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

Federal RegisterNov 14, 2019

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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.

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,

bbean@fdic.gov,

Michael E. Spencer, Chief, Capital Markets Strategies,

michspencer@fdic.gov,

Andrew D. Carayiannis, Senior Policy Analyst,

acarayiannis@fdic.gov,

or Brian Cox, Senior Policy Analyst,

brcox@fdic.gov,

Capital Markets Branch, (202) 898-6888; Michael B. Phillips, Counsel,

mphillips@fdic.gov,

Benjamin J. Klein, Counsel,

bklein@fdic.gov,

or Annmarie H. Boyd, Counsel,

aboyd@fdic.gov,

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

IArules@sec.gov,

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,

cdumas@cftc.gov;

Jeffrey Hasterok, Data and Risk Analyst, (646) 746-9736,

jhasterok@cftc.gov,

Division of Swap Dealer and Intermediary Oversight; Mark Fajfar, Assistant General Counsel, (202) 418-6636,

mfajfar@cftc.gov,

Office of the General Counsel; Stephen Kane, Research Economist, (202) 418-5911,

skane@cftc.gov,

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),

also known as the Volcker Rule, generally prohibits any banking entity from engaging in proprietary trading or from

acquiring or retaining an ownership interest in, sponsoring, or having certain relationships with a hedge fund or private equity fund (covered fund).

The statute expressly exempts from these prohibitions various activities, including among other things:

12 U.S.C. 1851.

Id.

• 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.

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

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.

E.g.,

12 U.S.C. 1851(d)(1)(G).

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).

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.

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

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).

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.

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).

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.

The agencies also invited comments on whether certain definitions, including “banking entity”

and “trading desk,”

and “covered fund”

should be modified.

See

83 FR 33437, 40-42.

See

83 FR 33442-46.

See

83 FR 33453-54.

See

83 FR 33471-82.

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,

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.

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.

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.

See

83 FR 33446-51.

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,

the exemption for risk-mitigating hedging activities,

the exemption for trading by a foreign banking entity that occurs solely outside of the United States,

and the liquidity management exclusion.

In addition, the agencies proposed establishing an exclusion for transactions to correct trading errors.

See

83 FR 33454-62.

See

83 FR 33464-67.

See

83 FR 33467-70.

See

83 FR 33451-52.

See

83 FR 33452-53.

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

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.

In addition, the agencies requested comment regarding tailoring the definition of “covered fund,” including potential additional exclusions,

and revising the provisions limiting banking entities' relationships with covered funds.

See

83 FR 33482-83

See

83 FR 33483-86.

See

83 FR 33471-82.

See

83 FR 33486-87.

To enhance compliance efficiencies, the agencies proposed tailoring the

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.

Firms with moderate trading assets and liabilities would have been required to adhere to a simplified compliance program, with a CEO attestation requirement,

and firms with limited trading assets and liabilities would have had a presumption of compliance with the rule.

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.

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.

In addition, the agencies requested comment on whether some or all of the reported quantitative measurements should be made publically available.

See

83 FR 33487-89; 33490-94.

See

83 FR 33489.

See

83 FR 33490.

See

83 FR 33454.

See

83 FR 33494-514.

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.

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.

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.

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.

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.

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

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 . . . .”

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.

12 U.S.C. 1851(b)(2)(B)(ii).

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.

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.

For example, several commenters suggested that Volcker Rule related supervision should be conducted solely by a bank's prudential onsite examiner,

and that the two market regulators be required to consult and coordinate with the prudential onsite examiner.

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.

83 FR 33436.

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.

See, e.g.,

ABA; Arvest Bank (Arvest); Credit Suisse; and Financial Services Forum (FSF).

See

ABA.

See, e.g.,

ABA; BB&T; CCMR; and FSF.

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.

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.

See, e.g.,

AFR; Public Citizen; Volcker Alliance; and CFA.

See, e.g.,

CAP; Merkley; and Public Citizen.

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.

A commenter also suggested possible penalties for rule violations and encouraged the agencies to elaborate on the consequences of

significant violations of the rule.

Other commenters recommended that the agencies impose strong penalties on banking entities that break the law.

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.

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.

See, e.g.,

Public Citizen and CAP.

See

Public Citizen.

See

Volcker 2.0 Form Letter.

See, e.g.,

Systemic Risk Council and Oonagh McDonald.

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.

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.

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.

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).

12 U.S.C. 1851(h)(1).

See

2013 rule § __.2(c).

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.

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.

On July 22, 2019, the agencies adopted a final rule amending the definition of “insured depository institution,” in a manner consistent with EGRRCPA.

See

final rule § __.2(r).

Public Law 115-174 (May 24, 2018).

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.

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.

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).

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.

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.

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.

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.

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.

Id.

See, e.g.,

IIB and Securities Industry and Financial Markets Association (SIFMA).

See, e.g.,

Capital One et al.; Credit Suisse; EBF; and Investment Adviser Association (IAA).

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.

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.

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

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

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).

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,

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 § __.13(b) of the 2013 rule, as if the qualifying foreign excluded fund were a covered fund.

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.

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.”

In the past, the staffs of the agencies issued several FAQs to address the treatment of RICs and FPFs.

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).

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.

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.

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).

Id.,

FAQ 16.

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.

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.

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.

Some commenters encouraged the agencies to exclude employee securities companies from the definition of “banking entity.”

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.

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.

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.

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.

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.

See

EFAMA.

See, e.g.,

ABA and FSF.

See

ABA.

See, e.g.,

ABA; BPI; SIFMA; JBA.

See

BB&T.

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

ABA; KeyCorp; Capital One et al.; State Street; Arvest; and SIFMA.

214

See

final rule § __.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 § __. 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

See

final rule § __.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

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 § __.3(b)(1)(iii).

229

See

final rule § __.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

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 § __.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 § __.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

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 § __.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

See

§ __.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

§ __.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

§ __.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

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

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 § __.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 § __.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

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 § __.3(d)(10).

275

See

final rule § __.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

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 § __.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

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