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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

    \894\ As discussed above, when examining informed trading of
advisor banks in options on the stocks of client firms, Lowry et al.
(2018) finds that informed trading by hedge funds increases
simultaneously with a decrease in informed trading by banks around
the enactment of section 13 of the BHC Act. See Michelle Lowry et
al., Informed Trading By Advisor Banks: Evidence from Options
Holdings, 32 Rev. Fin. Stud 605 (2018).
    \895\ See Boyarchenko, Eisenbach, Gupta, Shachar, and Van
Tassel, 2018, ``Bank Intermediated Arbitrage,'' Federal Reserve Bank
of New York Staff Report No. 858, last accessed 6/3/2019.
    \896\ These findings are also consistent with another paper that
finds an exogenous increase in the leverage ratio constraint in the
UK to have reduced repo market liquidity--an effect especially
pronounced in transactions between dealers and small customers. See
Antonis Kotidis and Neeltje Horen, Repo Market Functioning: The Role
of Capital Regulation (2018) (working paper) last accessed June 3,
2019.
---------------------------------------------------------------------------

    Post-crisis regulations may also be having effects on the co-
movement \897\ in liquidity metrics across markets. A recent paper
\898\ exploring this issue posits two channels for this increased co-
movement in liquidity. First, liquidity supply is capital intensive,
and absorbing trades into inventory in one risky asset class may use up
the capital capacity of a dealer to provide liquidity in other assets.
Basel III and liquidity requirements for banks may aggravate this
effect. Second, bank dealers may face uncertainty about their ability
to rely on the market making exemption in the 2013 rule, as the
distinctions between prohibited proprietary trading and permissible
market making may often be unclear. As discussed above, prior studies
suggest that the 2013 rule may have reduced the inventory capacity of
bank dealers. Empirically, the paper documents that co-movement among
measures of illiquidity of stock, bond, and CDS markets has risen
significantly after the 2007-2008 financial crisis, particularly during
the regulatory implementation period. For example, the regulatory
period is characterized by a much larger fraction of firms exhibiting
positive pairwise correlations between measures of illiquidity. The
paper concludes that the 2013 rule and the tightening of capital and
liquidity regulations reduced the inventory capacity of market makers,
resulting in higher co-movement in liquidity across various financial
markets. Importantly, the paper argues that these results are not
consistent with increased electronic trading as that would have
resulted in a reduced reliance on market makers and an increased
reliance on customers, which should have reduced (instead of increased)
co-movement in liquidity across markets.
---------------------------------------------------------------------------

    \897\ Co-movement in two variables generally refers to a
positive correlation of changes in the two variables over time. For
example, co-movement in returns refers to a pattern of positive
correlation in returns among different securities or asset classes.
Similarly, co-movement in liquidity metrics suggests a positive
correlation of changes in liquidity metrics. See, e.g., Nicholas
Barberis et al., Co-movement, 75 J. Fin. Econ. 283 (2005).
    \898\ See Xinjie Wang et al., Do Post-Crisis Regulations Affect
Market Liquidity? Evidence from the Co-Movement of Stock, Bond, and
CDS Illiquidity (2018) (working paper) last accessed 6/3/2019.
---------------------------------------------------------------------------

    With respect to liquidity in the dealer-centric, single-name CDS
market, the SEC elsewhere found that, while dealer-customer activity
and various trading activity metrics have generally remained stable,
interdealer trading, trade sizes, number of quotes, and quoted spreads
for certain illiquid borrowers have worsened since 2010.\899\ In
addition, a recent paper \900\ seeks to tie financial reforms to trends
in liquidity in the single-name CDS markets. Specifically, the paper
finds that the sample period (2010 through 2016) saw a decline in
interdealer trading, a decrease in net dealer inventories, and a
decline in customer transaction volume. In addition, bid-ask spreads in
later years are more heavily dependent on individual dealer inventories
rather than aggregate inventories of all dealers. Notably, the paper
does not estimate the optimal volume of trading activity. Overall, the
paper concludes that increased costs of market making have affected
liquidity provision in the single-name CDS market.
---------------------------------------------------------------------------

    \899\ See SEC Report 2017, supra note 774.
    \900\ See Mark Paddrik and Stathis Tompaidis, Market Making
Costs and Liquidity: Evidence from CDS Markets (Off. of Fin.
Research Working Paper 19-01, 2019) available at https://www.financialresearch.gov/working-papers/files/OFRwp-19-01_Market-Making-Costs-and-Liquidity-Evidence-from-CDS-Markets.pdf, last
accessed 7/5/2019.
---------------------------------------------------------------------------

    While these studies are necessarily limited in scope, methodology,
and measurement, their results may indicate that section 13 of the BHC
Act and the 2013 rule may have reduced dealer provision of liquidity,
particularly in times of stress.\901\ There is little empirical
evidence concerning whether customers will continue to provide
liquidity in times of severe market stress, possibly since such
empirical settings are scarce in the post-crisis period. One recent
paper builds a theoretical model \902\ that suggests that constraints
on dealer balance sheets may benefit customers and reduce transaction
costs as they can induce dealers to invest in technology designed to
match customers to each other. However, this model does not explicitly
examine dealer behavior in times of stress. In addition, the results
rely on strong modeling assumptions. The model assumes that only bank
dealers are able to develop technology to match customers and assumes
away the role of an inter-dealer market or competition among dealers in
the interdealer market. If these assumptions are violated, it is
unclear whether the results will continue to hold. For example, if
nonbank dealers (as well as bank dealers) can develop customer matching
technology, constraining dealer balance sheets may not be necessary for
the development of technology matching customers to other customers or
the disintermediation of trading, with its resulting welfare
improvements. Similarly, in the presence of an interdealer market,
constraining dealer balance sheets may benefit customers by
facilitating customer-to-customer trading but may also reduce the
ability of dealers to demand liquidity from other dealers.
---------------------------------------------------------------------------

