the focus on where the principal risk
and decision making behind the trading resides tailors the application
of the 2013 rule with respect to foreign banks' non-U.S. operations by
reducing compliance burdens and uncertainties of foreign banking
entities in their trading activity.\1088\
---------------------------------------------------------------------------

    \1085\ See, e.g., ABA; ISDA; Credit Suisse; Committee on Capital
Markets and IIB.
    \1086\ See, e.g., Bean; NAFCU; Better Markets; Merkley and Data
Boiler.
    \1087\ Id.
    \1088\ In addition, the agencies confirmed in this Supplementary
Information that the foreign trading exemption does not preclude a
foreign banking entity from engaging a non-affiliated U.S.
investment adviser as long as the actions and decisions of the
banking entity as principal occur outside of the United States. To
the extent that foreign banking entities were restricting engagement
of non-affiliated U.S. investment advisers due to uncertainty about
the 2013 rule, non-affiliated U.S. investment advisers may become
better able to compete for the foreign banking entity's investment
mandates.
---------------------------------------------------------------------------

    In addition, the final rule removes the counterparty prong and its
corresponding clearing and anonymous exchange and personnel
requirements. As a result, the final rule makes it easier for foreign
banking entities to transact with or through U.S. counterparties. To
the extent that foreign banking entities are currently bearing \1089\
and passing along compliance burdens to their U.S. counterparties, or
are unwilling to intermediate or engage in certain transactions with or
through U.S. counterparties, the final rule may reduce transaction
costs for U.S. counterparties and may increase the volume of trading
activity between U.S. counterparties and foreign banking
entities.\1090\
---------------------------------------------------------------------------

    \1089\ See, e.g., HSBC.
    \1090\ See, e.g., JBA.
---------------------------------------------------------------------------

    The SEC recognizes that this aspect of the final rule may adversely
affect the current competitive standing of U.S. banking entities
insofar as foreign banking entities will have greater ability to engage
in proprietary trading activities with U.S. counterparties.\1091\
However, the removal of the counterparty prong in the final rule
maintains a comparable treatment of the U.S. operations of U.S. and
non-U.S. banking entities with respect to the transactions that are
booked in the U.S., as neither U.S. nor non-U.S. banking entities are
able to rely on the foreign trading exemption for such activity.\1092\
The agencies have also received comment that the elimination of
clearing and exchange requirements may enable U.S. intermediaries to
compete for business in OTC financial products with foreign banking
entity counterparties, and that the amendments may foster trading
activity between foreign affiliates and branches of U.S. banking
entities and foreign banking entities without the constraints under the
counterparty prong on the involvement of their U.S. personnel.\1093\
---------------------------------------------------------------------------

    \1091\ See, e.g., FSF.
    \1092\ See, e.g., IIB.
    \1093\ Id.
---------------------------------------------------------------------------

    When a foreign banking entity engages in proprietary trading
through a U.S. dealer, such trades expose the counterparty to risks
related to the transaction, though such risks born by U.S.
counterparties likely depend on both the identity of the counterparty
and the nature of the instrument and terms of trading position.
Moreover, the SEC continues to emphasize that concerns about moral
hazard and the volume of risk-taking by foreign banking entities may be
less relevant for U.S. markets for two reasons.\1094\ First, foreign
banking entities are less likely to be beneficiaries of U.S. deposit
insurance and implicit bailout guarantees. Second, foreign banking
entities are likely subject to foreign

[[Page 62077]]

securities and prudential regulations that address these concerns.
---------------------------------------------------------------------------

    \1094\ See, e.g., 83 FR at 33537. See also JBA.
---------------------------------------------------------------------------

    In addition, as proposed, the final rule replaces references to
personnel arranging, negotiating, and executing trades with references
to relevant personnel. This change is consistent with the views of some
commenters, who stated that the current arrange, negotiate, or execute
test is burdensome and may restrain trading activity outside of the
U.S.\1095\ Specifically, the availability of the foreign trading
exemption is amended to be conditioned on the banking entity engaging
as a principal (including relevant personnel) not being located in the
U.S. or organized under U.S. laws. As discussed elsewhere in this
Supplementary Information, the agencies are modifying the rule such
that relevant personnel for the purposes of the foreign trading
exemption are limited to personnel engaged in the banking entity's
decision in the purchase or sale as principal. The SEC believes that
the location of the personnel engaged in the banking entity's decision
in the purchase or sale is a meaningful trigger for the application of
section 13 of the BHC Act and implementing rules. Specifically, the SEC
has considered how narrowing the personnel requirement may increase
risk exposure of banking entities from trading activity and conflicts
of interest between banking entities and their clients on the one hand
and may enhance market quality and availability of trading
counterparties on the other hand. In addition, as part of the baseline
for analysis, the conditions for the foreign trading exemption in the
2013 rule include both requirements concerning relevant personnel that
makes the decision to purchase or sell as principal and requirements
concerning personnel involved in arranging, negotiating, and executing
trades. As a result, under the 2013 rule foreign banking entities have
to determine whether a particular employee meets both the requirements
related to relevant personnel and related to personnel arranging,
negotiating, and executing purchases and sales. This aspect of the
final rule eliminates the need for a foreign banking entity to
separately establish that a given employee meets both sets of
requirements, reducing inefficiencies associated with foreign banking
entities relying on the foreign trading exemption from the proprietary
trading prohibition.
---------------------------------------------------------------------------

