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

Federal RegisterJul 31, 2020

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DEPARTMENT OF TREASURY

Office of the Comptroller of the Currency

12 CFR Part 44

[Docket No. OCC-2020-0002]

RIN 1557-AE67

FEDERAL RESERVE SYSTEM

12 CFR Part 248

[Docket No. R-1694]

RIN 7100-AF70

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 351

RIN 3064-AF17

COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 75

RIN 3038-AE93

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 255

[Release No. BHCA-9; File No. S7-02-20]

RIN 3235-AM70

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 (together, the agencies) are adopting amendments to the regulations implementing section 13 of the Bank Holding Company Act (BHC Act). Section 13 contains certain restrictions on the ability of a banking entity or 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 (covered funds). These final amendments are intended to improve and streamline the regulations implementing section 13 of the BHC Act by modifying and clarifying requirements related to the covered fund provisions of the rules.

DATES:

Effective date:

The final rule is effective October 1, 2020.

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, Elizabeth MacDonald, Manager, (202) 475-6316, Cecily Boggs, Senior Financial Institution Policy Analyst, (202) 530-6209, Brendan Rowan, Senior Financial Institution Policy Analyst, (202) 475-6685, Christopher Powell, Senior Financial Institution Policy Analyst, (202) 452-3442, Nathaniel Grant, Lead Financial Institution Policy Analyst, (202) 452-3105, 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,

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.

CFTC:

Cantrell Dumas, Special Counsel, (202) 418-5043,

cdumas@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.

SEC:

Juliet M. Han, Senior Counsel, William Miller, Senior Counsel, Benjamin A. Tecmire, Senior Counsel, or Jennifer Songer, Branch Chief at (202) 551-6787 or

IArules@sec.gov,

Investment Adviser Regulation Office, Division of Investment Management, and Katherine Hsu, Office Chief, or Benjamin Meeks, Special Counsel at (202) 551-3850, Office of Structured Finance, Division of Corporation Finance, U.S. Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background

II. Notice of Proposed Rulemaking

III. Overview of the Final Rule

IV. Summary of the Final Rule

A. Qualifying Foreign Excluded Funds

B. Modifications to Existing Covered Fund Exclusions

1. Foreign Public Funds

2. Loan Securitizations

3. Public Welfare and Small Business Funds

C. Additional Covered Fund Exclusions

1. Credit Funds

2. Venture Capital Funds

3. Family Wealth Management Vehicles

4. Customer Facilitation Vehicles

D. Limitations on Relationships With a Covered Fund

E. Ownership Interest

F. Parallel Investments

G. Technical Amendments

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

F. SEC Economic Analysis

G. Congressional Review Act

I. Background

Section 13 of the BHC Act,

also known as the Volcker Rule, generally prohibits any banking entity from engaging in proprietary trading or from acquiring or retaining an ownership interest in, sponsoring, or having certain relationships with a hedge fund or private equity fund (covered fund).

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

12 U.S.C. 1851.

Id.

• Underwriting and market making-related activities;

• Risk-mitigating hedging activities;

• Activities on behalf of customers;

• Activities for the general account of insurance companies; and

• Trading and covered fund activities and investments by non-U.S. banking entities solely outside the United States.

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

In addition, section 13 of the BHC Act contains an exemption that permits banking entities to organize and offer, including sponsor, covered funds, subject to certain restrictions, including

that banking entities do not rescue investors in those funds from loss, and are not themselves exposed to significant losses due to investments in or other relationships with these funds.

12 U.S.C. 1851(d)(1)(G). Other restrictions and requirements include: (1) The banking entity provides bona fide trust, fiduciary, or investment advisory services; (2) the fund is organized and offered only to customers in connection with the provision of such services; (3) the banking entity does not have an ownership interest in the fund, except for a

de minimis

investment; (4) the banking entity complies with certain marketing restrictions related to the fund; (5) no director or employee of the banking entity has an ownership interest in the fund, with certain exceptions; and (6) the banking entity discloses to investors that it does not guarantee the performance of the fund.

Id.

Authority under section 13 of the BHC Act for developing and adopting regulations to implement the prohibitions, restrictions, and exemptions of section 13 is shared among the Board, the FDIC, the OCC, the SEC, and the CFTC (individually, an agency, and collectively, the agencies).

The agencies originally issued a final rule implementing section 13 in December 2013 (the 2013 rule), and those provisions became effective on April 1, 2014.

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

Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships with, Hedge Funds and Private Equity Funds; Final Rule, 79 FR 5535 (Jan. 31, 2014).

The agencies published a notice of proposed rulemaking in July 2018 (the 2018 proposal) that proposed several amendments to the 2013 rule.

These proposed revisions sought to provide greater clarity and certainty about what activities are prohibited under the 2013 rule—in particular, under the prohibition on proprietary trading—and to better tailor the compliance requirements based on the risk of a banking entity's trading activities. The agencies issued a final rule implementing amendments to the 2013 rule in November 2019 (the 2019 amendments), and those provisions became effective in January 2020.

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).

Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds, 84 FR 61974 (Nov. 14, 2019). The regulations implementing section 13 of the BHC Act, as amended through June 1, 2020, are referred throughout as the “implementing regulations.”

As part of the 2018 proposal, the agencies proposed targeted changes to the provisions of the 2013 rule relating to acquiring or retaining an ownership interest in, sponsoring, or having certain relationships with a fund and sought comments on other aspects of the covered fund provisions beyond those changes for which specific rule text was proposed.

The 2019 amendments finalized those changes to the covered fund provisions for which specific rule text was proposed in the 2018 proposal.

The agencies indicated they would issue a separate proposal addressing and requesting comment on the covered fund provisions of the rule and other fund-related issues, and, in February 2020, the agencies issued a separate notice of proposed rulemaking that specifically addressed those areas (the 2020 proposal).

83 FR 33471-87.

In response to the 2018 proposal, the agencies received numerous comments related to covered fund issues for which no specific rule text was proposed. However, in the preamble to the 2019 amendments, the agencies generally deferred public consideration of such comments to a future proposed rulemaking. 84 FR 62016.

Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds, 85 FR 12120 (Feb. 28, 2020).

II. Notice of Proposed Rulemaking

In the 2020 proposal, the agencies proposed revisions to a number of the provisions regarding covered fund investments and activities as well as to other provisions of the implementing regulations related to the treatment of funds. The proposed changes, which were based on comments received in response to the agencies' questions in the 2018 proposal and the agencies' experience with the implementing regulations, were intended to reduce the extraterritorial impact of the implementing regulations, improve and streamline the covered fund provisions, and provide clarity to banking entities regarding the provision of financial services and the conduct of permissible activities in a manner that is consistent with the requirements of section 13 of the BHC Act.

To better limit the extraterritorial impact of the implementing regulations, the 2020 proposal would have exempted the activities of certain funds that are organized outside of the United States and offered to foreign investors (qualifying foreign excluded funds) from the restrictions of the implementing regulations. Under the 2013 rule, in certain circumstances, some foreign funds that are not “covered funds” may be subject to the implementing regulations as “banking entities,” if they are controlled by a foreign banking entity, and thus could be subject to more onerous compliance obligations than are imposed on similarly-situated U.S. covered funds, even though the foreign funds have limited nexus to the United States. Accordingly, the 2020 proposal would have codified an existing policy statement by the Federal banking agencies (the OCC, Board, and FDIC) that addresses the potential issues related to a foreign banking entity controlling qualifying foreign excluded funds.

The 2020 proposal also would have made modifications to several existing exclusions from the covered fund provisions to provide clarity and simplify compliance with the requirements of the implementing regulations. First, the 2020 proposal would have revised certain restrictions in the foreign public funds exclusion to more closely align the provision with the exclusion for similarly-situated U.S. registered investment companies. Second, the 2020 proposal would have permitted loan securitizations excluded from the definition of covered fund to hold a small amount of non-loan assets, consistent with past industry practice, and would have codified existing staff-level guidance regarding this exclusion. In addition, the 2020 proposal would have revised the exclusion for small business investment companies to account for the life cycle of those companies and requested comment on whether to clarify the scope of the exclusion for public welfare and other investments to include rural business investment companies and qualified opportunity funds. Finally, the 2020 proposal would have addressed concerns about certain components of the preamble to the 2013 rule related to calculating a banking entity's ownership interests in covered funds.

The agencies also included in the 2020 proposal several new exclusions from the covered fund definition in order to more directly align the regulation with the purpose of the statute. For example, the agencies recognized that the implementing regulations have inhibited banking entities' ability to extend credit by restricting their relationships with credit funds, and the 2020 proposal would have created a new exclusion for such funds. Under the 2020 proposal, banking entities would have been able to invest in and have certain relationships with credit funds that extend the type of credit that a banking entity may provide directly, subject to certain safeguards. Relatedly, the 2020 proposal would have established an exclusion from the definition of covered fund for venture capital funds. This provision was intended to facilitate banking entities' abilities to engage in this important type of development and investment activity, which may facilitate capital formation and provide important financing for small

businesses, particularly in areas where such financing may not be readily available. In addition, the agencies believed that excluding such activities would be consistent with the purpose of the statute, as it would exclude fund activities that do not present the risks that section 13 of the BHC Act was intended to address.

The 2020 proposal also would have allowed a banking entity to provide certain traditional financial services to its customers via a fund structure, subject to certain safeguards and limitations. First, the 2020 proposal would have excluded from the definition of covered fund an entity created and used to facilitate customer exposures to a transaction, investment strategy, or other service. Second, the 2020 proposal would have excluded from the covered fund definition wealth management vehicles that manage the investment portfolio of a family and certain other closely related persons. Both of these provisions were intended to allow a banking entity to provide such services in the manner best suited to its customers.

In addition, the 2020 proposal would have permitted a banking entity to engage in a limited set of covered transactions with a covered fund that the banking entity sponsors or advises or with which the banking entity has certain other relationships. The implementing regulations generally prohibit all covered transactions between a covered fund and its banking entity sponsor or investment adviser. The agencies, in the 2020 proposal, recognized that the existing restrictions have prevented banking entities from providing certain traditional banking services to covered funds, such as standard payment, clearing, and settlement services.

Lastly, the 2020 proposal would have clarified certain aspects of the definition of ownership interest. Currently, due to the broad definition of ownership interest, some loans by banking entities to covered funds could be deemed ownership interests. The 2020 proposal included a safe harbor for bona fide senior loans or senior debt instruments to make clear that an “ownership interest” in a fund would not include such credit interests in the fund. In addition, the 2020 proposal would have clarified the types of creditor rights that may attach to an interest without necessarily causing such an interest to fall within the scope of the definition of ownership interest. Finally, the 2020 proposal would have simplified compliance efforts by tailoring the calculation of a banking entity's compliance with the implementing regulations' aggregate fund limit and covered fund deduction and provided clarity to banking entities regarding their permissible investments made alongside covered funds.

Separately, the agencies proposed various technical edits to the implementing regulations.

See infra

Section IV.G (Technical Amendments).

The agencies invited comment on all aspects of the 2020 proposal, including specific proposed revisions and questions posed by the agencies. The agencies received approximately 40 unique comments from banking entities and industry groups, public interest groups, and other organizations and individuals. In addition, the agencies received six letters related to the subject matter considered in the 2020 proposal prior to the formal comment period. The agencies are now finalizing the 2020 proposal, with certain changes based on public comments, as described in detail below.

Comments are generally discussed in the relevant sections,

infra.

The agencies also received several miscellaneous comments. One commenter suggested revising § __.21 (Termination of activities or investments; penalties for violations) of the implementing regulations to provide for mandatory prison time for violations of the implementing regulations. Anonymous. The agencies believe that this comment is beyond the scope of the current rulemaking. Another commenter encouraged the agencies to exempt from the implementing regulations international banks with a small presence in the United States. Institute of International Bankers (IIB). The agencies believe that this comment is beyond the scope of the current rulemaking. A third commenter claimed that the 2020 proposal improperly assumed that the implementing regulations have certain burdens and that it did not adequately assess the costs and benefits of the proposed revisions to the implementing regulations. Occupy the SEC (Occupy). Contrary to the commenter's suggestions, the

Federal Register

notice for the 2020 proposal contained extensive discussion of the costs and benefits of the 2020 proposal.

See

85 FR 12151-76. This final rule contains similar analyses.

See infra,

Section IV (Administrative Law Matters). Several commenters expressed support for the comment letters submitted by other organizations.

E.g.,

IIB; European Banking Federation (EBF); Goldman Sachs Group, Inc. (Goldman Sachs); and Canadian Bankers Association (CBA). Finally, one comment was not relevant.

See

Charity Colleen Crouse.

III. Overview of the Final Rule

Similar to the 2020 proposal, the final rule clarifies and simplifies compliance with the implementing regulations, refines the extraterritorial application of section 13 of the BHC Act, and permits additional fund activities that do not present the risks that section 13 was intended to address. The agencies received comments from a diverse set of commenters: Comments from banking entities and financial services industry trade groups were generally supportive of the 2020 proposal and recommended additional modifications, while several organizations and individuals were generally opposed to the 2020 proposal. As described further below, the agencies have adopted many of the proposed changes to the implementing regulations, with certain targeted adjustments.

To reduce the extraterritorial impact of the implementing regulations, the final rule, similar to the 2020 proposal, exempts the activities of certain funds that are organized outside of the United States and offered to foreign investors (qualifying foreign excluded funds) from certain restrictions of the implementing regulations. Specifically, the final rule codifies an existing policy statement by the Federal banking agencies that addresses the potential issues related to a foreign banking entity controlling a qualifying foreign excluded fund. The final rule contains some modifications to the proposed exemption—the anti-evasion provision and compliance program requirements—to address comments that the proposed exemption would have unintentionally continued to subject qualifying foreign excluded funds to these requirements.

The final rule also revises, as proposed, but with some modifications, several existing exclusions from the covered fund provisions, to provide clarity and simplify compliance with the requirements of the implementing regulations. First, the final rule revises certain restrictions in the foreign public funds exclusion to more closely align the provision with the exclusion for similarly situated U.S. registered investment companies. Second, the final rule permits loan securitizations excluded from the definition of covered fund to hold a small amount of debt securities, consistent with past industry practice, and codifies existing staff-level guidance regarding this exclusion. In addition, the final rule revises the exclusion for small business investment companies to account for the life cycle of those companies and clarifies the scope of the exclusion for public welfare and other investments to include rural business investment companies and qualified opportunity funds. Finally, the final rule clarifies the calculation of ownership interests in covered funds that are attributed to a banking entity.