    \901\ See, e.g., supra notes 881, 887, 889, and 891.
    \902\ See Gideon Saar et al., From Market Making to Matchmaking:
Does Bank Regulation Harm Market Liquidity? (May 22, 2019) (working
paper) last accessed June 3, 2019.
---------------------------------------------------------------------------

    Moreover, as discussed above, existing research suggests that non-
dealer institutions may be constrained in their ability to secure
funding from prime brokers that are affected by post-crisis
regulations, limiting the ability of non-dealers to arbitrage away
mispricings. It is even less clear whether customers would be willing
and able to secure funding liquidity and stand on the buy side of
customer sells during severe market stress across asset markets.
    Finally, the agencies also received comment that end-users are
increasingly finding that their bank counterparties have reduced short-
term lending and repo activity, while other end-users are experiencing
higher discounts to posted collateral as a result of the 2013
rule.\903\ The SEC is informed by research on the effects of the
constraints dealers face as a result of post-crisis regulations and
liquidity provision.\904\ One particular study on this issue \905\
finds that dealer balance sheet constraints have broad market-wide
effects on bond liquidity beyond the liquidity of bonds with a
particular credit rating, sector, or issue size. The paper finds that,
prior to the crisis, bonds were more liquid when they were traded by
more levered dealers, dealers with higher return on assets and lower
vulnerability

(measured by conditional value-at-risk),\906\ dealers with lower risk-
weighted assets, and dealers with relatively low reliance on repo.
However, during the rule implementation period (post-2014) these
results have reversed, and bonds are more liquid when they are traded
by less-levered dealers, dealers with lower return on assets, dealers
with higher risk-weighted assets, and dealers with more reliance on
repo funding. Finally, unlike the pre-crisis period, during the rule
implementation period (post-2014), dealers with more reliance on repo
funding, with higher trading revenues, with larger maturity mismatches,
with higher measures of vulnerability, and with fewer assets held as
loans are less likely to accommodate customer order flow and are more
likely to access the interdealer market instead. Though these results
do not speak to dealer behavior in times of stress, they are based on a
substantially larger sample compared with the discussed above work
showing liquidity declines in times of stress. Overall, while the paper
does not delineate the effects of the Volcker Rule from other post-
crisis regulations (such as the supplemental leverage ratio), the
paper's findings indicate that tightening of dealer balance sheet
constraints due to the package of post-crisis financial regulations may
adversely affect the ability of affected dealers to intermediate
customer trading in bond markets.
---------------------------------------------------------------------------

    \903\ See Coalition for Derivatives End Users.
    \904\ For a more general model of the links between repo market
frictions and liquidity in underlying cash markets see, e.g., Yesol
Huh and Sebastian Infante, Bond Market Intermediation and the Role
of Repo (Oct. 22, 2018) (working paper) last accessed 6/3/2019.
    \905\ See Tobias Adrian et al., Dealer Balance Sheets and Bond
Liquidity Provision, 89 J. Monetary Econ. 92 (2017).
     See also SEC Report 2017, supra note 774, at 115-16.
    \906\ See Tobias Adrian and Markus Brunnermeier, CoVar, 106 Am.
Econ. Rev. 1705 (2016).
---------------------------------------------------------------------------

    The SEC also recognizes that the effects of the 2013 rule on the
ability and willingness of banks to engage in repo activity may be
compounded by other post-crisis reforms. For example, one study \907\
focuses on the effects of the liquidity coverage ratio, exploiting
cross-country differences in the implementation of the rule. The paper
finds that, as a result of the liquidity coverage ratio, U.S. dealers
reduced their reliance on repo in funding high-quality liquid assets by
more, and increased the maturity of lower-quality-collateral repos by
more, than did foreign dealers.
---------------------------------------------------------------------------

    \907\ See Marco Macchiavelli and Luke Pettit, Liquidity
Regulation and Financial Intermediaries (Jul. 29, 2019) (working
paper) last accessed 8/29/2019.
---------------------------------------------------------------------------

    Importantly, reduced ability and willingness to engage in repo
activity are likely to have downstream effects on customers and market
quality. For example, a paper \908\ recently showed that dealers'
ability to rely on repos to finance bond inventory has an effect on
bid-ask spreads and bond transaction costs; that dealers with less
access to funding liquidity are less likely to provide liquidity on a
principal basis and are more likely to trade on an agency basis
instead; and that funding liquidity has causal effects on bond market
liquidity.
---------------------------------------------------------------------------

    \908\ See Marco Macchiavelli and Xing Zhou, Funding Liquidity
and Market Liquidity: The Broker-Dealer Perspective (Jul. 17, 2019)
(working paper) last accessed 8/29/2019.
---------------------------------------------------------------------------

