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

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URL: https://www.frixlaw.com/law-library/documents/fr%3A2019-22695

## Record

- **Collection:** Federal Register
- **Document type:** Rule
- **Published:** November 14, 2019
- **Citation:** 84 FR 61974

## Text

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),
1

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).
2

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

1
12 U.S.C. 1851.

2

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.
3

3
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.
4

4

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).
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

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).

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

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).

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.

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.

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.

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.

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

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.

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

19

See
83 FR 33482-83

20

See
83 FR 33483-86.

21

See
83 FR 33471-82.

22

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.
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.

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.

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.

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.

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

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.

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 . . . .”
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.

30
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.
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

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.

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

36

See, e.g.,
AFR; Public Citizen; Volcker Alliance; and CFA.

37

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.
38

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

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.

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.

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

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 § __.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.
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 § __.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

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 § __.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

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 § 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 § __.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 § __.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 § __.2(ff).

81
Proposed rule § __.2(v).

82
Proposed rule § __.2(t).

83
Proposed rule § __.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 § __.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

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 § __.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 § __.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 § __.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 § __.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

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 § __.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 § __.2(s)(2), (3);
see also
final rule § __.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 § __.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

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 § __.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 § __.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 § __.3(b)(1)(i).

128

See
2013 rule § __.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 § __.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

connection with the activities of such business.
130

130

See
2013 rule § __.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 § __.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 § __.3(b)(2)(i).

134

See
final rule § __.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 § __.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

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 § __.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

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 § __.3(b)(1)(i).

183

See
2013 rule § __.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 § __.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 § __.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

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 § __.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 § __.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

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 § __.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

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

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2019-22695. Public record. Not legal advice.