The final rule adopts—as proposed, with some modifications—several new exclusions from the covered fund definition to more closely align the regulation with the purpose of the statute. First, the final rule establishes a new exclusion for funds that extend credit to permit the same credit-related activities that banking entities can engage in directly. In addition, the final rule creates an exclusion for venture capital funds to help ensure that banking entities can indirectly facilitate

this important type of development and investment activity to the same degree that banking entities can do so directly. Finally, the final rule adopts two exclusions for family wealth management and customer facilitation vehicles to provide banking entities flexibility to provide advisory and other traditional banking services to customers through a fund structure.

In an effort to clarify and simplify compliance with the implementing regulations, the final rule adopts revisions to the provisions that govern the relationship between a banking entity and a fund and the definition of ownership interest. Specifically, the final rule permits established, codified categories of limited low-risk transactions between a banking entity and a related fund, including riskless principal transactions, and allows a banking entity to engage in certain transactions with a related fund in connection with payment, clearing, and settlement activities. In addition, the final rule would provide an express safe harbor for senior loans and senior debt and provide clarity about the types of creditor rights that would be considered within the scope of the definition of ownership interest. Finally, the agencies are adopting revisions, as proposed, to provide clarity regarding a banking entity's permissible investments in the same investments as a covered fund organized or offered by such banking entity.

Frequently Asked Questions

The staffs of the agencies have addressed several questions concerning the implementing regulations through a series of staff Frequently Asked Questions (FAQs).

In the 2020 proposal, the agencies indicated that the proposed rule would not modify or revoke any previously issued staff FAQs, unless otherwise specified.

Several commenters recommended codifying specific FAQs and making explicit that other FAQs would continue to be in effect, unmodified.

Consistent with the 2020 proposal and commenters' suggestions, the final rule does not modify or revoke any previously issued staff FAQs, unless otherwise specified.

See https://www.occ.treas.gov/topics/capitalmarkets/financial-markets/trading-volckerrule/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-rule-section13.htm

(SEC);

https://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_28_VolckerRule/index.htm

(CFTC).

85 FR 12122-23.

E.g.,

Securities Industry and Financial Markets Association (SIFMA); Financial Services Forum (FSF); and IIB.

85 FR 12122-23.

Comment Period

Since the issuance of the 2020 proposal, the COVID-19 global pandemic has substantially disrupted activity in the United States and in other countries. The effects of the COVID-19 disruptions have created many challenges for households and businesses, and the agencies received comments requesting that the agencies extend the comment period for the 2020 proposal or delay the rulemaking more generally.

In contrast, one commenter expressed support for the rapid approval of the 2020 proposal, to provide banking entities regulatory relief during a period of financial stress.

The agencies announced on April 2, 2020, that they would consider comments submitted before May 1, 2020.

The agencies, however, do not believe that further delay of the rule is warranted, given the volume, depth, and diversity of comments submitted. The agencies believe, as well, that the final rule may provide clarity to banking entities that will enable banking entities to engage in financial services and other permissible activities in a manner that both is consistent with the requirements of section 13 of the BHC Act and will facilitate capital formation and economic activity.

E.g.,

Better Markets, Inc. (Better Markets) and Kathy Bowman.

American Bankers Association (ABA).

https://www.federalreserve.gov/newsevents/pressreleases/bcreg20200402a.htm.

Effective and Compliance Dates

The

Federal Register

notice accompanying the finalization of the 2019 amendments provided for a rolling compliance system.

The effective date of the amendments was January 1, 2020, and firms are required to comply with the revisions by January 1, 2021. Until the mandatory compliance date, banking entities are required to comply with the 2013 rule, or alternatively, a banking entity may voluntarily comply, in whole or in part, with the 2019 amendments prior to the compliance date.

84 FR 61974.

Several commenters on the 2020 proposal suggested that the agencies provide for voluntary early compliance with the final rule.

One commenter also suggested establishing a transition period of at least one year.

E.g.,

SIFMA; FSF; Japanese Bankers Association (JBA); and ABA.

JBA.

The effective date for the final rule will be October 1, 2020, to accommodate the requirements of the Riegle Community Development and Regulatory Improvement Act.

The agencies do not believe an extended compliance or transition period is necessary because the final rule largely tailors the regulations implementing section 13 of the BHC Act rather than increases compliance burdens.

See infra,

Section V.D (Riegle Community Development and Regulatory Improvement Act).

IV. Summary of the Final Rule

A. Qualifying Foreign Excluded Funds

Since the adoption of the 2013 rule, a number of foreign banking entities, foreign government officials, and other market participants have expressed concerns regarding instances in which certain funds offered and sold outside of the United States are excluded from the covered fund definition but still could be considered banking entities in certain circumstances (foreign excluded funds).

This situation may occur if a foreign banking entity controls the foreign fund. A foreign banking entity could be considered to control the fund based on common corporate governance structures abroad, such as where the fund's sponsor selects the majority of the fund's directors or trustees, or the foreign banking entity otherwise controls the fund for purposes of section 13 of the BHC Act. As a result, such a fund would be subject to the requirements of section 13 and the implementing regulations, including restrictions on proprietary trading, restrictions on investing in or sponsoring covered funds, and compliance obligations.

The implementing regulations generally exclude covered funds from the definition of “banking entity.” 2013 rule § __.2(c)(2)(i). However, because foreign excluded funds are not covered funds, they can become banking entities through affiliation with other banking entities.

The Federal banking agencies released a policy statement on July 21, 2017 (the policy statement), to address concerns about the possible unintended consequences and extraterritorial impact of section 13 and the implementing regulations for foreign excluded funds.

The policy statement noted that the Federal banking agencies would not take action against a foreign banking entity

based on attribution of

the activities and investments of a qualifying foreign excluded fund to a foreign banking entity, or against a qualifying foreign excluded fund as a banking entity, for a period of one year while staffs of the agencies considered alternative ways in which the implementing regulations could be amended, or other appropriate action could be taken, to address the issue. The policy statement has since been extended and is currently scheduled to expire on July 21, 2021.

Statement regarding Treatment of Certain Foreign Funds under the Rules Implementing Section 13 of the Bank Holding Company Act (July 21, 2017),

available at https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20170721a1.pdf.

“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.

Id.

Statement regarding Treatment of Certain Foreign Funds under the Rules Implementing Section 13 of the Bank Holding Company Act (July 17, 2019),

available at https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20190717a1.pdf.

For purposes of the policy statement, a “qualifying foreign excluded fund” means, with respect to a foreign banking entity, an entity that:

(1) Is organized or established outside the United States and the ownership interests of which are offered and sold solely outside the United States;

(2) Would be a covered fund were the entity organized or established in the United States, or is, or holds itself out as being, an entity or arrangement that raises money from investors primarily for the purpose of investing in financial instruments for resale or other disposition or otherwise trading in financial instruments;

(3) Would not otherwise be a banking entity except by virtue of the foreign banking entity's acquisition or retention of an ownership interest in, or sponsorship of, the entity;

(4) Is established and operated as part of a bona fide asset management business; and

(5) Is not operated in a manner that enables the foreign banking entity to evade the requirements of section 13 or implementing regulations.

To be eligible for this relief, the foreign banking entity's acquisition or retention of any ownership interest in, or sponsorship of, the qualifying foreign excluded fund must 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 implementing regulations, as if the qualifying foreign excluded fund were a covered fund. To provide greater clarity and certainty to banking entities and qualifying foreign excluded funds, and to limit the extraterritoriality of the rule, the 2020 proposal included a permanent exemption from the section 13 restrictions on proprietary trading and investing in or sponsoring covered funds for the activities of qualifying foreign excluded funds. The proposed exemption generally included the same eligibility criteria from the policy statement, although it included a modified version of the anti-evasion provision such that, in order to qualify, a fund could not be operated in a manner that enables “any other banking entity” (rather than “the foreign banking entity”) to evade the requirements of section 13 or the implementing regulations.

The agencies requested comment on all aspects of this exemption. Commenters were generally supportive of the 2020 proposal to exempt qualifying foreign excluded funds from certain requirements of the implementing regulations.

Two commenters expressed opposition to the proposed exemption.

SIFMA; Bank Policy Institute (BPI); Bundesverband Investment und Asset Management e.V. (BVI); American Investment Council (AIC); ABA; European Fund and Asset Management Association (EFAMA); Shareholder Advocacy Forum (SAF); IIB; JBA; CBA; and Credit Suisse.

Occupy and Data Boiler Technologies LLC (Data Boiler).

Some commenters requested that qualifying foreign excluded funds be excluded from the definition of banking entity.

One commenter expressed concern that the 2020 proposal would require qualifying foreign excluded funds to establish section 13 of the BHC Act compliance programs, imposing costs on qualifying foreign excluded funds.

This commenter noted that there may be situations under section 13 of the BHC Act where a foreign banking entity controls a qualifying foreign excluded fund, but under foreign law does not have the necessary authority to require it to adopt a section 13 compliance program. As such, this commenter advocated for either excluding this type of fund from the definition of banking entity or exempting this type of fund from the compliance program requirements under the rule.

One commenter expressed concern that a qualifying foreign excluded fund would still need to comply with various restrictions under section 13, including the provisions of § __.14 of the implementing regulations (

i.e.,

Super 23A) and the compliance program requirements.

IIB; JBA; CBA; Credit Suisse; and EBF.

JBA.

Credit Suisse.

Some commenters requested that the agencies change the anti-evasion provision of the qualifying foreign excluded funds definition so that it would only apply to the specific foreign banking entity, in a manner consistent with the policy statement.

One of these commenters suggested, as an alternative, revising the provision so that it would only apply to “any affiliated banking entities.”

IIB; JBA; Credit Suisse; and EBF.

Credit Suisse.

One commenter requested an anti-evasion safe harbor and changes to allow a fund to be a qualifying foreign excluded fund when a non-U.S. banking entity serves as a management company to the fund and is approved to provide fund management in accordance with local law.

This commenter also requested that the agencies limit the requirements in the proposed qualifying foreign excluded funds definition to only those set forth in § __.13(b) of the rule for covered fund activities conducted by foreign banking entities solely outside the United States, and treat as qualifying foreign excluded funds those funds for which the foreign banking entity cannot exercise voting rights.

JBA.

Pursuant to their authority under section 13(d)(1)(J) of the BHC Act, the agencies are adopting the exemption for the activities of qualifying foreign excluded funds substantially as proposed, but with modifications to the anti-evasion provision and compliance program requirements. Specifically, the agencies are exempting the activities of qualified foreign excluded funds from the restrictions on proprietary trading and investing in or sponsoring covered funds, if the acquisition or retention of the ownership interest in, or sponsorship of, the qualifying foreign excluded fund by the foreign banking entity meets the requirements for permitted covered fund activities and investments conducted solely outside the United States, as provided in § __.13(b) of the rule.

Under the final rule, a qualifying foreign excluded fund has the same meaning as in the policy statement as described above and in the 2020 proposal, except for the modification to the anti-evasion provision, as described below.

See

final rule § __.13(b).

Section 13(d)(1)(J) of the BHC Act gives the agencies rulemaking authority to exempt activities from the prohibitions of section 13, provided the agencies determine that the activity in question would promote and protect the safety and soundness of the banking entity and the financial stability of the

United States.

For the reasons described below, the agencies have determined that exempting the activities of qualifying foreign excluded funds promotes and protects the safety and soundness of banking entities and U.S. financial stability.

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

This relief is expected to promote and protect the safety and soundness of such funds and their foreign banking entity sponsors by putting them on a level playing field with their foreign competitors that are not subject to the implementing regulations. If the activities of these foreign funds were subject to the restrictions applicable to banking entities, their asset management activities could be significantly disrupted, and their foreign banking entity sponsors may be at a competitive disadvantage to other foreign bank and non-bank market participants conducting asset management business outside of the United States. Exempting the activities of these foreign funds allows their foreign banking entity sponsors to continue to conduct their asset management business outside the United States as long as the foreign banking entity's acquisition of an ownership interest in or sponsorship of the fund meets the requirements in § __.13(b) of the implementing regulations. Thus, the exemption is expected to have the effect of promoting the safety and soundness of these foreign funds and their sponsors, while at the same time limiting the extraterritorial impact of the implementing regulations, consistent with the purposes of sections 13(d)(1)(H) and (I) of the BHC Act.

The exemption is also expected to promote and protect U.S. financial stability. While qualifying foreign excluded funds have a very limited nexus to the U.S. financial system, the exemption would promote U.S. financial stability by providing additional capital and liquidity to U.S. capital markets without a concomitant increase in risk borne by U.S. entities. Because the exemption requires that the foreign banking entity's acquisition of an ownership interest in or sponsorship of the fund meets the requirements in § __.13(b) of the final rule, the exemption will help ensure that the risks of investments made by these foreign funds will be booked at foreign entities in foreign jurisdictions, thus promoting and protecting U.S. financial stability. Additionally, subjecting such funds to the requirements of the implementing regulations could precipitate disruptions in foreign capital markets, which could generate spillover effects in the U.S. financial system.

In response to comments regarding the anti-evasion provision, the final rule specifies that the qualifying foreign excluded fund must not be operated in a manner that enables the banking entity that sponsors or controls the qualifying foreign excluded fund, or any other affiliated banking entity (other than a qualifying foreign excluded fund), to evade the requirements of section 13 of the BHC Act or the final rule. This change is meant to clarify the scope of the anti-evasion provision and provide certainty for banking entities that sponsor or control the qualifying foreign excluded fund.

Consistent with feedback from several commenters, the agencies also have modified compliance requirements with respect to qualifying foreign excluded funds. While, under the final rule, the activities of a qualifying foreign excluded fund are exempted from the proprietary trading restrictions of § __.3(a) and the covered fund restrictions of § __.10(a) of the final rule, the qualifying foreign excluded fund is still a banking entity. Absent any additional changes, the qualifying foreign excluded fund could become subject to the compliance requirements of § __.20. However, since these qualifying foreign excluded funds are exempted from the proprietary trading requirements of § __.3(a) and covered fund restrictions of § __.10(a) of the final rule, the agencies believe that requiring a compliance program for the fund itself is overly burdensome and unnecessary. The requirements in § __.20 are intended to ensure and monitor compliance with the proprietary trading and covered fund provisions, and there would be no benefit to applying these requirements to an entity that is exempt from those provisions. Therefore, under the final rule, qualifying foreign excluded funds are not required to have compliance programs or comply with the reporting and additional documentation requirements under § __.20. However, any banking entity that owns or sponsors a qualifying foreign excluded fund will still be required to have in place appropriate compliance programs for itself and its other subsidiaries and provide reports and additional documentation as required by § __.20.

The final rule does not amend the definition of “banking entity” as requested by several commenters. Because “banking entity” is specifically defined in section 13 of the BHC Act, the agencies find it appropriate to address concerns related to foreign excluded funds through their exemptive rulemaking authority.