    As discussed above, corporate bond dealers, particularly bank-
affiliated dealers, may have, on aggregate, reduced their capital
commitment post-crisis--a result that is consistent with a reduction in
liquidity provision in corporate bonds because of the 2013 rule. In
addition, the 2013 rule may have resulted in many corporate bond
dealers shifting from trading in a principal capacity to agency
trading. Moreover, corporate bond dealers may decrease liquidity
provision during certain times of stress in general (e.g., during a
financial crisis) \909\ and after the 2013 rule in particular, as
discussed above. Nonbank dealers and non-dealer intermediaries may not
have fully offset the shortfall in liquidity provision, partly because
of their reliance on funding from financial institutions affected by
post-crisis financial reforms.
---------------------------------------------------------------------------

    \909\ Dealers provide less liquidity to clients and peripheral
dealers during stress times; during the peak of the crisis, core
dealers charged higher spreads to peripheral dealers and clients but
lower spreads to dealers with whom they had strong ties. See Marco
Di Maggio et al., The Value of Trading Relationships in Turbulent
Times, 124 J. Fin. Econ. 266 (2017). See also Jaewon Choi and Or
Shachar, Did Liquidity Providers Become Liquidity Seekers? (Oct.,
2013), New York Fed Staff Report No. 650.
---------------------------------------------------------------------------

    The SEC recognizes that the effects of the 2013 rule on the
activities of banking entities and conflicts of interest may flow
through to SEC-registered dealers and investment advisers affiliated
with banks and bank holding companies directly (if banks and holding
companies transact through their dealer affiliates) and indirectly
(e.g., through effects on capital requirements, profitability,
compliance systems, and policies and procedures), and may have an
effect on securities markets. As discussed in the proposal,\910\ the
presence and magnitude of spillover effects across different types of
financial institutions vary over time and may be more significant in
times of stress.\911\
---------------------------------------------------------------------------

    \910\ See 83 FR at 33534.
    \911\ See, e.g., Monica Billio et al., Econometric Measures of
Connectedness and Systemic Risk in the Finance and Insurance
Sectors, 104 J. Fin. Econ. 535 (2012). See also Zeno Adams et al.,
Spillover Effects Among Financial Institutions: A State-Dependent
Sensitivity Value at Risk Approach (SDSVar), 49 J. Fin. &
Quantitative Analysis 575 (2014). See also Adrian and Brunnermeier
(2016) supra note 906.
---------------------------------------------------------------------------

iv. Compliance Burdens, Profitability, and Competitive Effects
    In the proposal, the SEC recognized that the scope and breadth of
the compliance obligations impose costs on banking entities, which may
be particularly important for smaller entities.\912\ The SEC noted
commenters' estimates that banking entities may have added as many as
2,500 pages of policies, procedures, mandates, and controls per
institution for the purposes of compliance with the 2013 rule, which
need to be monitored and updated on an ongoing basis, and that some
banking entities may spend, on average, more than 10,000 hours on
training each year. In terms of ongoing costs, in the proposal the SEC
noted a market participant's estimate that some banking entities may
have 15 regularly meeting committees and forums, with as many as 50
participants per institution dedicated to compliance with the 2013
rule.
---------------------------------------------------------------------------

    \912\ See, e.g., 83 FR at 33550.
---------------------------------------------------------------------------

    In connection with the proposal, the agencies have received a
number of comments on the compliance burdens of the 2013 rule. Some
commenters presented trends in bank profitability, trading revenue, and
loan growth, arguing that the proposed amendments are unnecessary.\913\
Others indicated that the Volcker Rule may reduce bank profits due to
the elimination of proprietary trading but that lost profits are not
costs but intended regulatory effects of section 13 of the BHC
Act.\914\
---------------------------------------------------------------------------

    \913\ See, e.g., Volcker Alliance and AFR.
    \914\ See, e.g., Occupy the SEC.

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

    In response to those comments, the SEC continues to note that the
scope of this economic analysis is limited to SEC registrants, and
securities markets and their participants. Importantly, trends in
profitability are not informative of the direct causal effect on
profitability or compliance burdens of section 13 of the BHC Act or of
the 2013 rule, since there is no data about the amount of revenue or
compliance burdens that would have occurred in the absence of the 2013
rule. Moreover, the agencies have received a number of comments
pointing to large and significant burdens of section 13 of the BHC Act
and various components of the agencies' 2013 rule. For example, one
commenter estimated that proprietary trading requirements related to
RENTD involved annual costs of as much as about $513 million; that the
metrics-related policies and procedures requirements involved initial
burdens of approximately $41.5 million; that total compliance
expenditures of affected entities (including with respect to covered
funds) totaled between $402 million and $541 million; and that covered
funds requirements involved a cost of between $152 million and $690
million.\915\ Another commenter estimated that, for at least one
banking entity, sorting counterparties into customers and non-customers
for the purposes of calculating RENTD requires dozens of employees
spending thousands of hours in initial and ongoing burdens.\916\
Another commenter stated that simplifying covered funds requirements
would eliminate thousands of unnecessary hours in compliance burdens
related to activities that do not raise the concerns intended to be
addressed by section 13 of the BHC Act.\917\ One trade organization
indicated that duplicative examinations drastically increase burdens on
registrants, estimating that in 2016 members of the organization spent
in aggregate over 50,000 hours responding to inquiries and examinations
related to section 13 of the BHC Act.\918\
---------------------------------------------------------------------------

    \915\ See Data Boiler, citing its own analysis as well as SIA
Partners Briefing Note, July 2015, ``Volcker Implementation,''
available at http://en.finance.sia-partners.com/sites/default/files/post/sia_partners_-_briefing_note_volcker_coveredfunds_blog_version.pdf, last accessed
6/4/2019.
    \916\ See CCMC.
    \917\ See SFIG.
    \918\ See SIFMA.
---------------------------------------------------------------------------