    \1095\ See, e.g., EBF; HSBC and IIB.
---------------------------------------------------------------------------

ii. Efficiency, Competition, and Capital Formation
    The final rule likely expands the scope of trading activity by
foreign banking entities that may qualify for the foreign trading
exemption. As a result, the amendments may reduce the costs, benefits,
and effects on efficiency and capital formation of the 2013 rule
discussed in the economic baseline, and may increase competition
between U.S. and foreign banking entities. The final rule reflects
consideration of the potentially inefficient restructuring of
activities undertaken by foreign banking entities after the 2013 rule
came into effect and the loss of access of U.S. market participants to
foreign banking entity counterparties, on the one hand,\1096\ and,
advancement of the objectives of section 13 of the BHC Act, on the
other hand.
---------------------------------------------------------------------------

    \1096\ In the Proposing Release, the SEC noted that, according
to one market participant, at least seven international banks have
terminated or transferred existing transactions with U.S.
counterparties in order to comply with the foreign trading exemption
and to avoid compliance costs of relying on alternative exemptions
or exclusions. See 83 FR at 33537.
---------------------------------------------------------------------------

    Allowing foreign banking entities to be financed by U.S.-dealer
affiliates and to transact with U.S. counterparties on an OTC basis
(i.e., off-exchange) and without clearing the trades, may reduce costs
of non-U.S. banking entities' trading activity under the foreign
trading exemption, including with U.S. counterparties. These costs may
currently represent barriers to entry for foreign banking entities that
contemplate engaging in trading and other transaction activity using a
U.S. affiliate's financing and OTC trading with U.S. counterparties. To
that extent, the final rule may provide (1) incentives for foreign
banking entities that currently receive financing from non-U.S.
affiliates or other sources to move financing to U.S. dealer
affiliates, and (2) incentives for foreign banking entities that
currently do not transact with or through U.S. counterparties (or
transact with or through U.S. counterparties only in transactions that
are promptly cleared) to transact with or through U.S. counterparties
(or transact with or through U.S. counterparties outside of promptly
cleared transactions). As a result, the number of banking entities
engaging in trading activities in U.S. markets may increase, which may
enhance the incorporation of new information into prices. However, the
amendments may result in a shift in securities trading activity away
from U.S. banking entities to foreign banking entities that are not
comparably regulated.
    The final rule may increase market entry, as it will decrease the
need for foreign banking entities to rely on a narrower set of
unaffiliated market intermediaries in order to conduct trading activity
under the foreign trading exemption in compliance with the 2013 rule.
Additionally, the final rule may increase operational efficiency of
trading activity by foreign banking entities in the United States,
which may decrease costs to market participants and may increase the
level of market participation by U.S-dealer affiliates of foreign
banking entities.
    Consistent with the views of commenters,\1097\ the SEC continues to
recognize that the final rule may also affect competition among banking
entities.\1098\ The statute may introduce competitive disparities
between U.S. and foreign banking entities. Under the final rule,
foreign banking entities may enjoy a greater degree of flexibility in
financing proprietary trading and transacting with or through U.S.
counterparties relative to the baseline. At the same time, U.S. banking
entities are not able to engage in proprietary trading and are subject
to the substantive prohibitions of section 13 of the BHC Act. One
commenter indicated that non-U.S. banking entities will continue to
bear operational burdens because of the legal entity
requirements.\1099\ To the degree that the final requirements regarding
the location of the principal risk and relevant personnel are still
burdensome and constraining foreign banking entities in their reliance
on the foreign trading exemption, this may partly dampen the above
competitive effect. To the extent that banking entities at the holding
company level may be able to reorganize and move their business to a
foreign jurisdiction, some U.S. banking entity holding companies may
exit from the U.S. regulatory regime. However, under sections 4(c)(9)
and 4(c)(13) of the Banking Act, U.S. entities would have to conduct
the majority of their business outside of the United States to become
eligible for the exemption, reducing potential effects of their
activities on U.S. markets. In addition, certain changes in control of
banks and bank holding companies require supervisory approval. Hence,
the feasibility and magnitude of such regulatory arbitrage remain
unclear. The SEC also notes that, as referenced above, the final rule
preserves equal competitive treatment of the U.S. operations of both
U.S. and

[[Page 62078]]

non-U.S. banking entities that will remain unable to rely on the
foreign trading exemption and will remain subject to section 13 of the
BHC Act.\1100\
---------------------------------------------------------------------------