The agencies are not making any change regarding the applicability of § __.14 of the implementing regulations, which imposes limitations on relationships with covered funds, with respect to qualifying foreign excluded funds. The agencies believe it is appropriate to retain the application of § __.14 to qualifying foreign excluded funds to limit risks that may be borne by banking entities located in the United States through transactions with such funds.

Further, given the limited set of circumstances in which § __.14 would apply (

i.e.,

a transaction between a foreign excluded fund and a covered fund that is sponsored or advised by the same banking entity), the agencies do not believe that it is overly burdensome for a banking entity that sponsors or controls a qualifying foreign excluded fund to ensure that it is not in violation of § __.14.

A U.S. banking entity's exposure to a fund that would be a qualifying foreign excluded fund with respect to a foreign banking entity may still be a covered fund with respect to a U.S. banking entity under § __.10(b)(1)(iii) of the implementing regulations. A U.S. banking entity's investment in and relationship with such a fund could therefore be subject to the entirety of the applicable prohibitions and restrictions of Subpart C of the implementing regulations.

B. Modifications To Existing Covered Fund Exclusions

In the preamble to the 2013 rule, the agencies acknowledged that the covered fund definition was expansive.

To effectively tailor the covered fund provisions to the types of entities that section 13 of the BHC Act was intended to cover, the 2013 rule excluded various types of entities from the covered fund definition.

In response to comments received on the 2020 proposal, and based on experience implementing the rule, the agencies are modifying certain of the existing exclusions, as described below, to make them more appropriately structured to effectuate the intent of the statute and its implementing regulations.

See

79 FR 5677.

See id.

1. Foreign Public Funds

2013 Rule

To provide consistent treatment for U.S. registered investment companies and their foreign equivalents, the implementing regulations exclude foreign public funds from the definition of covered fund.

A foreign public fund

is generally defined under the 2013 rule as any issuer that is organized or established outside of the United States and the ownership interests of which are (1) authorized to be offered and sold to retail investors in the issuer's home jurisdiction and (2) sold predominantly through one or more public offerings outside of the United States.

The agencies stated in the preamble to the 2013 rule that they generally expect that an offering is made predominantly outside of the United States if 85 percent or more of the fund's interests are sold to investors that are not residents of the United States.

The 2013 rule defines “public offering” for purposes of this exclusion to mean a “distribution,” as defined in § __.4(a)(3) of subpart B, of securities in any jurisdiction outside the United States to investors, including retail investors, provided that the distribution complies with all applicable requirements in the jurisdiction in which such distribution is being made; the distribution does not restrict availability to only investors with a minimum level of net worth or net investment assets; and the issuer has filed or submitted, with the appropriate regulatory authority in such jurisdiction, offering disclosure documents that are publicly available.

In adopting the foreign public fund exclusion, the agencies' view was that it was appropriate to exclude these funds from the “covered fund”

definition because they are sufficiently similar to U.S. registered investment companies. 79 FR 5678.

2013 rule § __.10(c)(1);

see also

79 FR 5678.

2013 rule § __.10(c)(1)(iii).

The 2013 rule places an additional condition on a U.S. banking entity's ability to rely on the foreign public fund exclusion with respect to any foreign fund it sponsors.

The foreign public fund exclusion is only available to a U.S. banking entity with respect to a foreign fund sponsored by the U.S. banking entity if, in addition to the requirements discussed above, the fund's ownership interests are sold predominantly to persons other than the sponsoring banking entity, the issuer (or affiliates of the sponsoring banking entity or issuer), and employees and directors of such entities.

The agencies stated in the preamble to the 2013 rule that, consistent with the agencies' view concerning whether a foreign public fund has been sold predominantly outside of the United States, the agencies generally expect that a foreign public fund would satisfy this additional condition if 85 percent or more of the fund's interests are sold to persons other than the sponsoring U.S. banking entity and the specified persons connected to that banking entity.

Although the discussion of this condition generally refers to U.S. banking entities for ease of reading, the condition also applies to foreign subsidiaries of a U.S. banking entity.

See

2013 rule § __.10(c)(1)(ii) (applying this limitation “[w]ith respect to a banking entity that is, or is controlled directly or indirectly by a banking entity that is, located in or organized under the laws of the United States or of any State and any issuer for which such banking entity acts as sponsor”).

See

2013 rule § __.10(c)(1)(ii).

79 FR 5678.

2020 Proposal

In the 2020 proposal, the agencies acknowledged that some of the conditions of the 2013 rule's foreign public fund exclusion may not be necessary to ensure consistent treatment of foreign public funds and U.S. registered investment companies. Moreover, some conditions may make it difficult for a non-U.S. fund to qualify for the exclusion or for a banking entity to validate whether a non-U.S. fund qualifies for the exclusion, resulting in certain non-U.S. funds that are similar to U.S. registered investment companies being treated as covered funds.

To address these concerns, the 2020 proposal would have made certain modifications to the foreign public fund exclusion. First, the agencies proposed to replace the requirement that the fund be authorized to be offered and sold to retail investors in the issuer's home jurisdiction (the home jurisdiction requirement) and the requirement that the fund interests be sold predominantly through one or more public offerings outside of the United States, with a requirement that the fund is authorized to offer and sell ownership interests, and such interests are offered and sold, through one or more public offerings outside of the United States. This change would have permitted foreign funds to qualify for the exclusion if they are organized in one jurisdiction but only authorized to be sold to retail investors in another jurisdiction, as this is a fairly common way for foreign retail funds to be organized. Also, no longer requiring a fund to be sold predominantly through one or more public offerings was intended to reduce the difficulty that banking entities have described in determining and monitoring the distribution history and patterns of a third-party sponsored fund or a sponsored fund whose interests are sold through third-party distributors.

The agencies also proposed modifying the definition of “public offering” from the implementing regulations to add a new requirement that the distribution be subject to substantive disclosure and retail investor protection laws or regulations, to help ensure that foreign funds qualifying for this exclusion are sufficiently similar to U.S. registered investment companies. Additionally, the 2020 proposal would have only applied the condition that the distribution comply with all applicable requirements in the jurisdiction where it is made to instances in which the banking entity acts as the investment manager, investment adviser, commodity trading advisor, commodity pool operator, or sponsor. This proposed change was intended to address the potential difficulty that a banking entity investing in a third-party sponsored fund may have in determining whether the distribution of such fund complied with all the requirements in the jurisdiction where it was made.

To simplify the requirements of the exclusion and address concerns described by banking entities with the difficulty in tracking the sale of ownership interests to employees and their immediate family members, the 2020 proposal would have eliminated the limitation on selling ownership interests of the issuer to employees (other than senior executive officers) of the sponsoring banking entity or the issuer (or affiliates of the banking entity or issuer). This change was intended to help align the treatment of foreign public funds with that of U.S. registered investment companies, as the exclusion for U.S. registered investment companies has no such limitation. The 2020 proposal would have continued to limit the sale of ownership interests to directors or senior executive officers of the sponsoring banking entity or the issuer (or their affiliates), as the agencies believed that such a requirement would be simpler for a banking entity to track.

Finally, the 2020 proposal requested comment on the appropriateness of the expectation stated in the preamble to the 2013 rule that, for a U.S. banking entity-sponsored foreign fund to satisfy the condition that it be “predominantly” sold to persons other than the sponsoring U.S. banking entity and certain persons connected to that banking entity, at least 85 percent of the ownership interests in the fund should be sold to such other persons.

Discussion of Comments and the Final Rule

The agencies are adopting all of the proposed changes and are making certain adjustments in response to comments received, as discussed below.

Commenters on the 2020 proposal generally supported the proposed changes to the foreign public funds

exclusion.

Specifically, commenters supported the elimination of the home jurisdiction requirement and the requirement that the fund be sold predominantly through one or more public offerings.

Commenters supported the proposed change to the “public offering” definition to include a requirement that a distribution be subject to substantive disclosure and retail investor protection laws or regulations,

but did not recommend further specifying what substantive disclosure and investor protection requirements should apply because they generally viewed it as unnecessary and overly prescriptive.

Commenters also supported eliminating the restriction on share ownership by employees (other than senior executives and directors) of the U.S. banking entity that sponsors the foreign public fund.

In response to a specific question in the 2020 proposal, one commenter indicated that the proposed changes to the foreign public funds exclusion would not increase the risk of evasion of the requirements of section 13 and the implementing regulations, and thus no additional anti-evasion measures were necessary.

Another commenter stated that the proposed changes were less than ideal but were acceptable after balancing compliance costs and benefits.

IIB; SIFMA; BPI; ABA; EBF; EFAMA; FSF; Investment Company Institute (ICI); BVI; CBA; Committee on Capital Markets Regulation (CCMR); Data Boiler; Goldman Sachs; Investment Adviser Association (IAA); JBA; SAF; and U.S. Chamber of Commerce Center for Capital Markets Competitiveness (CCMC).

IIB; SIFMA; BPI; ABA; EBF; EFAMA; FSF; ICI; BVI; and CBA.

IIB; EFAMA; FSF; ICI; and BVI.

IIB; ICI; and CBA. One commenter supported this assertion by stating that 95 percent of the world's securities markets, including all major emerging markets, have substantive disclosure and retail investor protection rules that are guided by the International Organization of Securities Commissions' common principles for retail funds and the detailed policy work that informs those principles. ICI.

FSF.

SIFMA.

Data Boiler.

Commenters also recommended additional changes to further align the treatment of foreign public funds with that of U.S. registered investment companies or to prevent evasion of the rule.

Specifically, some commenters recommended eliminating the requirement that a fund actually be sold through a public offering and, instead, only require that a fund be authorized to be sold through a public offering.

These commenters generally viewed this requirement as burdensome and difficult to administer and noted that U.S. registered investment companies are not required to be sold in public distributions. The agencies do not consider the fact that there is no requirement for U.S. registered investment companies to be actually sold through public offerings as a sufficient rationale for removing this requirement from the foreign public fund exclusion. Requiring foreign public funds to be sold through one or more public offerings is intended to ensure that such funds are in fact public funds and thus sufficiently similar to U.S. registered investment companies. While there may be certain limited scenarios where a U.S. registered investment company is not sold to retail investors, the agencies believe that the vast majority of U.S. registered investment companies are sold to retail investors. Furthermore, U.S. registered investment companies are subject to robust registration, reporting, and other requirements that are familiar to the agencies, whereas foreign public funds are subject to a differing array of requirements depending on the jurisdiction where they are authorized to be sold. These other jurisdictions may have less developed requirements for retail funds, which may increase the likelihood of a fund seeking authorization for public distribution in certain foreign jurisdictions solely as a means of avoiding the covered fund prohibition. The agencies believe that eliminating this requirement would increase the risk of evasion by permitting foreign funds that may be authorized for sale to retail investors in a foreign jurisdiction—but are only sold through private offerings where no substantive disclosure or retail investor protections exist—to qualify for the exclusion. Such funds would not be comparable to U.S. registered investment companies and would not be the type of fund that foreign public fund exclusion was intended to address. Accordingly, the agencies are not adopting this suggested modification.

One commenter recommended that the agencies create an exclusion from the “proprietary trading” definition for the activities of regulated funds, including foreign public funds, under certain circumstances. ICI. The agencies note that such a change is not within the scope of this rulemaking.

IIB; SIFMA; and EBF.

One trade association commenter suggested eliminating a provision in the “public offering” requirement that prohibits a distribution from being limited to investors with a minimum net worth or net investment assets because some of its members distribute funds, including mutual funds, in offerings that do not meet this requirement but that are nonetheless subject to substantive disclosure and retail investor protection requirements. Similar to the reasons for retaining the requirement that a foreign public fund actually be sold through one or more public offerings, the agencies believe that retaining this requirement is necessary to ensure that funds qualifying for this exclusion are sufficiently similar to U.S. registered investment companies. In fact, one of the identifying characteristics of a covered fund is that its offerings are limited to investors with minimum net worth or net investment assets.

The agencies therefore believe that foreign funds that limit their offerings to investors with a minimum net worth or net investment assets are generally not sufficiently similar to U.S. registered investment companies, and thus the agencies are not adopting this suggested change to the “public offering” definition.

Under the Investment Company Act, certain funds whose offerings are limited to investors with minimum net worth or net investment assets are exempt from registration as investment companies.

See

15 U.S.C. 80a-3(c)(7). These funds are generally treated as covered funds under section 13 of the BHC Act and the implementing regulations.

See

12 U.S.C. 1851(h)(2); implementing regulations § __.10(b)(1)(i).

One commenter opposed the proposed elimination of the requirement in the “public offering” definition that a distribution comply with all applicable requirements in the jurisdiction in which such distribution is being made for a banking entity that does not serve as the fund's investment manager, investment adviser, commodity trading advisor, commodity pool operator, or sponsor.

The final rule adopts this modification as proposed, because the agencies believe the other eligibility criteria for a fund to qualify under the foreign public fund exclusion are sufficient to appropriately identify these funds. In addition, the agencies recognize that it may be difficult or impossible for a banking entity that invests in a third-party fund to know whether the fund's distribution complied with all applicable requirements in the jurisdiction where it was distributed.

Data Boiler.

One commenter recommended that the agencies require 85 percent of a foreign public fund's ownership interests be sold to and owned by “bona fide” retail investors in the fund's home jurisdiction.

However, for the same reasons that the agencies are eliminating the home jurisdiction requirement and the requirement that a fund be sold predominantly through public offerings,

the agencies are not adopting this requirement.

Oleh Zadorestskyy. This commenter also suggested that the agencies require proof that the investors were non-U.S. persons.

Some commenters suggested that the agencies identify common foreign fund types that are presumed to qualify for the exclusion for foreign public funds for the purpose of improving efficiency and simplifying compliance with the rule.

Other commenters recommended that issuers listed on an internationally-recognized exchange and available in retail-level denominations should automatically qualify for the exclusion for similar reasons.

Although the agencies expect many such funds will qualify for the exclusion, the agencies decline to adopt either of these suggested changes, as both would require the agencies' review and on-going monitoring of foreign laws and regulations to ensure that the types of funds that would qualify under these provisions are sufficiently similar to U.S. registered investment companies and that their exclusion as foreign public funds would continue to be appropriate.

IIB and EBF.

IIB; SIFMA; BPI; ABA; FSF; and CBA.

Some commenters recommended that the agencies entirely eliminate the restrictions on share ownership by parties affiliated with a U.S. banking entity sponsor of a foreign public fund.

Other commenters suggested that, if the restrictions on share ownership by banking entities affiliated with the sponsor were retained, the restrictions on share ownership by senior executives and directors should be removed.

The commenters generally viewed these requirements as unnecessary and burdensome to track and monitor. As discussed in the preamble to the 2013 rule, these requirements are intended to prevent evasion of section 13 of the BHC Act.