    Moreover, the SEC notes that risk-averse market participants are
compensated for bearing greater systematic \919\ risks with higher
expected returns.\920\ If capital markets have a high degree of
efficiency and arbitrage opportunities are generally scarce, greater
profitability may simply be indicative of greater risks taken on by
banking entities. Setting aside the challenges of causal inference
discussed above, trends in bank profitability may reflect not only
compliance burdens of the 2013 rule, but also the effects of the 2013
rule on banking entity risk exposures from permissible activities. That
is, banking entities may have become more willing to take risk through
engaging in activities permitted by the 2013 rule. For more discussion
of the existing evidence on the effects of the 2013 rule on the
activities of banking entities, see the preceding sections of the
economic baseline.
---------------------------------------------------------------------------

    \919\ The term ``systematic risk'' generally refers to the
variability of returns due to macroeconomic factors that affect all
risky assets and, thus, cannot be eliminated by diversification. See
Frank Reilly & Keith Brown, Investment Analysis & Portfolio
Management, 1025 (9th ed. 2009). See also Bodie, supra note 840, at
G-12.
    \920\ See supra note 840.
---------------------------------------------------------------------------

    The agencies also received a number of comments concerning the need
to tailor regulations to banking entities on the basis of risk profile
in order to balance the intended regulatory goals with compliance
burdens and competitive effects. Specifically, a number of commenters
supported tailoring the 2013 rule to more effectively accomplish the
underlying goals of section 13 of the BHC Act, reduce unnecessary
compliance burdens, particularly on smaller and mid-sized banking
entities and entities with small trading books, and more effectively
allocate supervisory resources to prudential goals.\921\
---------------------------------------------------------------------------

    \921\ See, e.g., IIB; CCMC; CREFC; CCMR; Covington; Capital One
et al. and Credit Suisse.
---------------------------------------------------------------------------

    The SEC continues to believe that the compliance regime under the
2013 rule and related burdens reduce the profitability of permissible
activities by bank-affiliated dealers and investment advisers and may
be passed along to customers or clients in the form of reduced
provision of services or higher service costs.\922\ Moreover, the SEC
continues to believe that the extensive compliance program under the
2013 rule detracts resources of some banking entities and their
compliance departments and supervisors from other compliance matters,
risk management, and supervision. Finally, the SEC continues to believe
that prescriptive compliance requirements may not optimally reflect the
organizational structures, governance mechanisms, or risk management
practices of complex, innovative, and global banking entities.
---------------------------------------------------------------------------

    \922\ See 83 FR at 33550.
---------------------------------------------------------------------------

    In the sections that follow the SEC discusses rule provisions of
the 2013 rule, how each amendment in the final rule changes the
economic effects of the regulatory requirements, and the anticipated
costs and benefits of the amendments.
c. Affected Participants
    The SEC-regulated entities directly affected by the final rule
include broker-dealers, security-based swap dealers, and investment
advisers.
i. Broker-Dealers \923\
---------------------------------------------------------------------------

    \923\ These estimates differ from the estimates in the proposal
and in the EGRRCPA Conforming Amendments Adopting Release, as these
estimates rely on more recent data and information about both U.S.
and global trading assets and liabilities of bank holding companies.
This analysis is based on data from Reporting Form FR Y-9C for
domestic holding companies on a consolidated basis and Report of
Condition and Income for banks regulated by the Board, FDIC, and OCC
for the most recent available four-quarter average, as well as data
from S&P Market Intelligence LLC on the estimated amount of global
trading activity of U.S. and non-U.S. bank holding companies.
Broker-dealer bank affiliations were obtained from the Federal
Financial Institutions Examination Council's (FFIEC) National
Information Center (NIC). Broker-dealer assets and holdings were
obtained from FOCUS Report data for Q4 2018.
---------------------------------------------------------------------------

    Under the 2013 rule, some of the largest SEC-regulated broker-
dealers are banking entities because they are affiliated with banks or
bank holding companies. Table 1 reports the number, total assets, and
holdings of broker-dealers by the broker-dealer's bank affiliation.

    While the 199 bank-affiliated broker-dealers subject to the 2013
rule (affected broker-dealers) are greatly outnumbered by the 3,595
broker-dealers that are either bank broker-dealers exempt under section
203 of EGRRCPA or nonbank broker-dealers, the affected broker-dealers
dominate other broker-dealers in terms of total assets (72.7% of total
broker-dealer assets) and aggregate holdings (66.5% of total broker-
dealer holdings).

                        Table 1--Broker-Dealer Count, Assets, and Holdings by Affiliation
----------------------------------------------------------------------------------------------------------------
                                                                                Holdings
         Broker-dealer bank affiliation               Number       Total assets,  Holdings, $mln    (altern.),
                                                                    $mln \924\         \925\        $mln \926\
----------------------------------------------------------------------------------------------------------------
Bank broker-dealers affected by the final rule               199       3,142,780         761,532         567,387
 \927\..........................................
All other broker-dealers \928\..................           3,595       1,179,805         382,451         225,675
                                                 ---------------------------------------------------------------
    Total.......................................           3,794       4,322,586       1,143,983         793,062
----------------------------------------------------------------------------------------------------------------