    \1097\ See, e.g., Bean; Data Boiler; FSF and Better Markets.
    \1098\ See 83 FR at 33538.
    \1099\ See, e.g., JBA.
    \1100\ See, e.g., IIB.
---------------------------------------------------------------------------

    To the extent that foreign banking entities currently engage in
cleared transactions with or through U.S. counterparties because of the
existing counterparty prong but would have chosen not to do so
otherwise, the final rule may reduce the amount of cleared
transactions. This may reduce opportunities for risk-sharing among
market participants and increase idiosyncratic counterparty risk born
by U.S. and foreign counterparties.
    At the same time, the final rule may increase the availability of
liquidity and reduce transaction costs for market participants seeking
to trade in U.S. securities markets. To the extent that non-U.S.
banking entities will face lower costs of transacting with U.S.
counterparties, it may become easier for U.S. banking entities or
customers to find a transaction counterparty willing to engage in, for
instance, hedging transactions. To that extent, U.S. market
participants accessing securities markets to hedge financial and
commercial risks may increase their hedging activity and assume a more
efficient amount of risk. The potential consequences of relocation of
non-U.S. banking entity activity to the United States for liquidity and
risk-sharing may be most concentrated in those asset classes and market
segments where activity is most constrained by the requirements in the
2013 rule.
iii. Alternatives
    The agencies could have amended the foreign trading exemption to
remove all conditions for the exemption, including the engaging as
principal and decision-making requirements, except for the booking
requirement.\1101\ Relative to the final rule, the SEC believes that
such an alternative approach would further lower the compliance burdens
of non-U.S. banking entities relying on the foreign trading exemption
and may foster more trading activity by U.S. affiliates of non-U.S.
banking entities. For example, the agencies have received comment that
the engaging as principal and decision-making requirements have led
Japanese firms to downsize their U.S. affiliates and that the decision-
making requirement is operationally difficult for Japanese banks
executing trades in U.S. markets because of time zone differences.
\1102\ To the degree that this alternative encourages more activity of
non-U.S. banking entities in the United States, U.S. counterparties may
benefit from greater availability and choice of banking entity
counterparties. However, the alternative would place U.S. banking
entities at a greater competitive disadvantage relative to the final
rule, because it would result in more flexibility for the U.S.
operations of non-U.S. banking entities to engage in trading activities
relative to the U.S. operations of U.S. banking entities.
---------------------------------------------------------------------------

    \1101\ See, e.g., JBA.
    \1102\ Id.
---------------------------------------------------------------------------

    In addition, the agencies have received comment suggesting an
exclusion of non-U.S. banking entities with limited U.S. assets and
operations from the scope of section 13 of the BHC Act.\1103\ The SEC
notes that nothing in the final rule changes or waives ongoing
statutory obligations of banking entities. However, to the degree that
reliance on the foreign trading exemption is burdensome and prevents
non-U.S. entities from trading in the United States, the final rule may
reduce compliance burdens related to the 2013 rule by introducing the
presumption of compliance for Group C banking entities. As discussed
above, the Group C threshold of $1 billion applies to the trading
assets and liabilities of the combined U.S. operations of the top-tier
foreign banking organization (including all subsidiaries, affiliates,
branches, and agencies of the foreign banking organization operating,
located, or organized in the United States). As a result, under the
final rule, non-U.S. banking entities that have limited trading assets
and liabilities in the United States will be able to avail themselves
of the rebuttable presumption of compliance and will no longer be
required to bear the fixed costs and burdens of demonstrating
compliance with section 13 of the BHC Act and the 2013 rule.
---------------------------------------------------------------------------

    \1103\ See IIB.
---------------------------------------------------------------------------

f. Covered Funds
    The agencies are adopting amendments to Sec.  __.11 and Sec. 
__.13, as proposed.
i. Costs and Benefits
    First, the final rule removes the requirement in Sec.  __.11(c)(3)
of the 2013 rule that a banking entity include, for purposes of the
aggregate fund limit and capital deduction, the value of any ownership
interests of a third-party covered fund (i.e., a covered fund that the
banking entity does not advise or organize and offer pursuant to Sec. 
__.11 of the 2013 rule) acquired or retained in accordance with the
underwriting or market making exemptions in Sec.  __.4. In addition,
the final rule removes the guarantee language in Sec.  __.11(c)(2) of
the 2013 rule which requires a banking entity to include, for purposes
of the aggregate fund limit and capital deduction, the value of any
ownership interests of a covered fund, the obligations or performance
of which is directly or indirectly guaranteed, assumed, or insured by
the banking entity.
    The final amendments aim to more closely align the requirements for
engaging in underwriting or market making-related activities with
respect to ownership interests in covered funds with the requirements
for engaging in these activities with respect to other financial
instruments. The SEC agrees with a number of commenters \1104\ and
continues to believe that the 2013 rule imposed requirements on
dealers' transactions in ownership interests in covered funds that may
limit the ability of dealers to underwrite and make markets in
ownership interests in covered funds, even if dealers are able to
underwrite and make markets in the underlying securities owned by
covered funds or in securities that are otherwise similar to ownership
interests in covered funds. The SEC continues to believe that, as also
articulated by a number of commenters,\1105\ the final amendments
provide banking entities with greater flexibility in underwriting and
market making ownership interests in covered funds.
---------------------------------------------------------------------------