Additionally, the agencies note that U.S. banking entity sponsors of foreign public funds would need to track the ownership of such funds by their affiliates and management officials even if the requirements were eliminated in order to determine whether they control such funds for BHC Act purposes.

Thus, for a U.S. banking entity relying on this exclusion with respect to a fund that it sponsors, the agencies are retaining the requirement that the fund be sold predominantly to persons other than the U.S. banking entity sponsor, the fund, affiliates of such sponsoring banking entity or fund, and the directors and senior executive officers of such entities (collectively, “U.S. banking entity sponsor and associated parties”).

SIFMA and FSF.

SIFMA; BPI; ICI; and CCMC.

79 FR 5678-79.

See

12 CFR 225.2(e); 12 CFR 225.31(d)(2)(ii). If a foreign public fund is controlled by a banking entity for BHC Act purposes, such fund could also be being treated as a banking entity under section 13.

See

implementing regulations § __.2(c); FAQ 14.

Relatedly, some commenters recommended that the agencies modify their expectation of the level of ownership of a foreign public fund that would satisfy the requirement that a fund be “predominantly” sold to persons other than its U.S. banking entity sponsor and associated parties,

which, in the preamble to the 2013 rule, the agencies stated was 85 percent or more (which would permit the U.S. banking entity sponsor and associated parties to own the remaining 15 percent). These commenters asserted that the relevant ownership threshold for U.S. registered investment companies is 25 percent, and that, for foreign public funds, the threshold should be the same. The agencies agree that the permitted ownership level of a foreign public fund by a U.S. banking entity sponsor and associated parties should be aligned with the functionally equivalent threshold for banking entity investments in U.S. registered investment companies, which is 24.9 percent.

Accordingly, the agencies have amended this provision in the final rule to require that more than 75 percent of the fund's interests be sold to persons other than the U.S. banking entity sponsor and associated parties.

BPI; FSF; ICI; and CCMC.

Although the implementing regulations do not explicitly prohibit a banking entity from acquiring 25 percent or more of a U.S. registered investment company, a U.S. registered investment company would become a banking entity if it is affiliated with another banking entity (other than as described in § __.12(b)(1)(ii) of the implementing regulations).

See

79 FR 5732 (“[F]or purposes of section 13 of the BHC Act and the final rule, a registered investment company . . . will not be considered to be an affiliate of the banking entity if the banking entity owns, controls, or holds with the power to vote less than 25 percent of the voting shares of the company or fund, and provides investment advisory, commodity trading advisory, administrative, and other services to the company or fund only in a manner that complies with other limitations under applicable regulation, order, or other authority.”).

For a U.S. banking entity that sponsors a foreign public fund, crossing the 24.9 percent ownership threshold (other than during a permitted seeding period) would cause the fund to be a covered fund (if no other exclusion applied), in which case the banking entity would be in violation of the 3 percent per-fund investment limit.

See

implementing regulations § __.12(a)(2)(ii)(A). The agencies believe that such a strict prohibition against a U.S. banking entity acquiring 25 percent or more of a foreign public fund that it sponsors is appropriate because of the elevated risk of evasion by the sponsoring banking entity, which may be able to control the investments made by the fund.

One commenter recommended that, with respect to foreign public funds sponsored by U.S. affiliates of foreign banking entities, the agencies exclude the sponsoring U.S. banking entity's non-U.S. affiliates and their directors and employees from the restrictions on share ownership, provided that such non-U.S. affiliates are not controlled by a U.S. banking entity.

This commenter asserted that there is no U.S. financial stability or safety and soundness benefit to applying this restriction to such non-U.S. affiliates and their directors and employees, as the risks of any such investments are borne solely outside the United States. However, with the change described above, which permits a U.S. banking entity sponsor and associated parties to hold less than 25 percent of a foreign public fund, the agencies do not believe that this change is necessary. Even if the requirement were modified as the commenter suggested, the banking entity and its affiliates would still be limited to owning less than 25 percent of the fund without the fund becoming a banking entity.

IIB.

One commenter requested that the agencies modify § __.12(b)(1) of the implementing regulations, which governs attribution of ownership interests in covered funds to banking entities, to clarify that the banking entity “or an affiliate” can provide the advisory, administrative, or other services required in § __.12(b)(1)(ii)(B) for the non-attribution rule to apply. The commenter requested this clarification because § __.12(b)(1)(ii)(B) is cross-referenced by FAQ 14, which, as discussed above, states that a foreign public fund will not be treated as a banking entity if it complies with the test in § __.12(b)(1)(ii) (

i.e.,

the banking entity holds less than 25 percent of the voting shares in the foreign public fund and provides advisory, administrative, or other services to the fund). The agencies confirm that the requested interpretation is correct and, accordingly, have amended § __.12(b)(1)(ii) of the implementing regulations to clarify that the ownership limit applies to the banking entity and its affiliates, in the aggregate, and the requirement that the banking entity provide advisory or other services can be satisfied by the banking entity or its affiliates.

One commenter noted that FAQ 16, which relates to the seeding period for foreign public funds, uses 3 years as an example of the duration of such a seeding period, and requested that the agencies confirm that a foreign public fund's seeding period can be longer than

3 years.

Another commenter requested that the agencies codify the 3-year seeding period in the implementing regulations.

The agencies believe that, depending on the facts and circumstances of a particular foreign public fund, the appropriate duration of its seeding period may vary and, under certain facts and circumstances, may exceed three years. The agencies believe that this flexibility is appropriate and thus decline to further specify such a limit. Another commenter requested that the agencies codify the foreign public fund seeding FAQ,

FAQ 14, and FAQ 16, both described above, in the implementing regulations.

The agencies decline to codify these FAQs at this time but note that the final rule does not modify or revoke any previously issued staff FAQs, unless otherwise specified.

IAA.

CCMC.

The foreign public fund seeding FAQ states that staffs of the agencies would not advise that a seeding vehicle that is operated pursuant to a written plan to become a foreign public fund and that meets certain conditions be treated as a covered fund during such seeding period.

IIB.

In the final rule, the agencies are adopting the amendments to the foreign public funds exclusion as proposed, with the additional modifications described above. The agencies believe the revised requirements will make the foreign public fund exclusion more effective by expanding its availability, providing clarity, and simplifying compliance with its requirements, while continuing to ensure that the funds that qualify are sufficiently similar to U.S. registered investment companies.

2. Loan Securitizations

Section 13 of the BHC Act provides that “[n]othing in this section shall be construed to limit or restrict the ability of a banking entity . . . to sell or securitize loans in a manner otherwise permitted by law.”

To effectuate this statutory mandate, the 2013 rule excluded from the definition of covered fund loan securitizations that issue asset-backed securities and hold only loans, certain rights and assets that arise from the structure of the loan securitization or from the loans supporting a loan securitization, and a small set of other financial instruments (permissible assets).

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

See

2013 rule § __.10(c)(8). Loan is further defined as any loan, lease, extension of credit, or secured or unsecured receivable that is not a security or derivative. Implementing regulations § __.2(t).

Since the adoption of the 2013 rule, several banking entities and other participants in the loan securitization industry have commented that the limited set of permissible assets has inappropriately restricted their ability to use the loan securitization exclusion. In the 2018 proposal, the agencies asked several questions regarding the efficacy and scope of the exclusion and the Loan Securitization Servicing FAQ.

Comments focused on permitting small amounts of non-loan assets and clarifying the treatment of leases and related assets.

83 FR 33480-81.

In response to these concerns, the 2020 proposal would have codified the Loan Securitization Servicing FAQ and permitted loan securitizations to hold a small amount of non-loan assets. The agencies requested comment on all aspects of the proposed changes to the loan securitization exclusion, and comments were generally supportive of the proposed revisions.

Several commenters also suggested revisions to the 2020 proposal.

Comments are discussed in detail below.

E.g.,

SIFMA; BPI; Managed Funds Association (MFA); PNC Financial Services Group, Inc. (PNC); Goldman Sachs; Loan Syndications and Trading Association (LSTA); and Structured Finance Association (SFA).

E.g.,

SIFMA; CCMC; BPI; and IIB.

One commenter suggested that some jurisdictions' risk retention rules may vary from the regulations implementing section 15G of the Exchange Act (15 U.S.C. 78o-11), which requires a banking entity to retain and maintain a certain minimum interest in certain asset-backed securities.

See

IIB. This commenter recommended allowing banking entities to hold certain investments in compliance with certain foreign laws (

e.g.,

European risk retention rules). The agencies understand that rules for risk retention vary across jurisdictions. However, the agencies believe that the requested action is outside the scope of the current rulemaking. In addition, another commenter requested that the agencies clarify the definition of asset-backed securities as used in the loan securitization exclusions.

See

Arnold & Porter Kaye Scholer LLP (Arnold & Porter). The agencies discuss the definition of asset-backed securities in Section IV.C.1.iii (Credit Funds),

infra.

Servicing Assets

The implementing regulations permit loan securitizations to hold rights or other assets (servicing assets) that arise from the structure of the loan securitization or from the loans supporting a loan securitization.

Rights or other servicing assets are assets designed to facilitate the servicing of the underlying loans or the distribution of proceeds from those loans to holders of the asset-backed securities.

In response to confusion regarding the scope of the provisions permitting servicing assets and a separate provision limiting the types of permitted securities, the staffs of the agencies released the Loan Securitization Servicing FAQ. The FAQ clarified that a servicing asset may or may not be a security, but if the servicing asset is a security, it must be a permitted security under the rule.

§§ __.2(t); __.10(c)(8)(i)(D); __.10(c)(8)(v).

See, e.g.,

FASB Statement No. 156: Accounting for Servicing of Financial Assets, ¶ 61 (FAS 156).

The 2020 proposal would have codified the Loan Securitization Servicing FAQ in the implementing regulations to clarify the scope of the servicing asset provision.

Commenters generally supported the codification of the Loan Securitization Servicing FAQ, indicating that such a codification would promote transparency and ensure continued use of the loan securitization exclusion.

For the above reasons, the final rule adopts the codification of the Loan Securitization Servicing FAQ as proposed.

The 2020 proposal also clarified that special units of beneficial interest and collateral certificates meeting the requirements of paragraph (c)(8)(v) of the exclusion that are securities need not meet the requirements of paragraph (c)(8)(iii) of the exclusion.

See

2020 proposal § __.10(c)(8)(i)(B). The agencies are adopting this revision, as proposed.

E.g.,

SIFMA; PNC; and SFA. One commenter indicated that the current Loan Securitization Servicing FAQ was sufficient and that codifying the FAQ was not necessary; however, the commenter did not elaborate on or justify this position. Data Boiler.

Cash Equivalents

The loan securitization exclusion permits issuers relying on the exclusion to hold certain types of contractual rights or assets related to the loans underlying the securitization, including cash equivalents. In response to questions about the scope of the cash equivalents provision, the Loan Securitization Servicing FAQ stated that “cash equivalents” means high quality, highly liquid investments whose maturity corresponds to the securitization's expected or potential need for funds and whose currency corresponds to either the underlying loans or the asset-backed securities.

To promote transparency and clarity, the 2020 proposal would have codified this additional language in the Loan Securitization Servicing FAQ regarding the meaning of “cash equivalents.”

The agencies did not propose requiring “cash equivalents” to be “short term,” because the agencies recognized that a loan securitization may need greater flexibility to match the maturity of high quality, highly liquid investments to its expected or potential need for funds. Commenters generally supported the codification of the definition of “cash equivalents” in the loan securitization

exclusion.

The final rule adopts the codification of “cash equivalents” as proposed.

See supra,

n.14.

2020 proposed rule § __.10(c)(8)(iii)(A).

E.g.,

LSTA; PNC; and SIFMA. One commenter expressed opposition to this codification but did not elaborate or justify this position.

See

Data Boiler.

Limited Holdings of Certain Debt Securities

In the preamble to the 2013 rule, the agencies declined to permit loan securitizations to hold a certain amount of non-loan assets.

The agencies supported a narrow scope of permissible assets in loan securitizations, suggesting that such an approach would be consistent with the purpose of section 13 of the BHC Act.

79 FR 5687-88.

79 FR 5687.

Several commenters on the 2018 proposal disagreed with the agencies' views and supported expanding the range of permissible assets in an excluded loan securitization. After considering the comments received on the 2018 proposal, the 2020 proposal would have allowed a loan securitization vehicle to hold up to five percent of the fund's total assets in non-loan assets. The agencies indicated that authorizing loan securitizations to hold small amounts of non-loan assets could, consistent with section 13 of the BHC Act, permit loan securitizations to respond to investor demand and reduce compliance costs associated with the securitization process without significantly increasing risk to banking entities and the financial system.

The agencies requested comment on, among other things, the maximum amount of permitted non-loan assets, the methodology for calculating the cap on non-loan assets, and whether the agencies should limit the type of assets that could be held under the non-loan asset provision. Specifically, the agencies requested comment on whether the non-loan asset provision should be limited to debt securities or should exclude certain financial instruments such as derivatives and collateralized debt obligations.

85 FR 12128-29.

Commenters were generally supportive of allowing loan securitizations to hold a limited amount of non-loan assets.

These commenters indicated that the requirements for the current loan securitization exclusion are too restrictive and excessively limit use of the exclusion and prevent issuers from responding to investor demand, and suggested that a limited bucket of non-loan assets would not fundamentally alter the characteristics and risks of securitizations or otherwise increase risks in banking entities or the financial system.

E.g.,

SIFMA; CCMC; ABA; Credit Suisse; MFA; Goldman Sachs; LSTA; BPI; and SFA.

E.g.,

LSTA and Goldman Sachs.

Several commenters recommended against limiting the type of assets that could be held per the non-loan asset provision.

For example, one commenter stated that allowing excluded loan securitizations to invest in any class of asset would allow those vehicles to achieve investment goals during periods of constrained loan supply, while another commenter indicated that such a restriction would be unnecessary given that the low limit on non-loan assets would constrain risks.

In contrast, one commenter suggested limiting the type of permissible assets to securities with risk characteristics similar to loans.

E.g.,

MFA; LSTA; and SFA. One commenter also requested that the agencies make clear that the non-loan assets would not be subject to the other provisions of the loan securitization exclusion. LSTA.

SFA and LSTA.

JBA.

Numerous commenters suggested raising the cap on non-loan assets from five percent of assets to ten percent of assets,

while one commenter indicated that a five percent cap would be sufficient.

Commenters that supported an elevated limit on non-loan assets generally argued that a ten percent limit would further reduce compliance burdens while not materially increasing risk.

SIFMA; CCMC; ABA; Credit Suisse; MFA; Goldman Sachs; LSTA; and SFA.