    Some of the amendments to the 2013 rule that the agencies are
adopting differentiate banking entities on the basis of their
consolidated trading assets and liabilities.\929\ Table 2 reports
affected broker-dealer counts, assets, and holdings by consolidated
trading assets and liabilities of the (top-level) parent firm. The SEC
estimates that 163 broker-dealer affiliates of firms with less than $20
billion in consolidated trading assets and liabilities account for
20.4% of bank-affiliated broker-dealer assets and 17.8% of holdings (or
7% using the alternative measure of holdings).\930\
---------------------------------------------------------------------------

    \924\ Broker-dealer total assets are based on FOCUS report data
for ``Total Assets.''
    \925\ Broker-dealer holdings are based on FOCUS report data for
securities and spot commodities owned at market value, including
bankers' acceptances, certificates of deposit and commercial paper,
state and municipal government obligations, corporate obligations,
stocks and warrants, options, arbitrage, other securities, U.S. and
Canadian government obligations, and spot commodities.
    \926\ This alternative measure excludes U.S. and Canadian
government obligations and spot commodities.
    \927\ This category includes all bank-affiliated broker-dealers
except those exempted by section 203 of EGRRCPA.
    \928\ This category includes both bank affiliated broker-dealers
subject to section 203 of EGRRCPA and broker-dealers that are not
affiliated with banks or holding companies.
    \929\ See, e.g., 2013 rule Sec.  __.20(d)(1).
    \930\ See supra note 926.
    \931\ This analysis excludes SEC-registered broker-dealers
subject to section 203 of EGRRCPA.
    \932\ Consolidated trading assets and liabilities are estimated
using information reported in form FR Y-9C data and from S&P Market
Intelligence LLC on the estimated amount of global trading activity
provided for U.S. and non-U.S. firms. These estimates exclude from
the definition of consolidated trading assets and liabilities
government, agency, and GSE securities. U.S. trading assets and
liabilities are calculated on the basis of the most recent four-
quarter average, except for foreign firms without an intermediate
holding company, for which the amount of trading activity for the
nonbank and edge subsidiaries does not exclude securities of
government-sponsored enterprises. For top-tier bank holding
companies, top-tier independent depositary institutions, and foreign
parents with U.S. activity, Ginnie Mae securities are included in
the calculation of trading assets and liabilities because of data
limitations. (It is not possible to exclude Ginnie Mae securities
without also excluding Fannie Mae and Freddie Mac securities.)

             Table 2--Broker-Dealer Counts, Assets, and Holdings by Consolidated Trading Assets and Liabilities of the Banking Entity \931\
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                  Total assets,                                                  Holdings
 Consolidated trading assets and liabilities \932\     Number          $mln         Percent     Holdings, $mln    Percent    (altern.), $mln    Percent
--------------------------------------------------------------------------------------------------------------------------------------------------------
>=50bln............................................         28          2,152,225         68            555,787         73            510,325         90
20bln-50bln........................................          8            349,716         11             70,054          9             17,611          3
10bln-20bln........................................          9            198,895          6             49,797          7             13,301          2
5bln-10bln.........................................         24            261,622          8             55,316          7             14,295          3
1bln-5bln..........................................         33             66,583          2             18,319          2              4,998          1
<=1bln.............................................         97            113,740          4             12,259          2              6,857          1
                                                    ----------------------------------------------------------------------------------------------------
    Total..........................................        199          3,142,780        100            761,532        100            567,387        100
--------------------------------------------------------------------------------------------------------------------------------------------------------

ii. Security-Based Swap Dealers
    The final rule may also affect bank-affiliated SBSDs. As compliance
with SBSD registration requirements is not yet required, there are
currently no registered SBSDs. However, the SEC has previously
estimated that as many as 50 entities may potentially register as
security-based swap dealers and that as many as 16 of these entities
may already be SEC-registered broker-dealers.\933\ Similarly, the SEC
previously estimated that between 0 and 5 entities may register as
Major Security-Based Swap Participants (MSBSPs).\934\ On the basis of
the analysis of TIW transaction and positions data on single-name
credit-default swaps, the SEC believes that all entities that may
register with the SEC as SBSDs are bank-affiliated firms, including
those that are SEC-registered broker-dealers. Therefore, the SEC
estimates that, in addition to the bank-affiliated SBSDs that are
already registered as broker-dealers and included in the discussion
above, as many as 34 other bank-affiliated SBSDs may be affected by
these amendments. Similarly, on the basis of the analysis of TIW data,
the SEC estimates that none of the entities that may register with the
SEC as MSBSPs are affected by the final rule.
---------------------------------------------------------------------------

    \933\ See Capital, Margin, Segregation Adopting Release, 84 FR
at 43960.
    \934\ Id.
---------------------------------------------------------------------------

    Importantly, compliance with capital and other substantive
requirements for SBSDs under Title VII of the Dodd-Frank Act is not yet
required.\935\ The SEC recognizes that firms may choose to move
security-based swap trading activity into (or out of) an affiliated
bank or an affiliated broker-dealer instead of registering as a
standalone SBSD, if bank or broker-dealer capital and other regulatory
requirements are less (or more) costly than those that may be imposed
on SBSDs under Title VII. As a result, the above figures may

overestimate or underestimate the number of SBSDs that are not broker-
dealers and that may become SEC-registered entities affected by the
final rule. Quantitative cost estimates are provided separately for
affected broker-dealers and potential SBSDs.
---------------------------------------------------------------------------

    \935\ Id.
---------------------------------------------------------------------------

iii. Private Funds and Private Fund Advisers \936\
---------------------------------------------------------------------------