    \1104\ See, e.g., SIFMA.
    \1105\ See, e.g., SIFMA and ISDA.
---------------------------------------------------------------------------

    In addition, the SEC continues to recognize that the 2013 rule's
restrictions on underwriting and market making-related activities
involving ownership interests in covered funds impose costs on banking
entities, as also discussed by a number of commenters.\1106\ Under the
final rule, banking entities are able to engage in potentially
profitable market making and underwriting in ownership interests in
covered funds that they do not advise or organize or offer without the
value of any ownership interests of the covered fund acquired or
retained in connection with underwriting or market making-related
activities becoming subject to aggregate limits and capital deduction.
Some commenters noted that this amendment would facilitate capital-
raising activities of covered funds,\1107\ increase liquidity, and
generally benefit the marketplace.\1108\ The SEC agrees with these
commenters and continues to believe that SEC-regulated banking

[[Page 62079]]

entities will benefit from this amendment to the extent that they
engage in underwriting and market making activities involving ownership
interests in covered funds, or to the extent that they restricted or
eliminated such activities as a result of the requirements in the 2013
rule. These benefits may also, at least partially, flow to funds and
investors in those covered funds. In addition, as some commenters
pointed out,\1109\ banking entities may become more willing and able to
underwrite and make markets in ownership interests in covered funds.
---------------------------------------------------------------------------

    \1106\ See, e.g., BPI; IIB; SIFMA; ABA and Goldman Sachs.
    \1107\ See SIFMA.
    \1108\ See ISDA.
    \1109\ See, e.g., BPI.
---------------------------------------------------------------------------

    Some commenters indicated that these amendments would greatly
increase banking entities' exposure to interests in covered funds,
which would entail additional risks.\1110\ For example, the removal of
the guarantee language in Sec.  __.11(c)(2) would allow dealers to have
arrangements such as a put option on the ownership interest in the
covered fund, which could expose the banking entity to additional risk.
The SEC continues to recognize that ownership interests in covered
funds expose banking entities to the risks related to covered funds.
The SEC agrees with the commenters that it is possible that covered
fund ownership interests acquired or retained by a banking entity
acting as an underwriter or engaged in market making-related activities
may lead to losses for banking entities.\1111\ However, the SEC also
continues to recognize that the risks of market making or underwriting
of ownership interests in covered funds are substantively similar to
the risks of market making or underwriting of otherwise comparable
financial instruments, the activity which is expressly permitted by
section 13 of the BHC Act. Therefore, the same general tensions
discussed in section V.F.3.c of this Supplementary Information between
potential benefits for capital formation and liquidity and potential
costs related to banking entity risk exposures and market fragility
apply to banking entities' underwriting and market making activities
involving ownership interests in covered funds and other types of
securities.
---------------------------------------------------------------------------

    \1110\ See, e.g., Volcker Alliance; AFR and Bean.
    \1111\ See, e.g., AFR and Data Boiler.
---------------------------------------------------------------------------

    Second, the final rule amends section Sec.  __.13(a) of the 2013
rule to expand the scope of permissible risk-mitigating hedging
activities involving ownership interests in covered funds, and to
remove the demonstrability requirement of the risk-mitigating hedging
exemption for covered funds activities, in each case as proposed.\1112\
Under the final rule, in addition to being able to acquire or retain an
ownership interest in a covered fund as a risk-mitigating hedge with
respect to certain employee compensation agreements as permitted under
the 2013 rule, the banking entity will be able to acquire or retain an
ownership interest in a covered fund 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. Some commenters stated that acquiring or retaining ownership
interests in covered funds as a hedge when acting as intermediary on
behalf of a customer accommodates client facilitation and related risk
management activities.\1113\ The SEC agrees with those commenters and
continues to recognize that the 2013 rule's restrictions on risk-
mitigating hedging activities with respect to ownership interests in
covered funds limit banking entities' ability to hedge the risks of
fund-linked derivatives through ownership interests in the covered
funds referenced by those derivatives. In addition, in the proposal the
SEC recognized that, as a result of the approach in the 2013 rule,
banking entities may not be able to participate in offering certain
customer facilitating products related to covered funds.\1114\ The
final rule is likely to benefit banking entities and their customers,
as well as bank-affiliated advisers of covered funds, as the final rule
increases the ability of banking entities to facilitate customer-facing
transactions while hedging banking entities' own risk exposure.\1115\
As a result, this amendment may increase banking entity intermediation
and provide customers with more efficient access to the risks and
returns of covered funds. To the degree that banking entities'
acquisition or retention of ownership interests in covered funds to
hedge customer-facing transactions may facilitate banking entities'
engagement in customer-facing transactions, customers of banking
entities may benefit from greater availability of financial instruments
providing exposure to covered funds and related intermediation. Banking
entities' ability to hedge customer-facing transactions through the
acquisition or retention of ownership interests in covered funds may be
particularly valuable as private capital plays an increasingly
important role in U.S. capital markets and firm financing.
---------------------------------------------------------------------------