PNC. Another commenter who generally supported the proposed modifications to the loan securitization exclusion did not urge the agencies to raise the cap on non-loan assets.

See

BPI.

E.g.,

LSTA; SIFMA; and Goldman Sachs.

Several commenters also suggested a method for calculating the cap on non-loan assets: The par value of assets on the day they are acquired.

100

These commenters suggested that relying on par value is accepted practice in the loan securitization industry and would obviate concerns related to tracking amortization or prepayment of loans in a securitization portfolio.

101

One of these commenters further specified that the limit should be calculated (1) according to the par value of the acquired assets on the date of investment over the securitization's total collateral pool and (2) only at the time of investment.

102

Another commenter indicated that the cap should be calculated as the lower of the purchase price and par value of the non-qualifying assets over the issuer's aggregate capital commitments plus its subscription based credit facility.

103

A third commenter suggested having a separate valuation mechanism for equity securities, which the commenter suggested should be market value upon acquisition.

104

100

SIFMA; BPI; ABA; and LSTA.

101

SIFMA and BPI.

102

BPI.

103

Goldman Sachs.

104

SFA.

Finally, two commenters opposed allowing excluded loan securitizations to hold non-loan assets and suggested that such a change would be contrary to the purpose of section 13 of the BHC Act or would result in loan securitizations with differing risk characteristics, potentially increasing monitoring costs on investors.

105

In addition, a commenter claimed that the 2020 proposal to allow excluded loan securitizations to hold non-loan assets would be contrary to section 13 of the BHC Act.

106

Specifically, this commenter suggested that the rule of construction in 12 U.S.C. 1851(g)(2) only permits the securitization or sale of loans and that legislative history supports this reading of the statute.

105

JBA and Data Boiler.

106

Occupy.

The agencies previously concluded and continue to believe they have legal authority to adopt the proposed allowance for a limited amount of non-loan assets.

107

Section 13(g)(2) of the BHC Act states, “[n]othing in this section shall be construed to limit or restrict the ability of a banking entity or nonbank financial company supervised by the Board to sell or securitize loans in a manner otherwise permitted by law.”

108

This rule of construction is permissive—it allows the agencies to design the regulations implementing section 13 in a way that accommodates and does not unduly “limit or restrict” the ability of banking entities to sell or securitize loans. Contrary to the commenter's argument, this provision does not mandate that any loan securitization exclusion only relate to loans. As discussed in this section and the preamble to the 2020 proposal,

109

the agencies believe that allowing excluded loan securitizations to hold limited amounts of non-loan assets would, in fact, promote the ability of

banking entities to sell or securitize loans.

107

See

79 FR 5688-92 (stating, for example, that “[t]he [a]gencies also do not believe that they lack the statutory authority to permit a loan securitization relying on the loan securitization exclusion to use derivative[s,] as suggested by [Occupy]” and that, more broadly, the agencies have the authority to allow excluded loan securitizations to hold non-loan assets).

108

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

109

85 FR 12128-29.

After considering the foregoing comments, the agencies are revising the loan securitization exclusion to permit a loan securitization to hold a limited amount of debt securities. Loan securitizations provide an important mechanism for banking entities to fund lending programs. Allowing loan securitizations to hold a small amount of debt securities in response to customer and market demand may increase a banking entity's capacity to provide financing and lending. To minimize the potential for banking entities to use this exclusion to engage in impermissible activities or take on excessive risk, the final rule permits a loan securitization to hold debt securities (excluding asset-backed securities and convertible securities), as opposed to any non-loan assets, as the 2020 proposal would have allowed.

110

Final rule § __.10(c)(8)(i)(E).

Although several commenters supported allowing a loan securitization to hold any non-loan asset to provide flexibility and allow the issuer's investment manager to respond to changing market demands, the agencies believe that limiting the assets to debt securities is more consistent with the activities of an issuer focused on securitizing loans, rather than engaging in other activities. The agencies have determined, consistent with the views of another commenter, that non-loan assets with materially different risk characteristics from loans could change the character and complexity of an issuer and raise the type of concerns that section 13 of the BHC Act was intended to address. Moreover, as described further below, limiting the assets to those with risk characteristics that are similar to loans will allow for a simpler and more transparent calculation of the five percent limit, which will facilitate banking entities' compliance with the exclusion. For the same reasons, the final rule does not permit a loan securitization to hold asset-backed securities or convertible securities as part of its five percent allowance for debt securities. This helps to ensure that a loan securitization will not be exposed to complex financial instruments and will retain the general characteristic of a loan securitization issuer.

Similarly, to reduce potential risk-taking and to ensure that the fund is composed almost entirely of loans with minimal non-loan assets, the final rule retains the 2020 proposal's five percent limit on non-loan assets. Commenters differed on whether raising the limit on non-loan assets was appropriate or necessary to ensure flexibility, and it is not clear what benefit would accrue to issuers who could hold debt securities of, for example, seven or ten percent versus five percent. The amount of non-loan assets held by a fund should not be so significant that it fundamentally changes the character of the fund from one that is engaged in securitizing loans to one that is engaged in investing in other types of assets.

The agencies are also clarifying the methodology for calculating the five percent limit on non-convertible debt securities.

111

The 2020 proposal only provided that “the aggregate value of any such other assets must not exceed five percent of the aggregate value of the issuing entity's assets” and requested comment about how the agencies should calculate this limit.

112

As suggested by several commenters, the final rule specifies that the limit on non-convertible debt securities must be calculated at the most recent time of acquisition of such assets. Specifically, the aggregate value of debt securities held under § __.10(c)(8)(i)(E) of the final rule may not exceed five percent of the aggregate value of loans held under § __.10(c)(8)(i)(A), cash and cash equivalents held under § __.10(c)(8)(iii)(A), and debt securities held under § __.10(c)(8)(i)(E), where the value of the loans, cash and cash equivalents, and debt securities is calculated at par value at the time any such debt security is purchased.

113

111

Final rule § __.10(c)(8)(i)(E)(

)-(

112

2020 proposal § __.10(c)(8)(i)(E); 85 FR 12129.

113

Final rule § __.10(c)(8)(i)(E)(

)-(

The agencies have chosen the most recent time of acquisition of non-convertible debt securities as the moment of calculation to simplify the manner in which the 5 percent cap applies. This would permit an issuer that, at some point in its life, held debt securities in excess of five percent of its assets to qualify for the exclusion if it came into compliance with the five percent limit prior to a banking entity relying on the exclusion with respect to such issuer. The agencies believe that a continuous monitoring obligation could impose significant burdens on excluded issuers and could cause an issuer to be disqualified from the loan securitization exclusion based on market events not under its control. It is also unnecessary to require this calculation at other intervals because limiting permissible assets to those that have similar characteristics as loans addresses the potential for evasion of the five percent limit that could arise if the issuer held more volatile assets.

114

The agencies also have authority to address acts that function as an evasion of the requirements of the exclusion.

See

implementing regulations § __.21.

In the final rule, this measurement is based only on the value of the loans and debt securities held under §§ __.10(c)(8)(i)(A) and (E) and the cash and cash equivalents held under § __.10(c)(8)(iii)(A) rather than the aggregate value of all of the issuing entity's assets. The purpose of the five percent limit is to ensure the investment pool of a loan securitization is composed of loans. Therefore, the calculation takes into account the assets that should make up the issuing entity's investment pool and excludes the value of other rights or incidental assets, as well as derivatives held for risk management. This further simplifies the calculation methodology by excluding assets that may be more complex to value and that are ancillary to the loan securitization's investment activities. This straightforward calculation methodology will ensure that the loan securitization exclusion remains easy to use and will facilitate banking entities' compliance with the exclusion.

The agencies recognize that a loan securitization's transaction agreements may require that some categories of loans, cash equivalents, or debt securities be valued at fair market value for certain purposes. To accommodate such situations, the exclusion provides that the value of any loan, cash equivalent, or permissible debt security may be based on its fair market value if (1) the issuing entity is required to use the fair market value of such loan or debt security for purposes of calculating compliance with concentration limitations or other similar calculations under its transaction agreements and (2) the issuing entity's valuation methodology values similarly situated assets, for example non-performing loans, consistently. This provision is intended to provide issuers with the flexibility to leverage existing calculation methodologies while preventing issuers from using inconsistent methodologies in a manner to evade the requirements of the exclusion.

Leases

A commenter on the 2018 proposal suggested that the loan securitization exclusion be expanded to cover leases and related assets, including operating or capital leases.

115

In response, in the 2020 proposal the agencies stated that they were “not proposing to separately

list leases within the loan securitization exclusion because leases are included in the definition of loan and thus are permitted assets for loan securitizations under the current exclusion.”

116

That same commenter made a comment on the 2020 proposal urging the agencies to reconsider explicitly including operating leases and leased properties in the loan securitization exclusion.

117

This commenter asserted that unless the agencies specifically revise the definition of “rights or other assets” to explicitly include leased property, then securitization vehicles with operating leases that rely on the residual property value after expiration of the lease to support their asset-backed securities would not be able to qualify under the loan securitization exemption, despite the 2013 rule's provisions for special units of beneficial interest and collateral certificates.

115

See

85 FR 12128.

116

Id.

117

SFA.

Consistent with the 2020 proposal, the agencies are not separately listing leases within the loan securitization exclusion because leases are included in the definition of loan and thus are permitted assets for loan securitizations under the current exclusion. The agencies are also not modifying the definition of “rights or other assets” to explicitly include leased property, as any residual value of such leased property upon expiration of an operating lease should meet the requirements to constitute an asset that is related or incidental to purchasing or otherwise acquiring and holding loans.

3. Public Welfare and Small Business Funds

i. Public Welfare Funds

Section 13(d)(1)(E) of the BHC Act permits, among other things, a banking entity to make and retain investments that are designed primarily to promote the public welfare of the type permitted under 12 U.S.C. 24(Eleventh).

118

Consistent with the statute, the implementing regulations exclude from the definition of “covered fund” issuers that make investments that are designed primarily to promote the public welfare, of the type permitted under paragraph 11 of section 5136 of the Revised Statutes of the United States (12 U.S.C. 24), including the welfare of low- and moderate-income communities or families (such as providing housing, services, or jobs) (the public welfare investment exclusion).

119

118

See

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

119

Implementing regulations § __.10(c)(11)(ii)(A).

The 2020 proposal noted that the OCC's regulations implementing 12 U.S.C. 24(Eleventh) provide that investments that receive consideration as qualified investments under the regulations implementing the Community Reinvestment Act (CRA) are public welfare investments for national banks.

120

The 2020 proposal requested comment on whether any change should be made to clarify that all permissible public welfare investments, under any agency's regulation, are excluded from the covered fund restrictions.

121

The 2020 proposal specifically asked whether investments that would receive consideration as qualified investments under the CRA should be excluded from the definition of covered fund, either by incorporating these investments into the public welfare investment exclusion or by establishing a new exclusion for CRA-qualifying investments.

122

120

See

85 FR 12130; 12 CFR 24.3.

121

See

85 FR 12130 (noting that such a change could provide additional certainty regarding community development investments made through fund structures).

122

See id.

In addition, the 2020 proposal requested comment on whether Rural Business Investment Companies (RBICs) are typically excluded from the definition of “covered fund” because of the public welfare investment exclusion or another exclusion and on whether the agencies should expressly exclude RBICs from the definition of covered fund.

123

RBICs are licensed under a program designed to promote economic development and job creation in rural communities by investing in companies involved in the production, processing, and supply of food and agriculture-related products.

124

123

See id.

124

See id.

The Tax Cuts and Jobs Act established the “opportunity zone” program to provide tax incentives for long-term investing in designated economically distressed communities.

125

The program allows taxpayers to defer and reduce taxes on capital gains by reinvesting gains in “qualified opportunity funds” (QOF) that are required to have at least 90 percent of their assets in designated low-income zones.

126

The 2020 proposal requested comment on whether many or all QOFs would meet the terms of the public welfare investment exclusion and on whether the agencies should expressly exclude QOFs from the definition of covered fund.

127

125

See id.

126

See id.

127

See id.

Commenters generally supported clarifying that funds that make investments that qualify for consideration under the CRA qualify for the public welfare investment exclusion.

128

Commenters noted that this clarification would be consistent with the OCC's regulations concerning public welfare investments and the CRA, provide greater certainty, and avoid unnecessarily chilling public welfare investment activities.

129

One commenter stated that some banking entities have been reluctant to invest in certain community development funds due to uncertainty as to whether these funds were covered funds.

130

This commenter stated that explicitly excluding funds that qualify for consideration under the CRA from the definition of covered fund would eliminate this uncertainty and would help support the type of community development efforts that the public welfare investment exclusion was designed to promote.

131

In addition, some commenters recommended excluding funds that qualify for the public welfare investment exclusion from the definition of “banking entity.”

132

128

See

SIFMA; FSF; BPI; ABA; PNC; Community Development Venture Capital Alliance (CDVCA); IIB; and Data Boiler (stating that incorporating the CRA public welfare exemption may ease some challenges faced by communities during the current COVID pandemic, but all PWI should not be excluded).

129

See

SIFMA; FSF; and CDVCA.

130

See

CDVCA.

131

See id.

132

See

SIFMA; BPI; ABA; and IIB.

Commenters also generally favored explicitly excluding RBICs and QOFs from the definition of “covered fund,” either by adopting new exclusions, or by clarifying the scope of the public welfare investment exclusion.

133

Commenters stated that explicitly excluding these funds from the definition of “covered fund” would be consistent with the statutory provision permitting public welfare investments. Commenters stated that RBICs and QOFs must make investments that are clearly designed primarily to promote the public welfare because they are required to invest primarily in ways that promote job creation in rural communities (which may have significant low- and moderate-income populations or be economically disadvantaged and in need of revitalization or stabilization) and in economically distressed communities, respectively.

134

Commenters stated that

certain RBICs and QOFs qualify for the public welfare investment exclusion, but providing an express exclusion for these funds would reduce uncertainty and associated compliance burdens and would encourage banking entities to provide capital to projects that promote economic development in rural and low-income communities.

135

One commenter stated that RBICs and QOFs engage in investments that are substantively similar or identical to those of public welfare investment funds that are already excluded from the definition of covered fund and of the type that Congress recognized that section 13 of the BHC Act was not designed to prohibit.

136

Another commenter stated that explicitly excluding RBICs would result in the provision of valuable expertise and services to RBICs and provide funding and assistance to small businesses and low- and moderate-income communities.

137

One commenter expressed skepticism about providing a new exclusion for RBICs and QOFs but suggested that certain of these funds may currently qualify for the public welfare investment exclusion.