    \936\ These estimates are calculated from Form ADV data as of
March 31, 2019. An investment adviser is defined as a ``private fund
adviser'' if it indicates that it is an adviser to any private fund
on Form ADV Item 7.B. An investment adviser is defined as a ``bank-
affiliated RIA'' if it indicates on Form ADV Item 6.A.(7) that it is
actively engaged in business as a bank, or it indicates on Form ADV
Item 7.A.(8) that it has a ``related person'' that is a banking or
thrift institution. For purposes of Form ADV, a ``related person''
is any advisory affiliate and any person that is under common
control with the adviser. The definition of ``control'' for purposes
of Form ADV, which is used in identifying related persons on the
form, differs from the definition of ``control'' under the BHC Act.
In addition, this analysis does not exclude SEC-registered
investment advisers affiliated with banks that have consolidated
total assets less than or equal to $10 billion and trading assets
and liabilities less than or equal to 5% of total assets. Thus,
these figures may overestimate or underestimate the number of bank-
affiliated RIAs.
---------------------------------------------------------------------------

    This section focuses on RIAs advising private funds. Using Form ADV
data, Table 3 reports the number of RIAs advising private funds by fund
types, as those types are defined in Form ADV. Table 4 reports the
number and gross assets of private funds advised by RIAs and separately
reports these statistics for bank-affiliated RIAs. As can be seen from
Table 3, the two largest categories of private funds advised by RIAs
are hedge funds and private equity funds.
    Bank-affiliated RIAs advise a total of 4,316 private funds with
approximately $2 trillion in gross assets. Per Form ADV data, bank-
affiliated RIAs' gross private fund assets under management are
concentrated in hedge funds and private equity funds. On the basis of
this data, bank-affiliated RIAs advise 929 hedge funds with
approximately $668 billion in gross assets and 1,420 private equity
funds with approximately $395 billion in assets. While bank-affiliated
RIAs are subject to all of section 13's restrictions, because RIAs do
not typically engage in proprietary trading, the SEC continues to
believe that they will not be affected by the final rule as it relates
to proprietary trading.

 Table 3--SEC-Registered Investment Advisers Advising Private Funds, by
                             Fund Type \937\
------------------------------------------------------------------------
                                                               Bank-
                Fund type                     All RIA       affiliated
                                                                RIA
------------------------------------------------------------------------
Hedge Funds.............................           2,656             154
Private Equity Funds....................           1,644              98
Real Estate Funds.......................             526              52
Securitized Asset Funds.................             220              45
Liquidity Funds.........................              46              16
Venture Capital Funds...................             193               8
Other Private Funds.....................           1,066             146
                                         -------------------------------
    Total Private Fund Advisers.........           4,756             296
------------------------------------------------------------------------

    Table 4--The Number and Gross Assets of Private Funds Advised by SEC-Registered Investment Advisers \938\
----------------------------------------------------------------------------------------------------------------
                                                      Number of private funds           Gross assets, $bln
                                                 ---------------------------------------------------------------
                    Fund type                                          Bank-                           Bank-
                                                      All RIA     affiliated RIA      All RIA     affiliated RIA
----------------------------------------------------------------------------------------------------------------
Hedge Funds.....................................          10,431             929           7,160             668
Private Equity Funds............................          14,775           1,420           3,446             395
Real Estate Funds...............................           3,472             320             646             100
Securitized Asset Funds.........................           1,814             358             661             129
Liquidity Funds.................................              83              30             297             195
Venture Capital Funds...........................           1,201              43             136               3
Other Private Funds.............................           4,460           1,217           1,396             474
                                                 ---------------------------------------------------------------
    Total Private Funds.........................          36,230           4,316          13,741           1,964
----------------------------------------------------------------------------------------------------------------

    In addition,  for an additional period of 2 years until July 21,
2021, the banking agencies will not treat qualifying foreign excluded
funds that meet the conditions included in the policy statement
discussed above as banking entities or attribute their activities and
investments to the banking entity that sponsors the fund or otherwise
may control the fund under the circumstances set forth in the policy
statement.\939\
---------------------------------------------------------------------------

    \937\ This table includes only the advisers that list private
funds on Section 7.B.(1) of Form ADV. The number of advisers in the
``Any Private Fund'' row is not the sum of the rows that follow,
since an adviser may advise multiple types of private funds. Each
listed private fund type (e.g., real estate fund, liquidity fund) is
defined in Form ADV, and those definitions are the same for purposes
of the SEC's Form PF.
    \938\ Gross assets include uncalled capital commitments on Form
ADV.
    \939\ See ``Statement regarding Treatment of Certain Foreign
Funds under the Rules Implementing Section 13 of the Bank Holding
Company Act,'' July 19, 2019, available at https://www.occ.gov/news-issuances/news-releases/2019/nr-ia-2019-79a.pdf, last accessed July
19, 2019.
---------------------------------------------------------------------------

iv. Registered Investment Companies
    The potential that a registered investment company (RIC) or a
business development company (BDC) would be treated as a banking entity
where the fund's sponsor is a banking entity and holds 25% or more of
the RIC or BDC's voting securities after a seeding period also forms
part of the baseline. On the basis of Commission filings and public
data, the SEC estimates that, as of year-end 2018, there were
approximately