    \1112\ The effects of removal of demonstrability requirement are
discussed in section V.F.3.c.
    \1113\ See, e.g., BPI and FSF.
    \1114\ See 83 FR at 33547-33549.
    \1115\ This was also supported by commenters. See, e.g., BPI;
Forum; ISDA and SIFMA.
---------------------------------------------------------------------------

    The SEC recognizes that, under certain circumstances, an increased
ability of banking entities to acquire or retain ownership interests in
covered funds in connection with risk-mitigating hedging activities may
result in banking entities' exposure to greater risk.\1116\ Some
commenters supported this view.\1117\ The SEC continues to recognize
that banking entities' transactions in fund-linked products that
reference covered funds with customers can expose a banking entity to
risk in cases where a customer fails to perform, transforming the
banking entity's covered fund hedge of the customer trade into an
unhedged, and potentially illiquid, position in the covered fund
(unless and until the banking entity takes action to hedge this
exposure and bears the corresponding costs of hedging). However, the
SEC also continues to recognize that such counterparty default risk is
present in any principal transaction in illiquid financial instruments,
including when facilitating customer trades in the securities in which
covered funds invest, as well as in market making and underwriting
activities. Commenters also recognized this.\1118\ The SEC continues to
note that, under the final rule, risk-mitigating hedging transactions
involving covered funds must be conducted consistent with the other
requirements of the 2013 rule, including the requirements with respect
to risk-mitigating hedging transactions. For example, such transactions
must be made in accordance with the banking entity's written policies,
procedures, and internal controls; not give rise, at the inception of
the hedge, to any significant new or additional risk that is not itself
hedged contemporaneously with the risk-mitigating hedging requirements;
and be subject to continuing review, monitoring, and management by the
banking entity. Therefore, the SEC continues to believe that hedging
and customer facilitation in ownership interests in covered funds does
not necessarily pose a greater risk to banking entities than hedging or
customer facilitation in similar financial instruments that is
permissible under the 2013 rule.
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    \1116\ 79 FR at 5737.
    \1117\ See, e.g., AFR and Volcker Alliance.
    \1118\ See, e.g., SIFMA; Forum and ISDA.
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    Third, the final rule amends section Sec.  __.13(b)(4) of the 2013
rule to remove the financing prong of the foreign fund exemption and
formally incorporates existing staff guidance regarding the marketing
of ownership

[[Page 62080]]

interests in foreign funds to U.S. residents into section Sec. 
__.13(b)(3).\1119\ Under the final rule, a foreign banking entity is
able to acquire or retain ownership interests in and sponsor covered
funds with financing for the banking entity's ownership or sponsorship
provided, directly or indirectly, by branches or affiliates of the
banking entity, including SEC-regulated dealers, that are located in
the United States or organized under the laws of the United States or
any state. The costs, benefits, and effects on efficiency, competition,
and capital formation of this amendment generally parallel those of the
removal of the financing prong with respect to trading activity outside
of the United States in section V.F.3.e of this Supplementary
Information.\1120\
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    \1119\ The SEC understands that, as a practical matter, market
participants have adjusted their activity in light of the FAQs
regarding the marketing restriction. See supra note 59, FAQ 13.
Hence, the SEC continues to believe that the economic effects of the
amendment to incorporate existing staff guidance are likely to be de
minimis, and the SEC focuses this discussion on the removal of the
financing prong.
    \1120\ In addition, the agencies confirmed in this Supplementary
Information that the foreign fund exemption (1) permits the U.S.
personnel and operations of a foreign banking entity to act as an
investment adviser to a covered fund in certain circumstances and
(2) does not preclude a foreign banking entity from engaging a non-
affiliated U.S. investment adviser as long as the actions and
decisions of the banking entity as principal occur outside of the
United States. To the extent that foreign banking entities were
restricting (1) hiring of U.S. personnel to provide investment
advice and recommend investment selections to the manager or general
partner of a covered fund relying on the foreign fund exemption, or
(2) engagement of non-affiliated U.S. investment advisers due to
uncertainty about the 2013 rule, foreign banking entities may be
more likely to hire U.S. personnel to provide such services, and
non-affiliated U.S. investment advisers may become better able to
compete for the foreign banking entity's investment mandates.
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    In light of commenters' responses,\1121\ the SEC continues to
believe that foreign banking entities may benefit from the final rule
and enjoy greater flexibility in financing their covered fund activity.
In addition, allowing foreign banking entities to obtain financing of
covered fund transactions from U.S.-dealer affiliates may reduce costs
to foreign banking entities as the amendment may decrease their need to
rely on foreign dealer affiliates solely for the purposes of avoiding
the compliance costs and prohibitions of the 2013 rule. This may
increase the operational efficiency of covered fund activity by foreign
banking entities outside the United States.
---------------------------------------------------------------------------