138

Another commenter stated that it is not necessary to expressly exclude QOFs from the definition of covered fund, noting that these funds should be of the type primarily intended to promote the public welfare of low- and moderate-income areas and should therefore qualify for the current public welfare investment exclusion.

139

133

See

SIFMA; FSF; ABA (addressing QOFs); and Small Business Investor Alliance (SBIA) (addressing RBICs).

134

See

SIFMA and FSF.

135

See

SIFMA and FSF.

136

See

SIFMA.

137

See

SBIA.

138

See

Data Boiler.

139

See

PNC.

After carefully considering the comments received, the agencies are revising the public welfare investment exclusion to explicitly incorporate funds, the business of which is to make investments that qualify for consideration under the Federal banking agencies' regulations implementing the CRA.

140

Explicitly excluding these types of investments from the definition of covered fund clarifies and gives full effect to the statutory exemption for public welfare investments.

141

In addition, this clarification will reduce uncertainty and will facilitate public welfare investments by banking entities.

140

Final rule § __.10(c)(11)(ii)(A).

141

See

12 U.S.C. 1851(d)(1)(E). A banking entity must have independent authority to make a public welfare investment. For example, a banking entity that is a state member bank may make a public welfare investment to the extent permissible under 12 U.S.C. 338a and 12 CFR 208.22.

The agencies are also adopting explicit exclusions from the definition of covered fund for RBICs and QOFs in § __.10(c)(11) of the final rule. These types of funds were created by Congress to promote development in rural and low-income communities, and, due to their similarity to SBICs and public welfare investments, the agencies believe that section 13 of the BHC Act was not intended to restrict the types of funds that engage in those activities. RBICs are companies licensed under the Rural Business Investment Program, a program designed to promote economic development and the creation of wealth and job opportunities among individuals living in rural areas and to help meet the equity capital investment needs primarily of smaller enterprises located in such areas.

142

Likewise, QOFs were developed as part of a program to promote long-term investing in designated economically distressed communities and are required to have at least 90 percent of their assets in designated low-income zones.

143

Congress created RBICs and QOFs to encourage investment in rural areas, small enterprises, and low-income areas. Providing an explicit exclusion for these funds in the implementing regulations gives effect to section 13 of the BHC Act's provision permitting public welfare investments and avoids chilling the activities of funds that were not the target of section 13 of the BHC Act.

144

Although many of these funds may already qualify for the public welfare investment exclusion, the agencies are explicitly excluding these funds from the definition of covered fund to reduce uncertainty and compliance burden. Thus, under the final rule, a covered fund does not include an issuer that has elected to be regulated or is regulated as a RBIC, as described in 15 U.S.C. 80b-3(b)(8)(A) or (B), or that has terminated its participation as a RBIC in accordance with 7 CFR 4290.1900 and does not make any new investments (other than investments in cash equivalents, which, for the purposes of this paragraph, means high quality, highly liquid investments whose maturity corresponds to the issuer's expected or potential need for funds and whose currency corresponds to the issuer's assets) after such termination.

145

Likewise, under the final rule, a covered fund does not include an issuer that is a QOF, as defined in 26 U.S.C. 1400Z-2(d).

146

142

See, e.g.,

Rural Business Investment Company (RBIC) Program, 85 FR 16519, 16520 (Mar. 24, 2020).

143

See

26 U.S.C. 1400Z-2(d).

144

See

12 U.S.C. 1851(d)(1)(E); 156 Cong. Rec. S5896 (daily ed. July 15, 2010) (Statement of Sen. Merkley) (noting that Section 13(d)(1)(E) permits investments “of the type” permitted under 12 U.S.C. 24 (Eleventh), including “a range of low-income community development and other projects,” but “is flexible enough to permit the [agencies] to include other similar low-risk investments with a public welfare purpose”).

145

Final rule § __.10(c)(11)(iii). As with SBICs, discussed below, the final rule contemplates that an issuer that ceases to be a RBIC during wind-down may continue to qualify for the exclusion from the definition of “covered fund” for RBICs if the issuer satisfies certain conditions designed to prevent abuse.

146

Final rule § __.10(c)(11)(iv). As with other types of issuers excluded from the covered fund definition, a banking entity must have independent authority to invest in a QOF.

The final rule does not exclude funds that qualify for the public welfare investment exclusion from the definition of “banking entity” as requested by some commenters.

147

The term “banking entity” is specifically defined in section 13 of the BHC Act.

148

In addition, the agencies do not believe that applying the definition of banking entity places an undue burden on banking entities' public welfare investments. The agencies believe that banking entities are able to design their permissible public welfare investments so as not to cause the investment fund to become a banking entity. For public welfare investment funds that are banking entities, the agencies believe that the burden-reducing amendments adopted in this final rule and the 2019 amendments should mitigate concerns about compliance burdens.

147

See

SIFMA and BPI.

148

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

ii. Small Business Investment Companies

Consistent with section 13 of the BHC Act,

149

the implementing regulations exclude from the definition of “covered fund” SBICs and issuers that have received notice from the Small Business Administration to proceed to qualify for a license as an SBIC, which notice or license has not been revoked.

150

The agencies proposed revising the exclusion for SBICs to clarify how the exclusion would apply to SBICs that surrender their licenses during wind-down phases.

151

Specifically, the agencies proposed revising the exclusion for SBICs to apply explicitly to an issuer that has voluntarily surrendered its license to operate as an SBIC in accordance with 13 CFR 107.1900 and does not make new investments (other than investments in cash equivalents) after such voluntary

surrender.

152

The agencies explained that applying the exclusion to an issuer that has surrendered its SBIC license is appropriate because of the statutory exemption for investments in SBICs and because banking entities may otherwise become discouraged from investing in SBICs due to concerns that an SBIC may become a covered fund during its wind-down phase.

153

The agencies further noted that the proposed revisions included a number of requirements designed to ensure that the exclusion would not be abused.

154

In particular, the exclusion would apply only to an issuer that voluntarily surrenders its license in accordance with 13 CFR 107.1900 and that does not make any new investments (other than investments in cash equivalents).

155

149

See

12 U.S.C. 1851(d)(1)(E) (permitting investments in SBICs).

150

See

implementing regulations § __.10(c)(11)(i).

151

See

85 FR 12131.

152

See id.

153

See id.;

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

154

See

85 FR 12131.

155

See id.

Most commenters that directly addressed the 2020 proposal's revisions concerning SBICs supported the proposed revisions, stating that the proposed revisions would provide greater certainty to banking entities wishing to invest in SBICs and would increase investment in small businesses.

156

One commenter stated that revising the exclusion for SBICs would prevent a banking entity from being forced to sell an interest in an SBIC that became a covered fund for reasons outside of the banking entity's control.

157

Commenters further noted that the proposed revisions included sufficient safeguards against evasion and did not present safety or soundness concerns.

158

One commenter recommended against revising the exclusion from the definition of covered fund for SBICs. This commenter expressed concern about frequent buying and selling of SBICs and noted that section 13 of the BHC Act and its implementing regulations do not prohibit a banking entity from lending to small businesses.

159

The commenter further expressed concern that an SBIC that surrenders its license may be doing so because it has failed or no longer wishes to comply with the Small Business Administration's regulations.

160

156

See

SIFMA; BPI; ABA; PNC; and SBIA.

157

See

SBIA.

158

See

SIFMA; BPI; and SBIA.

159

See

SIFMA; BPI; and SBIA.

160

See

Data Boiler.

After carefully considering the comments received, the agencies are adopting the revisions to the exclusion from the definition of covered fund for SBICs, as proposed.

161

The revisions will provide greater certainty to banking entities, give full effect to the provision of section 13 of the BHC Act that permits investments in SBICs, and support capital formation for small businesses. In response to one commenter's concerns regarding the exclusion for SBICs,

162

the agencies note that a banking entity's investment in an SBIC must comply with all applicable laws and regulations, including the prohibition against proprietary trading under section 13 of the BHC Act and its implementing regulations. Furthermore, as noted above, the revised exclusion for SBICs includes safeguards designed to prevent abuse or evasion. In particular, the exclusion would only apply to an issuer that has voluntarily surrendered its license to operate as an SBIC in accordance with 13 CFR 107.1900 and that does not make new investments (other than investments in cash equivalents) after such voluntary surrender.

161

See

final rule § __10(c)(11)(i).

162

See

Data Boiler.

C. Additional Covered Fund Exclusions

In addition to modifying certain existing exclusions, the agencies are creating four new exclusions from the definition of “covered fund” to better tailor the provision to the types of entities that section 13 was intended to cover. These exclusions are for credit funds, venture capital funds, family wealth management vehicles, and customer facilitation vehicles.

General Comments

Many commenters were broadly supportive of the proposed new exclusions from the definition of “covered fund.”

163

Some commenters recommended adopting additional exclusions for an array of fund types and situations, including for tender bond vehicles,

164

ownership interests erroneously acquired or retained,

165

certain real estate funds,

166

and funds in their seeding period.

167

The agencies are declining to adopt these suggested exclusions because the requested actions are outside the scope of the current rulemaking. In addition, one commenter urged the agencies to redefine the definition of “covered fund,” to rely on a characteristics-based approach.

168

The agencies decline to revise the definition of “covered fund” for the reasons articulated in the preamble to the 2013 rule.

169

163

E.g.,

SIFMA; JBA; Credit Suisse; and SAF.

164

SIFMA.

165

SIFMA and BPI.

166

IAA.

167

ABA.

168

JBA.

169

See

79 FR 5671.

1. Credit Funds

i. Background and 2020 Proposal

In the preamble to the 2013 rule, the agencies declined to establish an exclusion from the definition of covered fund for funds that make loans, invest in debt, or otherwise extend the type of credit that banking entities may provide directly under applicable banking law (credit funds).

170

The agencies cited concerns about whether credit funds could be distinguished from private equity funds and hedge funds and the possible evasion of the requirements of section 13 of the BHC Act through the availability of such an exclusion. In addition, the agencies suggested that some credit funds would be able to operate using other exclusions from the definition of covered fund in the 2013 rule, such as the exclusion for joint ventures or the exclusion for loan securitizations.

171

170

See

79 FR 5705.

171

Id.

However, commenters on the 2018 proposal noted that many credit funds have not been able to utilize the joint venture and loan securitization exclusions. In response, the agencies included in the 2020 proposal a specific exclusion for credit funds. Under the 2020 proposal, a credit fund would have been an issuer whose assets consist solely of:

• Loans;

• Debt instruments;

• Related rights and other assets that are related or incidental to acquiring, holding, servicing, or selling loans, or debt instruments; and

• Certain interest rate or foreign exchange derivatives.

172

2020 proposal § __.10(c)(15)(i).

The proposed exclusion would have been subject to certain additional requirements to reduce evasion concerns and help ensure that banking entities invest in, sponsor, or advise credit funds in a safe and sound manner. For example, the proposed exclusion would have imposed (1) certain activity requirements on the credit fund, including a prohibition on proprietary trading;

173

(2) disclosure and safety and soundness requirements on banking entities that sponsor or serve as an advisor for a credit fund;

174

(3) safety and soundness requirements on all banking entities that invest in or have certain relationships with a credit

fund;

175

and (4) restrictions on the banking entity's investment in, and relationship with, a credit fund.

176

The proposed exclusion also would have permitted a credit fund to receive and hold a limited amount of equity securities (or rights to acquire equity securities) that were received on customary terms in connection with the credit fund's loans or debt instruments.

177

173

2020 proposal § __.10(c)(15)(ii).

174

2020 proposal § __.10(c)(15)(iii).

175

2020 proposal § __.10(c)(15)(iv).

176

2020 proposal § __.10(c)(15)(v).

177

2020 proposal § __.10(c)(15)(i)(C)(

)(

iii

ii. Comments

The agencies requested comment on all aspects of the proposed credit fund exclusion. In addition, the agencies solicited comment on specific provisions of the proposed exclusion, including the permissibility of certain assets and requirements related to the activities of the credit fund and the relationship between a banking entity and a credit fund.

178

See

85 FR 12133.

General

Commenters were generally supportive of adopting an exclusion for credit funds, and several commenters suggested specific revisions to the proposed exclusion.

179

Several commenters supportive of the 2020 proposal urged the agencies not to adopt any further limitations on the proposed exclusion and indicated that the proposed exclusion would not increase the risk of evasion of the requirements of section 13 of the BHC Act.

180

Two commenters expressed general opposition to or concern about the proposed credit fund exclusion.

181

179

E.g.,

CCMC; AIC; SIFMA; FSF; ABA; Arnold & Porter; and Goldman Sachs.

180

E.g.,

SIFMA; Credit Suisse; Goldman Sachs; and Arnold & Porter.

181

Better Markets and Data Boiler. One of these commenters suggested that banking entities should instead rely on the exclusions for joint ventures and loan securitizations. Data Boiler.

Asset Requirements

Commenters were generally supportive of allowing a credit fund to invest broadly in loans and debt instruments, certain related assets, and certain derivatives.

182

One commenter recommended against delineating between permissible and non-permissible types of loans and debt instruments, arguing that credit funds should be able to extend credit to the same degree as would be permitted for the banking entity to extend directly.

183

Another commenter encouraged the agencies to clarify and expand the definition of debt instrument and derivatives, to include all tranches of debt, collateralized loan and collateralized debt obligations, and any derivatives related to hedging credit risk, such as credit default swaps and total return swaps.

184

In addition, a commenter suggested clarifying that no specific credit standard applies to loans held by a credit fund.

185

One commenter also urged the agencies to establish a safe harbor to the permissible asset restrictions for banking entities that rely, in good faith, on a representation by the credit fund that the credit fund only invests in permissible assets.

186

182

E.g.,

SIFMA; Arnold & Porter; and ABA. One commenter also noted that the permissible holding period for debt previously contracted varies depending on applicable regulations and suggested that the agencies specify the holding period for debt previously contracted assets owned by a credit fund and provide for an extension process. Arnold & Porter.

183

SIFMA. The same commenter also urged the agencies to permit credit funds to hold commodity forward contracts, which the commenter argued may be an appropriate hedge for extensions of credit to agricultural businesses. SIFMA.

184

Credit Suisse.

See also

Arnold & Porter (recommending expanding the types of permissible derivatives, to allow for more effective hedging and easier disposal of portfolio assets).

185

ABA.

186

Arnold & Porter.

Two commenters recommended limiting permissible assets to only loans or debt instruments, and not equity.

187

In contrast, a range of commenters argued that allowing a credit fund to receive certain assets, like equity, related to an extension of credit would promote the sale of loans and extensions of credit.

188

Some of these commenters suggested that taking equity as partial consideration for extending credit is commonplace in the debt and loan markets and that such a provision could ensure that credit funds are able to facilitate loan and debt workouts and restructurings, a critical financial intermediation function.