15,700 RICs \940\ and 104 BDCs. Although RICs and BDCs are generally
not banking entities themselves subject to the 2013 rule, they may be
indirectly affected by the 2013 rule and the final rule, for example,
if their sponsors or advisers are banking entities. For instance, bank-
affiliated RIAs or their affiliates may reduce their level of
investment in the funds they advise, or potentially close those funds,
to avoid those funds becoming banking entities themselves.
---------------------------------------------------------------------------

    \940\ This estimate includes open-end companies, exchange-traded
funds, closed-end funds, and non-insurance unit investment trusts
and does not include fund of funds. The inclusion of fund of funds
increases this estimate to approximately 17,200.
---------------------------------------------------------------------------

v. Entities Reporting Metrics to the SEC \941\
---------------------------------------------------------------------------

    \941\ The estimates in this section are based on Appendix A
information provided by reporters to the SEC under the 2013 rule at
the holding company level for April 2018 through March 2019, based
on the most complete filing for each reporting period. Appendix A
records for a particular trading desk are reported to the SEC if a
trading desk books activity into the SEC registrant.
---------------------------------------------------------------------------

    The regulatory reporting requirements of the 2013 rule with respect
to bank-affiliated broker-dealers, SBSDs, and RIAs are described in
section V.F.2.a above. As discussed below, the final rule increases the
threshold for entities subject to metrics reporting from the $10
billion under the 2013 rule to $20 billion in trading assets and
liabilities. Moreover, the final amendments that link the trading desk
definition to the market risk capital rule have an effect on the volume
of reporting to the SEC and corresponding burdens.
    The agencies have received a number of comments opposing the
proposed amendments to metrics reporting and challenging the agencies'
assessment of the proposed amendments.\942\ For example, one commenter
indicated that the SEC's assessment of the overall streamlining effects
of the amendments to metrics reporting and recordkeeping will not be
supported by a full-fledged cost-benefit analysis.\943\ Another
commenter stated that the proposal presented no analysis showing that
the benefits of eliminating some metrics outweigh the costs of imposing
new metrics.\944\ A number of commenters indicated that the agencies
should not adopt any of the proposed amendments to metrics reporting as
they would result in a significant net increase in metrics data.\945\
One commenter estimated that the proposed requirements would require
its member institutions to report hundreds of thousands of additional
data points each month.\946\ One commenter indicated that the extended
reporting timeframe for metrics submission is insufficient and frequent
resubmissions are likely to persist.\947\ In response to these comments
and to enable a quantification of the economic effects of the metrics
amendments on the volume and timeliness of metrics reporting, the SEC
is updating the economic baseline with summary information about the
current volume and resubmission statistics by different groups of
Appendix A  filers.
---------------------------------------------------------------------------

    \942\ See, e.g., ABA; Credit Suisse; CCMR; FSF, Public Citizen
and SIFMA.
    \943\ See SIFMA Annex C.
    \944\ See CCMR.
    \945\ See, e.g., CCMC and FSF.
    \946\ See FSF.
    \947\ See SIFMA Annex C.
    \948\ For the purposes of this analysis, each record is one line
of the matrix reported to the SEC, with the value filled out by the
reporting entity, on a monthly basis, for all its related trading
desks. The total number of records also includes the header, body,
and footer. Each submission is the full data matrix reported by the
reporting entity to the SEC for any specific reporting month.

   Table 5--Volume of Metrics Records Submitted to the SEC, by Trading
                      Assets and Liabilities \948\
------------------------------------------------------------------------
                                             Number of        Records
      Trading assets & liabilities           reporters       submitted
------------------------------------------------------------------------
>50bln..................................               8      40,771,825
20bln-50bln.............................               4       7,357,794
<20bln..................................               6      10,440,677
                                         -------------------------------
    Total...............................              18      58,570,296
------------------------------------------------------------------------

             Table 6--Trading Desks Reporting Metrics to the SEC, by Trading Assets and Liabilities
----------------------------------------------------------------------------------------------------------------
                                                                                Average         Average
                                                                      Average        number of       number of
                  Trading assets & liabilities                      number  of      records per    records  per
                                                                       desks        submission         desk
----------------------------------------------------------------------------------------------------------------
>50bln..........................................................              56         450,921           7,588
20bln-50bln.....................................................              43         195,010           5,172
<20bln..........................................................              38         216,433           7,093
----------------------------------------------------------------------------------------------------------------

                 Table 7--Time Delays and Resubmissions of Metrics Records Submitted to the SEC
----------------------------------------------------------------------------------------------------------------
                                                                                Percent of      Percent of
                                                   Total number     Percent of        records         records
          Trading assets & liabilities             of submitted     records not     resubmitted     resubmitted
                                                      records       resubmitted        once            twice
----------------------------------------------------------------------------------------------------------------
                                    Panel A. Resubmissions of Initial Records
----------------------------------------------------------------------------------------------------------------
>50bln..........................................      40,785,033              34              56              10
20bln-50bln.....................................       6,908,332              61              39               0
<20bln..........................................      10,441,265              96               4               0
----------------------------------------------------------------------------------------------------------------

                                                                                Average delay
                                                   Total records                   Average delay    in initial
                                                  submitted late    Percent of      in initial      submissions
          Trading assets & liabilities               (initial      late initial     submissions       (days,
                                                    submission)     submissions    (days, simple    weighted by
                                                                                average)      record count)
----------------------------------------------------------------------------------------------------------------
                                 Panel B. Delayed Submission of Initial Records
----------------------------------------------------------------------------------------------------------------
>50bln..........................................       4,771,713              12               2               2
20bln-50bln.....................................       4,020,778              58              32              32
<20bln..........................................      10,437,647           99.97              46              42
----------------------------------------------------------------------------------------------------------------