    \1121\ Several commenters supported removing the financing prong
from the foreign fund exemption. See, e.g., BPI; EBF; IIB; JBA and
New England Council.
---------------------------------------------------------------------------

    Other commenters indicated that elimination of the financing prong
could result in a U.S. branch or affiliate that extends financing to
bear some risks.\1122\ The SEC agrees with the commenters and continues
to recognize that the economic exposure and risks of foreign banking
entities' covered funds activities may be incurred not just by the
foreign banking entities, but by U.S. entities financing the covered
fund ownership interests, e.g., through margin loans covering
particular transactions. However, the SEC also continues to note that
the final rule retains the 2013 rule's requirement that the investment
or sponsorship, including any related hedging, is not accounted for as
principal by any U.S. branch or affiliate.\1123\ The SEC continues to
believe that concerns about the size of U.S. banking entity risk
exposures are less relevant when the covered fund activity is conducted
by, and the risk consolidates to, foreign banking entities. Moreover,
as noted above, U.S. banking entities providing financing to their
foreign banking entity affiliates are likely to be separately subject
to a full range of capital, margin, and other obligations unrelated to
section 13 of the BHC Act, which may further mitigate risks to the U.S.
branches and affiliates of foreign banking entities.
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    \1122\ See, e.g., Better Markets and CAP.
    \1123\ Some commenters supported this view. See, e.g., EBF and
BPI.
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ii. Efficiency, Competition, and Capital Formation
    As discussed above, the SEC believes that the final rule's
amendments to the covered fund provisions in subpart C provide banking
entities with greater flexibility in underwriting, market making, and
hedging ownership interests in covered funds. To the extent that the
2013 rule's restrictions on underwriting and market making with
interests in covered funds limit fund formation, the final rule may
reduce long-term compliance costs and, as a result, increase capital
formation. In addition, to the extent that banking entities experience
a reduction in compliance costs and an increased ability to accommodate
clients and perform risk management activities, the willingness of SEC-
regulated entities to commit capital and take on underlying risk
exposures may increase, which may enhance capital formation.
    The final rule may affect competition between foreign and domestic
entities, as foreign banking entities may benefit from the final rule
and enjoy greater flexibility in financing their covered fund activity.
To the extent that costs of compliance with the ``financing prong'' of
the 2013 rule's foreign fund exemption may represent barriers to entry
for foreign banking entities' covered fund activities, the final rule
may increase foreign banking entities' operational efficiency and
promote their sponsorship and financing of covered funds.
    The final rule's amendments to Sec.  __.11 and Sec.  __.13 do not
change the information available to market participants, and the SEC
does not believe that these amendments are likely to have an effect on
informational efficiency. To the degree that these amendments may
provide banking entities with more flexibility to underwrite, make
markets in, and hedge ownership interests in covered funds, and to the
extent these activities facilitate capital formation, these amendments
may improve allocative efficiency.
iii. Alternatives
    The agencies considered alternatives that would scope out from
calculation of the per-fund limit, aggregate fund limit, and capital
deduction for banking entities all ownership interests acquired or
retained by banking entities in connection with other underwriting and
market making. For example, the agencies considered excluding the value
of ownership interests acquired or retained in connection with
underwriting or market making-related activities with respect to
covered funds offered or organized by the banking entity from the
calculation of the per-fund and aggregate limits and capital
deductions.\1124\ If the agencies had adopted this alternative, this
would have provided dealers a level of flexibility in underwriting and
making markets in ownership interests in covered funds that is more
similar to the level of flexibility for dealers in conducting these
activities with respect to all other types of financial instruments,
including the underlying financial instruments owned by the same
covered funds.
---------------------------------------------------------------------------

    \1124\ Some commenters supported this alternative. See, e.g.,
ISDA.
---------------------------------------------------------------------------

    Compliance with the 2013 rule for covered funds imposes costs on
banking entities. To the extent that, under the baseline, such costs
prevent banking entities that are dealers from making markets in or
underwriting certain financial instruments, this alternative would
enable them to engage in potentially profitable market making in and
underwriting ownership interests in covered funds. The benefits of this
alternative may also flow through to funds, investors, and customers as