189

Most commenters supportive of the 2020 proposal were generally opposed to a quantitative limit on the amount of equity securities (or rights to acquire an equity security) received on customary terms in connection with such loans or debt instruments that could be held by a credit fund, citing compliance costs and diminished flexibility,

190

but some commenters indicated that a limitation of 20 or 25 percent of total assets could be acceptable if the agencies were to impose a limit.

191

187

Data Boiler and Better Markets. One of these commenters argued that the inclusion of non-loan instruments would be contrary to the purpose of section 13 of the BHC Act. Data Boiler. As indicated by the agencies in the preamble to the 2020 proposal, taking limited amounts of non-loan or debt assets as consideration for an extension of credit is common and is a permitted practice for insured depository institutions. Therefore, the agencies believe it would not be inconsistent with section 13 of the BHC Act to facilitate the sale of loans by establishing a credit fund exclusion that allows a credit fund to hold a limited amount of certain equity instruments related to extensions of credit. See also the discussion about permitting excluded loan securitizations to hold a small amount of non-loan assets,

supra

Section IV.B.2 (Loan Securitizations).

188

E.g.,

SIFMA; Credit Suisse; ABA; and Arnold & Porter.

189

E.g.,

SIFMA; Credit Suisse; and Arnold & Porter.

190

SIFMA; FSF; CCMC; AIC; ABA; and Goldman Sachs.

191

SIFMA and CCMC.

Commenters supportive of allowing credit funds to hold certain related assets, such as equity, in connection with an extension of credit suggested that the provision would not raise significant safety and soundness or evasion concerns. For example, one commenter claimed that such a provision would not raise the risk of evasion, in part, because equity options received as consideration generally expire unexercised.

192

Other commenters argued that the activity requirements of the exclusion would prevent a credit fund from becoming actively involved in the purchase and sale of equity instruments.

193

Another commenter suggested that the agencies could impose a requirement that non-loan or non-debt assets be acquired on arms-length terms and adhere to bank safety and soundness standards.

194

192

Arnold & Porter.

193

Goldman Sachs and FSF.

194

ABA.

Separately, several commenters recommended allowing excluded credit funds to hold any type of asset, up to a certain percentage of aggregate assets, either 20 or 25 percent of a credit fund's total assets.

195

These commenters asserted that permitting a credit fund to own equity securities and other assets would help the fund more effectively provide credit, without altering the character of the credit fund, and would reduce compliance burdens associated with launching and operating a credit fund.

196

In addition, these commenters claimed that a limited bucket for non-loan and non-debt assets would be consistent with the ability of banking entities and some business development companies to invest in equity.

197

195

SIFMA; FSF; Credit Suisse; ABA; and Goldman Sachs. One commenter also suggested a formula for determining the cap. Goldman Sachs.

196

E.g.,

SIFMA and Goldman Sachs.

197

Id.

Banking Entity and Issuer Requirements

Generally, commenters either agreed that certain restrictions to ensure that a credit fund is actually engaged in prudently providing credit and credit

intermediation and is not operated for the purpose of evading the provisions of section 13 of the BHC Act were appropriate or did not object to the inclusion of these requirements.

198

Several commenters, however, offered revisions to the activities, sponsor or advisor, banking entity, or investment and relationship limit requirements. For example, several commenters requested clarification on the prohibition on proprietary trading by an excluded credit fund contained in § __.10(c)(15)(ii)(A) of the 2020 proposal. One commenter suggested that the definition of proprietary trading for a credit fund should depend on the definition used by the banking entity.

199

Another commenter encouraged the agencies to incorporate the exclusions and exemptions from the prohibition on proprietary trading into the credit fund exclusion's prohibition on proprietary trading.

200

A third commenter recommended making explicit that exercising rights for certain related assets, such as an equity warrant, is not proprietary trading.

201

198

E.g.,

SIFMA; Better Markets; FSF; and Goldman Sachs. One commenter also indicated that the disclosure requirement for banking entities that sponsor or advise funds is appropriate. Arnold & Porter.

199

SIFMA. For example, the commenter suggested that a credit fund sponsored by a banking entity subject to the market risk rule should be permitted to use the definitions of proprietary trading and trading account in § __.3(b)(1)(ii).

200

FSF.

201

Arnold & Porter.

Commenters also requested revisions to and clarification about the limits on a banking entity's investment in, and relationship with, a credit fund. One commenter argued that the imposition of § __.14 of the implementing regulations (which imposes limitations on the relationship between a banking entity and a fund it sponsors or advises) would be duplicative of (1) the requirement that the banking entity not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of the credit fund and (2) certain conflict of interest, high-risk, and safety and soundness restrictions.

202

Another commenter claimed that there was little benefit to imposing the requirements of § __.14 (described above) and § __.15 (which imposes certain material conflicts of interest, high-risk investments, and safety and soundness and financial stability requirements on permitted covered fund activities) of the implementing regulations in the context of credit funds and suggested that the partial application of § __.14, in particular, could lead to unexpected and inappropriate outcomes, such as allowing a banking entity to invest in the equity of a credit fund, but not the debt instruments issued by that same credit fund.

203

That same commenter also recommended eliminating § __.10(c)(15)(v)(B) of the 2020 proposal—which would have required that the banking entity's investment in, and relationship with, the credit fund be conducted in compliance with, and subject to, applicable banking laws and regulations—because applicable banking laws and regulations apply regardless of the banking entity's use of the credit fund exclusion.

204

202

SIFMA.

203

Arnold & Porter.

204

Arnold & Porter.

In addition, a commenter argued that banking entities that serve as investment advisers or commodity trading advisors to credit funds should not be subject to the disclosure and safety and soundness requirements of § __.10(c)(15)(iii) of the 2020 proposal since investment advisers and commodity trading advisors who do not otherwise sponsor or invest in a fund are generally not subject to section 13 of the BHC Act. The commenter argued that § __.10(c)(15)(iii) of the 2020 proposal would impose differing requirements on a credit fund depending on whether the investment adviser or commodity trading advisor was an insured depository institution or a bank holding company. That commenter also claimed that the portfolio requirements in § __.10(c)(15)(iv)(B) of the 2020 proposal could require banking entities to establish complex compliance programs to assess credit fund compliance with state and foreign laws and that the agencies should limit the scope of the provision to only federal banking laws and regulations.

205

Id.

Finally, one commenter contended that the application of certain requirements in the exclusion is contingent on the type of banking entity that invests in or sponsors a credit fund and urged the agencies to make explicit that only the identity of the sponsor of the credit fund, and not its affiliates or third-party investors, determines which portfolio quality and safety and soundness requirements apply to the credit fund.

206

More generally, this commenter asked the agencies to make explicit in the preamble to the final rule that the actions of unaffiliated, third-party banking entities do not affect whether a banking entity may invest in a fund.

207

206

Id.

207

Id.

Other Comments

Commenters also submitted several miscellaneous comments about the proposed exclusion for credit funds. One commenter requested that the agencies clarify the definition of asset-backed securities as used in the proposed credit fund exclusion and the current loan securitization exclusion.

208

That same commenter also urged the agencies to revise the proposed credit fund exclusion to allow banking entities with more stringent credit requirements, such as insured depository institutions, to invest in credit funds that hold distressed debt.

209

208

Id.

209

Id.

Finally, the 2020 proposal requested comment on whether to combine the proposed credit fund exclusion with the loan securitization exclusion. Commenters were generally opposed to combining the two exclusions, citing different classes of assets in which the two types of issuers invest and a fundamental difference in structure (loan securitizations issue asset-backed securities, while credit funds do not).

210

In addition, one commenter argued that while combining the two exclusions would increase the simplicity of the rule, such an amalgamated exclusion could result in increased compliance burdens for issuers who are accustomed to the lack of credit requirements in the current loan securitization exclusion.

211

210

SIFMA; FSF; CCMC; Credit Suisse; and Data Boiler.

211

Arnold & Porter.

iii. Final Exclusion

After consideration of the comments, the agencies are adopting the credit fund exclusion as proposed, with certain modifications. The agencies believe that the credit fund exclusion in the final rule (1) addresses the application of the covered fund provisions to credit-related activities that certain banking entities are permitted to engage in directly and (2) is consistent with Congress's intent that section 13 of the BHC Act limit banking entities' investment in and relationships with hedge funds and private equity funds, but not limit or restrict banking entities' ability to extend credit.

212

The agencies also believe that the credit fund exclusion in the final rule, with the eligibility criteria described below, will address concerns the agencies expressed in the preamble to the 2013

rule about the ability to administer an exclusion for credit funds and the potential evasion of section 13 of the BHC Act.

213

Banking entities already have experience using and complying with the loan securitization exclusion. Establishing an exclusion for credit funds based on the framework provided by the loan securitization exclusion allows banking entities to provide traditional extensions of credit regardless of the specific form, whether directly via a loan made by a banking entity, or indirectly through an investment in or relationship with a credit fund that transacts primarily in loans and certain debt instruments.

212

See

12 U.S.C. 1851(g)(2), (h)(2). Paragraph (g)(2) of section 13 of the BHC Act makes clear that the Volcker rule is not intended to impede banking entities' ability to extend credit by, for example, selling loans or securitize loans.

See

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

213

See

79 FR 5705.

The credit fund exclusion limits the universe of potential funds that can rely on the exclusion by clearly specifying the types of activities in which those funds may engage. Excluded credit funds can transact in or hold only loans; debt instruments that would be permissible for the banking entity relying on the exclusion to hold directly; certain rights or assets that are related or incidental to the loans or debt instruments, including equity securities (or rights to acquire an equity security) received on customary terms in connection with such loans or debt instruments; and certain interest rate and foreign exchange derivatives. The credit fund exclusion, with these eligibility criteria, should not raise evasion concerns. Similarly, the agencies' expectations regarding the amount of permissible equity securities (or rights to acquire an equity security) held and the requirement that the credit fund not engage in activities that would constitute proprietary trading should help to ensure that the extensions of credit, whether directly originated or acquired from a third party, are held by the credit fund for the purpose of facilitating lending and not for the purpose of evading the requirements of section 13. Finally, the restrictions on guarantees and other limitations should eliminate the ability and incentive for either the banking entity sponsoring a credit fund or any affiliate to provide additional support beyond the ownership interest retained by the sponsor. Thus, the agencies expect that, together, the criteria for the credit fund exclusion will prevent a banking entity from having any incentive to bail out such funds in periods of financial stress or otherwise expose the banking entity to the types of risks that the covered fund provisions of section 13 were intended to address.

Consistent with commenters' suggestions, the agencies are keeping separate the credit fund exclusion and the loan securitization exclusion because the structures and purposes of those two types of issuers differ sufficiently to warrant different requirements. For example, loan securitizations and credit funds have different asset composition and different financing and legal structures. Therefore, the agencies are finalizing a credit fund exclusion separate from the loan securitization exclusion.

Asset Requirements

Under the final rule, a credit fund, for the purposes of the credit fund exclusion, is an issuer whose assets consist solely of:

• Loans;

• Debt instruments;

• Related rights and other assets that are related or incidental to acquiring, holding, servicing, or selling loans, or debt instruments; and

• Certain interest rate or foreign exchange derivatives.

214

Final rule § __.10(c)(15)(i).

Several provisions of the exclusion are similar to and modeled on conditions in the loan securitization exclusion to ease compliance burdens. For example, any derivatives held by the credit fund must relate to loans, permissible debt instruments, or other rights or assets held and reduce the interest rate and/or foreign exchange risks related to these holdings.

215

In addition, any related rights or other assets held that are securities must be cash equivalents, securities received in lieu of debts previously contracted with respect to loans held or, unique to the credit fund exclusion, equity securities (or rights to acquire equity securities) received on customary terms in connection with the credit fund's loans or debt instruments.

216

215

Final rule § __.10(c)(15)(i)(D).

216

Final rule § __.10(c)(15)(i)(C). In a minor change from the 2020 proposal, the agencies are making clear that rights or other assets held under paragraph (c)(15)(i)(C) of that section may not include any derivative, other than a derivative that meets the requirements of paragraph (c)(15)(i)(D) of that section.

In the 2020 proposal, the agencies requested comment on whether to impose a limit on the amount of equity securities (or rights to acquire equity securities) that may be held by an excluded credit fund.

217

After a review of the comments and further deliberation, the agencies are not adopting a quantitative limit on the amount of equity securities (or rights to acquire equity securities) that may be held by an excluded credit fund. Any such equity securities or rights are limited by the requirements that they be (a) received on customary terms in connection with the fund's loans or debt instruments and (b) related or incidental to acquiring, holding, servicing, or selling those loans or debt instruments. The agencies generally expect that the equity securities or rights satisfying those criteria in connection with an investment in loans or debt instruments of a borrower (or affiliated borrowers) would not exceed five percent of the value of the fund's total investment in the borrower (or affiliated borrowers) at the time the investment is made. The agencies understand that the value of those equity securities or other rights may change over time for a variety of reasons, including as a result of market conditions and business performance, as well as more fundamental changes in the business and the credit fund's corresponding management of the investment (

e.g.,

exchanges of debt instruments for equity in connection with mergers and restructurings or a disposition of all portion of the credit investment without a corresponding disposition of the equity securities or rights due to differences in market conditions or other factors). Accordingly, the agencies can foresee various circumstances where the relative value of such equity securities or rights in a borrower (or affiliated borrowers) would over the life of the investment exceed five percent on a basis consistent with the requirements. Nonetheless, the agencies expect that the fund's exposure to equity securities (or other rights), individually and collectively and when viewed over time, would be managed on a basis consistent with the fund's overall purpose.

217

85 FR 12133.

The agencies are also not imposing additional restrictions on the types of equity securities (or rights to acquire an equity security) that a credit fund may hold. The final rule prevents a banking entity from relying on the credit fund exclusion unless any debt instruments and equity securities (or rights to acquire an equity security) held by the credit fund and received on customary terms in connection with the credit fund's loans or debt instruments are permissible for the banking entity to acquire and hold directly and a sponsor of a credit fund must ensure that the credit fund complies with certain safety and soundness standards.

218

Combined with the prohibition on proprietary trading by a credit fund,

219

these limitations are expected to prevent evasion of section 13 of the BHC Act and should be sufficient to prevent

banking entities from investing in or sponsoring credit funds that hold excessively risky equity securities (or rights to acquire an equity security).

220

218

Final rule § __.10(c)(15)(iv)(B), (iii)(B).

219

Final rule § __.10(c)(15)(ii)(A).

220

One commenter suggested requiring that equity securities (or rights to acquire an equity security) be acquired via arms-length market transactions and adhere to bank safety and soundness standards.