[[Page 62081]]

banking entities may become more willing and able to underwrite and
make markets in products linked to covered funds and to provide
customers with an economic interest in the profits and losses of
covered funds. This may increase investor access to the returns and
risks of private funds, which may be particularly valuable when issuers
are increasingly relying on private capital and delaying public
offerings. Finally, the increased ability of banking entities to engage
in market making and underwriting activities with respect to covered
funds under this alternative may have increased market quality for
covered funds that are traded.
    The SEC also continues to recognize that transactions in covered
funds--including transactions with customers, and holdings of ownership
interests in covered funds related to underwriting and market making--
necessarily involve the risk of losses. However, the risks of market
making or underwriting by banking entities of financial instruments
held by the covered fund, or financial instruments or securities that
are otherwise similar to covered funds, are substantively similar.
Therefore, the same tensions among the economic effects discussed in
section V.F.3.c of this Supplementary Information between potential
benefits to capital formation and liquidity and potential costs related
to bank risk exposures and market fragility apply to both banking
entity interests from underwriting and market making in financial
instruments and underwriting and market making in covered funds. It is
not clear that the existence of a legal and management structure of a
covered fund per se changes the economic risk exposure of banking
entities, and, thus, the capital formation and other tensions of the
economic effects discussed above. Therefore, the SEC continues to
believe that this alternative would simply involve a more consistent
treatment of financial instruments and interests in covered funds as it
pertains to underwriting and market making. However, as discussed above
in section V.F.1 of this Supplementary Information, some of the effects
of the 2013 rule's provisions are difficult to evaluate outside of
economic downturns, and the SEC is unable to measure the amount of
capital formation or liquidity in covered funds or investments of the
covered funds that does not occur because of the existing treatment of
underwriting and market making activities by banking entities involving
covered funds.
g. Compliance Program
    The SEC continues to recognize that the scope and breadth of the
compliance obligations under the 2013 rule impose significant costs on
banking entities, which may be particularly burdensome for smaller
entities. For example, in the proposal, the SEC cited a market
participants' estimate that some banking entities have added as many as
2,500 pages, per institution, of policies, procedures, mandates, and
controls (which need to be monitored and updated on an ongoing basis)
\1125\ for purposes of compliance with the 2013 rule, and that some
banking entities may spend, on average, more than 10,000 hours on
training each year.\1126\ The SEC also cited a market participants'
estimate that some banking entities may have 15 regularly meeting
committees and forums, with as many as 50 participants per institution
dedicated to compliance with the 2013 rule.\1127\
---------------------------------------------------------------------------

    \1125\ See 83 FR 33432.
    \1126\ Id.
    \1127\ Id.
---------------------------------------------------------------------------

    The compliance regime of the 2013 rule and related burdens may
reduce the profitability of covered activities by dealers and
investment advisers that are banking entities and may be passed along
to customers or clients in the form of reduced provision of services or
higher service costs. Moreover, the SEC recognizes that the extensive
compliance program under the 2013 rule may detract resources of banking
entities and their compliance departments and supervisors from other
compliance matters, risk management, and supervision. Finally,
prescriptive compliance requirements may not optimally reflect the
organizational structures, governance mechanisms, or risk management
practices of complex, innovative, and global banking entities. However,
the SEC agrees with commenters \1128\ that compliance programs are
important to support the safety and soundness of the U.S. financial
markets.
---------------------------------------------------------------------------

    \1128\ See, e.g., AFR and Bean.
---------------------------------------------------------------------------

i. Costs and Benefits
    The final rule is expected to lower compliance burdens in two ways.
First, the SEC continues to believe that the amendments would increase
flexibility in complying with the final rule for banking entities
without significant trading assets and liabilities, reducing compliance
costs for these entities. Second, the adopted amendments would
streamline the compliance program for banking entities with significant
trading assets and liabilities. The SEC continues to believe that, to
the extent that the requirements in the 2013 rule are duplicative and
that maintaining compliance systems to comply with both the general and
an enhanced compliance program requirements is inefficient, banking
entities with significant trading assets and liabilities may benefit
from the amendments. The specific final amendments are discussed below.
    For Group C entities, the agencies are adopting presumed compliance
with proprietary trading and covered fund prohibitions. Some commenters
noted that the presumed compliance standard proposed for Group C
entities may benefit entities with very low levels of trading
activity.\1129\ In light of the commenters' responses, the SEC
continues to believe that the presumption of compliance will provide
Group C entities with additional compliance flexibility. The SEC
estimates that approximately 97 broker-dealers that hold 3.6% of assets
held by broker-dealers subject to the final rule would be able to avail
themselves of the rebuttable presumption of compliance and would not
have to apply the final rule's compliance program requirements. Out of
these 97 broker-dealers, 28 are subject to the enhanced requirements
under the 2013 rule, 51 are subject to the standard compliance
requirements under the 2013 rule, and 18 qualify for the simplified
compliance regime under the 2013 rule. As discussed in section V.B, the
agencies estimate recordkeeping or reporting burden reductions related
to presumed compliance with the final rule are as high as
$1,648,812.\1130\
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    \1129\ See, e.g., B&F Capital Markets Inc.
    \1130\ See section V.B. Ongoing cost reduction for broker-
dealers: (40 hours per firm x 18 broker-dealers + 265 hours per firm
x 79 broker-dealers) x 0.18 dealer weight x (Attorney at $423 per
hour) = $1,648,812.
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    Some commenters expressed concern that Group C entities may
experience uncertainty because of the absence of specific guidance
about what events would trigger an agency to rebut the presumption of
compliance,\1131\ and, as a result, incur compliance costs related to
establishing internal systems and controls in anticipation of potential
rebuttal of the presumption.\1132\ To the extent that some Group C
entities experience this uncertainty and costs, they may not fully
enjoy the benefits of presumed compliance. One commenter estimated that
smaller banking entities would likely incur an additional one-time cost
of $50,000-$100,000 in

[[Page 62082]]

consulting or legal advice fees.\1133\ Using this estimate, the total
initial cost related to consulting or legal advice fees for Group C
broker-dealers may range between $873,000 and $1,746,000.\1134\
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    \1131\ See, e.g., Chatham; ABA and SIFMA.
    \1132\ See, e.g., Covington; Chatham; EBF; JBA and Data Boiler.
    \1133\ See Data Boiler.
    \1134\ Initial set-up burden increase for broker-dealers: 97
broker-dealers x 0.18 dealer weight x $100,000 = $1,746,000. Using
the lower bound: 97 broker-dealers x 0.18 dealer weight x $50,000 =
$873,000.
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    Some commenters opposed the presumption of compliance.\1135\ The
SEC continues to recognize that the presumption of compliance for Group
C entities may increase the risks of non-compliance with the statute.
However, the SEC also continues to note that the amendments do not
waive the proprietary trading and covered fund prohibitions of section
13 of the BHC Act for such entities.
---------------------------------------------------------------------------

    \1135\ See, e.g., Occupy the SEC and Data Boiler.
---------------------------------------------------------------------------

    For Group B entities, the agencies are adopting the simplified
compliance program as proposed. Some commenters expressed support for
this approach for Group B entities.\1136\ In the proposal, the SEC
recognized that existing compliance program requirements may burden
entities that engage in little covered trading activity but have larger
total assets.\1137\ The SEC continues to recognize that this amendment
may reduce costs for banking entities that have more than $10 billion
in total assets but do not have significant trading assets and
liabilities, as these banking entities do not qualify for the
simplified compliance program under the 2013 rule. As shown in Table 2,
the SEC estimates that 66 broker-dealers would qualify for the
simplified compliance regime under the final rule. As discussed in
section V.B, the agencies estimate recordkeeping or reporting burden
reductions related to the simplified compliance program for Group B
broker-dealers to be $1,130,679 for registered broker-dealers and up to
$582,471 for entities that may choose to register as SBSDs.\1138\
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    \1136\ See, e.g., CFA and JBA.
    \1137\ See 83 FR 33432.
    \1138\ Cost reduction for broker-dealers: 225 hours per firm x
0.18 dealer weight x 66 broker-dealers x (Attorney at $423 per hour)
= $1,130,679.
    Cost reductions for entities that may register as SBSDs may be
as high as 225 hours per firm x 0.18 dealer weight x 34 SBSDs x
(Attorney at $423 per hour) = $582,471. The estimate for SBSDs
assumes that 34 SBSDs not already registered as broker-dealers would
be Group B entities and so may overestimate the cost savings.
---------------------------------------------------------------------------

    The agencies are amending covered fund recordkeeping requirements
to apply to Group A entities only, rather than to banking entities with
over $10 billion in total assets. The SEC believes that the covered
funds activities of banking entities without significant trading assets
and liabilities may generally be smaller in scale and less complex than
those of banking entities with significant trading assets and
liabilities. Thus, the value of additional documentation requirements
for banking entities without significant trading assets and liabilities
may be lower. The final amendment reflects these considerations and may
reduce the costs associated with these covered funds recordkeeping
requirements by reducing the number of banking entities subject to
these requirements.\1139\ The SEC continues to note that entities with
moderate trading assets and liabilities would still be required to
comply with all the covered fund provisions and that the proposal
simply eliminates recordkeeping for the purposes of demonstrating
compliance. However, in general, the SEC believes that SEC oversight of
dealers and investment advisers of covered funds should not be
adversely affected, as the remaining compliance requirements will be
sufficient to monitor compliance with the statute. As discussed in
section V.B, the agencies estimate recordkeeping or reporting burden
reductions related to the covered fund recordkeeping requirements to be
$2,208,060 for registered broker-dealers and up to $517,752 for
entities that may choose to register as SBSDs.\1140\
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    \1139\ As discussed in section V.F.2.c, RIAs do not typically
engage in proprietary trading, and the SEC continues to believe that
they will not be affected by the final rule as it relates to
proprietary trading. In addition, the SEC does not have the
information necessary to quantify the compliance p