See

ABA. Under the final rule, a banking entity may not rely on the credit fund exclusion unless any equity securities (or rights to acquire an equity security) held by the credit fund are permissible for the banking entity to acquire and hold directly under applicable federal banking laws and regulations. Final rule § __.10(c)(15)(iv)(B). In addition, the final rule requires that equity securities (or rights to acquire an equity security) related or incidental to acquiring, holding, servicing, or selling such loans or debt instruments must be received on customary terms in connection with such loans or debt instruments. Final rule § __.10(c)(15)(i)(C)(

)(

iii

). Finally, a banking entity's investment in, and relationship with, the issuer must comply with the limitations imposed in § __.15, as if the issuer were a covered fund. Final rule § __.10(c)(15)(v)(A).

The agencies are, however, clarifying that the provision allowing related rights and other assets does not separately permit the holding of derivatives. The preamble to the 2020 proposal made clear that “any derivatives held by the credit fund must relate to loans, permissible debt instruments, or other rights or assets held, and reduce the interest rate and/or foreign exchange risks related to these holdings.”

221

The agencies suggested then and currently believe that allowing a credit fund issuer to hold derivatives not related to interest rate or foreign exchange hedging would not be necessary to facilitate the indirect extension of credit by banking entities and may pose the very risks that section 13 of the BHC Act was intended to reach. To ensure that the credit fund exclusions does not inadvertently allow the holding of certain derivatives unrelated to interest rate and/or foreign exchange risks, the final rule explicitly excludes derivatives from permissible related right and other assets.

222

221

85 FR 12132.

222

Final rule § __.10(c)(15)(i)(C)(

The agencies are not adopting a broad expansion of permissible assets, as recommended by several commenters. Contrary to commenters' suggestions, allowing credit funds to hold unlimited amounts of non-debt instruments or derivatives, such as credit default or total return swaps, could present evasion concerns and is not necessary for effectuating the rule of construction.

223

The agencies believe that only those instruments that facilitate the extension of credit and directly-related hedging activities should be permitted under the exclusion. For example, allowing the unlimited holding of credit default swaps by a majority owned or sponsored credit fund could raise the risks that section 13 of the BHC Act was intended to address. Moreover, permitting excluded credit funds to invest up to 25 percent of total assets in any type of asset could turn the exclusion for credit funds into an exclusion for the type of funds that section 13 of the BHC Act was intended to address. Such a result would be contrary to section 13 of the BHC Act.

223

The agencies' rationale, in the preamble to the 2013 rule, for limiting the permissible assets for the loan securitization exclusion is particularly relevant.

See

79 FR 5691 (“Under the final rule as adopted, an excluded loan securitization would not be able to hold derivatives that would relate to risks to counterparties or issuers of the underlying assets referenced by these derivatives because the operation of derivatives, such as these, that expand potential exposures beyond the loans and other assets, would not in the Agencies' view be consistent with the limited exclusion contained in the rule of construction under section 13(g)(2) of the BHC Act, and could be used to circumvent the restrictions on proprietary trading and prohibitions in section 13(f) of the BHC Act. The Agencies believe that the use of derivatives by an issuing entity for asset-backed securities that is excluded from the definition of covered fund under the loan securitization exclusion should be narrowly tailored to hedging activities that reduce the interest rate and/or foreign exchange risks directly related to the asset-backed securities or the loans supporting the asset-backed securities because the use of derivatives for purposes other than reducing interest rate risk and foreign exchange risks would introduce credit risk without necessarily relating to or involving a reduction of interest rate risk or foreign exchange risk.”).

There are several additional changes recommended by commenters that the agencies are not including in the final rule. Specifically, the final rule does not:

• Allow excluded credit funds to hold commodity forward contracts. Although these contracts have legitimate value as hedging instruments, the agencies do not believe this type of hedging activity is consistent with the purpose of the exclusion for credit funds, which is to allow banking entities to share the risks of their permissible lending activities or to engage in permissible lending activities indirectly through a fund structure.

• Permit banking entities that are insured depository institutions or their operating subsidiaries to invest in credit funds through a contribution to a credit fund of troubled loans and debt previously contracted assets from the banking entity's portfolio. The conditions in the final rule are intended to ensure that a credit fund generally engages in activities that the banking entity may engage in directly and that the banking entity's investment in and relationship with the fund are conducted in a safe and sound manner. The agencies decline to deviate from these standards for any particular type of credit fund because doing so could permit activities that raise the type of concerns that section 13 of the BHC Act was intended to address.

• Further specify the holding period for securities held in lieu of debts previously contracted held by a credit fund. Generally, a banking entity may not rely on this exclusion unless any debt instruments and equity securities (or rights to acquire equity securities) held by the fund would be permissible for the banking entity to acquire and hold directly under applicable federal banking laws and regulations. However, the requirement that a banking entity be able to hold a given asset directly does not apply to securities held in lieu of debts previously contracted under the final regulations. Because a banking entity's ability to invest in or sponsor an excluded credit fund is not contingent on how long the credit fund holds securities held in lieu of debts previously contracted, the agencies do not believe it is necessary to amend the regulations to impose a specific holding period on securities held by a credit fund in lieu of debts previously contracted.

224

The agencies note that banking entities must otherwise comply with applicable law.

See infra, Additional Banking Entity Requirements.

• Revise or expand on the definition of debt instrument. The agencies believe that the term debt instrument already has a general meaning that is used in the marketplace and by regulators and that a new definition is unnecessary given this widely understood meaning and could cause confusion.

• Adopt a safe harbor for banking entities that rely, in good faith, on a representation by the credit fund that it only invests in permissible assets. It is the responsibility of the banking entity to ensure that it complies with section 13 of the BHC Act and the implementing regulations, and such responsibility cannot be substituted solely with a representation from a credit fund.

Activity Requirements

The agencies are adopting the activity requirements for issuers in the 2020 proposal without revision. Under the final rule, a credit fund is not a covered fund, provided that:

• The fund does not engage in activities that would constitute proprietary trading, as defined in § __.3(b)(1)(i) of the rule, as if the fund were a banking entity;

225

and

225

Final rule § __.10(c)(15)(ii)(A).

• The fund does not issue asset-backed securities.

226

Final rule § __.10(c)(15)(ii)(B).

The agencies decline to adopt changes recommended by commenters because the agencies believe the activity requirements are clear and appropriate. The first provision explicitly references the prohibition on proprietary trading by a banking entity in § __.3 of the implementing regulations and, in particular, the short-term intent prong contained in § __.3(b)(1)(i). For the avoidance of doubt, a credit fund would not be able to elect a different definition of proprietary trading or trading account. Varying the definition of proprietary trading depending on the type of banking entity that sponsors or invests in the credit fund, as suggested by a commenter, could result in conflicting requirements for credit funds with multiple banking entity investors and generally increase compliance burdens on credit funds. The agencies also note that activities permitted under § __.10(c)(15) generally would not be considered proprietary trading, provided that an excluded credit fund does not purchase or sell one or more financial instruments principally for the purpose of short-term resale, benefit from actual or expected short-term price movements, realize short-term arbitrage profits, or hedge one or more of the positions resulting from the purchases or sales of financial instruments.

The agencies are not expressly incorporating the permitted activities in §§ __.4, __.5, and __.6 of the implementing regulations into the text of the final credit fund exclusion. The exclusion for credit funds is intended to allow banking entities to share the risks of otherwise permissible lending activities. Accordingly, the agencies would not expect that a credit fund would be formed for the purpose of engaging, or in the ordinary course would be engaged, in the activities permitted under §§ __.4, __.5, and __.6 of the implementing regulations. Nevertheless, to the extent that a credit fund seeks to engage in any of those activities as an exemption from the prohibition on engaging in proprietary trading, as defined in § __.3(b)(1)(i) of the final rule, and does so in compliance with the requirements and conditions of the applicable exemption, then the final rule would not preclude such activities.

227

Similarly, with respect to the exclusions from the definition of proprietary trading contained in § __.3(d) of the implementing regulations, the agencies note that the trading activities identified in § __.3(d) are by definition not deemed to be proprietary trading, such that the performance by an excluded credit fund of those activities would not be inconsistent with the final credit fund exclusion.

228

227

The agencies recognize, however, that compliance with certain requirements and conditions in §§ __.4, __.5, and __.6 of the implementing regulations may be inapt and/or highly impractical in the context of a credit fund, particularly given the asset and activity restrictions contained in § __.10(c)(15). For example, the exemptions for underwriting and market making-related activities in § __.4 require that a banking entity relying on such exemptions, among other things, be licensed or registered to engage in the applicable activity in accordance with applicable law. Moreover, to the extent that a credit fund is a banking entity with significant trading assets and liabilities (

i.e.,

because it, together with its affiliates and subsidiaries, has trading assets and liabilities that equal or exceed $20 billion over the four previous calendar quarters), it also would be required to maintain a separate compliance program specific to those exemptions.

228

Similarly, trading activity that satisfies the 60-day rebuttable presumption in § __.3(b)(4) would be presumed not to be proprietary trading for these purposes.

Finally, the agencies are not revising the definition of “asset-backed security” in the implementing regulations. The definition of “asset-backed security” in the implementing regulations specifically refers to the meaning specified in section 3(a)(79) of the Exchange Act (15 U.S.C. 78c(a)(79)).

229

This definition is used elsewhere in banking law,

230

and banking entities and others in the loan securitization industry have adapted their operations in reliance of the definition contained in the Exchange Act. Moreover, the 2013 rule included the requirement that the fund issue asset backed securities as part of the loan securitization criteria, and banking entities have become familiar with this definition, as they have implemented and utilized the exclusion.

229

Implementing regulations § __.10(d)(2).

230

See

12 CFR 244 (Credit Risk Retention).

Requirements for a Sponsor, Investment Adviser, or Commodity Trading Advisor

The agencies are adopting the proposed requirements for a sponsor, investment adviser, or commodity trading advisor to an excluded credit fund with one modification.

Investors in a credit fund that a banking entity sponsors or for which the banking entity serves as an investment adviser or commodity trading advisor may have expectations related to the performance of the credit fund that raise bailout concerns. To ensure that these investors are adequately informed of the banking entity's role in the credit fund, the final rule requires a banking entity that acts as a sponsor, investment adviser, or commodity trading advisor to an excluded credit fund to provide prospective and actual investors the disclosures specified in § __.11(a)(8) of the implementing regulations.

231

Final rule § __.10(c)(15)(iii)(A). These disclosures include, among other things, that losses are borne solely by investors and not the banking entity, that investors should examine fund documents, and that ownership interests are not insured by the FDIC or guaranteed. Final rule § __.11(a)(8).

Second, a banking entity that acts as a sponsor, investment adviser, or commodity trading advisor must ensure that the activities of the credit fund are consistent with safety and soundness standards that are substantially similar to those that would apply if the banking entity engaged in the activities directly.

232

The agencies note, contrary to the suggestion of a commenter, that this provision does not apply to any investment adviser or commodity trading advisor to a credit fund who does not also sponsor or acquire an ownership interest in the credit fund. Rather, the requirements in § __.10(c)(15) apply only to a sponsor, investment adviser, or commodity trading adviser that relies on the exclusion to sponsor or acquire an ownership interest in the credit fund. The covered fund provisions in § __.10 of the implementing regulations only affect the operations of banking entities that, as principal, directly or indirectly, acquire or retain any ownership interest in or sponsor a covered fund.

233

Thus, the safety and soundness provision only applies to banking entities that sponsor an excluded credit fund or that have an ownership interest in an excluded credit fund and also serve as an investment adviser or commodity trading advisor to the fund.

232

Final rule § __.10(c)(15)(iii)(B).

233

Implementing regulations § __.10(a)(1).

More generally, to clarify an issue raised by some commenters, the agencies note that whether a specific banking entity may use the credit fund exclusion to make or have an otherwise impermissible investment in or relationship with a credit fund is contingent on the permissible activities of the banking entity. That is, the same fund may be a covered fund with respect to one banking entity and an excluded credit fund with respect to a different banking entity. A banking entity continues to be responsible for ensuring that its particular investment, sponsorship, or adviser activities comply with section 13 of the BHC Act and its implementing regulations. This principle applies to paragraphs (iii), (iv), and (v) of the credit fund exclusion.

The final rule moves the requirement that the banking entity must comply with § __.14 of the implementing regulations to § __.10(c)(15)(iii). This organizational change is in response to commenters that requested the agencies confirm that that the § __.14 limitations do not apply to a banking entity that merely invests in a credit fund, as opposed to a banking entity that sponsors or advises the fund. The agencies believe this change is appropriate because the limitations on banking entities' relationships with a covered fund in § __.14 only apply when a banking entity serves, directly or indirectly, as the investment manager, investment adviser, commodity trading advisor, or sponsor to a covered fund.

234

In addition, the agencies appreciate that mere investment by a banking entity in a credit fund does not raise the type of concerns Super 23A was intended to address, and thus the agencies are applying § __.14 only when a banking entity acts as a sponsor, investment adviser, or commodity trading advisor to a credit fund, in each case as though the credit fund were a covered fund.

235

The limitations in § __.15 of the implementing regulations regarding material conflicts of interest, high-risk investments, and safety and soundness and financial stability remain applicable to banking entities' investment in, and relationship with, excluded credit funds.

234

Final rule § __.14(a)(1).

235

Final rule § __.10(c)(15)(iii)(C).

Additional Banking Entity Requirements

As provided in the 2020 proposal, a banking entity may not rely on the credit fund exclusion if it guarantees the performance of the fund.

236

In a revision to the 2020 proposal, under the final rule a banking entity may not rely on the credit fund exclusion if the fund holds any debt instruments or equities (or rights to acquire an equity security) received on customary terms in connection with loans or debt instruments held by the credit fund that the banking entity is not permitted to acquire and hold directly under applicable federal banking laws and regulations.

237

This change is to clarify, as suggested by a commenter, that this requirement is specific only to federal banking laws and regulations. Whether a credit fund's holdings are permissible for a banking entity to hold under state or foreign laws is not relevant to compliance with section 13 of the BHC Act. That said, the agencies note that banking entities must comply with the laws of the jurisdiction applicable to its activities and operations and should be cognizant of whether a credit fund it sponsors or in which it invests complies with the laws of the jurisdictions in which the credit fund operates.

238

236

Final rule § __.10(c)(15)(iv).

237

Final rule § __.10(c)(15)(iv)(B).

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For example, banking entities that are organized under state or foreign laws may, depending on the nature of the organization, need to comply with other laws.

Investment and Relationship Limits

Finally, the agencies are adopting the proposed provisions related to a banking entity's investment in and relationship with a credit fund with one revision. Under the final rule, a banking entity's investment in, and relationship with, the issuer must comply with the limitations in § __.15 of the implementing regulations regarding material conflicts of interest, high-risk investments, and safety and soundness and financial stab

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