    The SEC notes two important caveats relevant for the interpretation
of these statistics. First, direct attribution of specific trading
activity by a trading desk to an SEC registrant or group of registrants
is not feasible, since the trading desk may book transactions into
multiple legal entities, including both those registered with the SEC
as well as those that are not registered. As a result, the scope of
activity reported in this section is likely to overestimate the records
and reporting by legal entities registered with the SEC. Second, the
SEC does not receive reporting from trading desks that do not transact
on behalf of SEC-registered entities. Therefore, these estimates may
significantly underestimate the overall volume of metrics reporting by
all banking entities (including those that are not registered with the
SEC) related to the 2013 rule.
3. Economic Effects
a. Treatment of Entities Based on the Size of Trading Assets and
Liabilities
    As proposed, the agencies are adopting a categorization of banking
entities into three groups on the basis of the size of their trading
activity. Under the final rule, banking entities with significant
trading assets and liabilities (Group A entities) are required to
comply with a streamlined but comprehensive version of the 2013 rule's
compliance program requirements, as discussed below. Banking entities
with moderate trading assets and liabilities (Group B entities) are
subject to reduced requirements and an even more tailored approach in
light of their smaller trading activities. The burdens are further
reduced for banking entities with limited trading assets and
liabilities (Group C entities), for which the amendments establish a
presumption of compliance, which can be rebutted by the agencies. The
sections that follow discuss the economic effects of each of the
amendments on these groups of entities.
i. Costs and Benefits
    First, banking entities with significant trading assets and
liabilities are defined as those that have, together with affiliates
and subsidiaries, trading assets and liabilities (excluding trading
assets and liabilities attributable to trading activities permitted
pursuant to Sec.  __.6(a)(1) and (2) of subpart B) the average gross
sum of which, over the previous consecutive four quarters, as measured
as of the last day of each of the four previous calendar quarters,
equals or exceeds $20 billion.\949\ This $20 billion threshold is
higher than the threshold that the agencies proposed in the proposal.
Accordingly, more banking entities may qualify as Group B entities
rather than Group A entities (as compared to those that would have
qualified under the proposal's lower threshold), which will reduce
compliance burdens for more banking entities relative to the
proposal.\950\ The agencies received comments that a higher than the
proposed $10 billion trading assets and liabilities threshold would
provide Group B banking entities that are near or approaching $10
billion threshold with flexibility to have moderate growth over time
and to manage their business without triggering the more stringent
compliance requirements imposed on Group A banking entities.\951\ In
addition, some commenters stated that potential fluctuations resulting
from customer-driven trades, quarter-end activity, and market and
foreign exchange volatility may cause banking entities that are near or
approaching the $10 billion threshold to exceed this threshold.\952\
The SEC recognizes that fluctuations in customer demand or market
events may cause these banking entities to exceed the $10 billion
threshold temporarily or permanently, which could trigger a more
enhanced compliance regime and expose these banking entities to higher
compliance costs.\953\ Thus, a $20 billion threshold accounts for such
fluctuations and provides banking entities that are near or approaching
$10 billion in trading assets and liabilities with more certainty
regarding their compliance burdens.
---------------------------------------------------------------------------

    \949\ With respect to a banking entity that is a foreign banking
organization or a subsidiary of a foreign banking organization, this
threshold for having significant trading assets and liabilities
applies according to the trading assets and liabilities of the
combined U.S. operations of the top-tier foreign banking
organization (including all subsidiaries, affiliates, branches, and
agencies of the foreign banking organization operating, located, or
organized in the United States).
    \950\ The final rule defines banking entities with moderate
trading assets and liabilities as those that are neither banking
entities with significant trading assets and liabilities nor banking
entities with limited trading assets and liabilities.
    \951\ See, e.g., Capital One et al.; ABA; BPI; and Custody
Banks.
    \952\ See, e.g., Custody Banks and BPI.
    \953\ See supra note 123.
---------------------------------------------------------------------------

    Some commenters stated that changing the threshold from $10 to $20
billion would have minimal effect on the number of banking entities
that would remain categorized as having significant trading assets and
liabilities.\954\ The SEC estimates that there are 66 broker-dealers
with approximately 16% of all broker-dealer holdings (or 6% based on
the alternative measure) that would qualify as Group B entities with
the adopted $20 billion threshold--compared to 57 broker-dealers with
between 9% and 4% of all broker-dealer holdings that would have
qualified under the proposed threshold value. Thus, relative to the
proposal, 15 additional broker-dealers will experience the cost
reduction because of reduced compliance burdens.
---------------------------------------------------------------------------

    \954\ See, e.g., ABA; Custody Banks; New England Council;
Capital One et al.; SIFMA; State Street and BPI.
---------------------------------------------------------------------------

    Second, as in the proposal, the agencies are defining a banking
entity with limited trading assets and liabilities as a banking entity
that has, together with its affiliates and subsidiaries on a
consolidated basis, trading assets and liabilities (excluding trading
assets and liabilities attributable to trading activities permitted
pursuant to Sec.  __.6(a)(1) and (2) of subpart B) the average gross
sum of which, over the previous consecutive four quarters, as measured
as of the last day of each of the four previous calendar quarters, is

less than $1 billion. However, in the proposal, the agencies proposed
this threshold to be calculated on the worldwide consolidated basis for
both foreign and domestic registrants. Unlike in the proposal, with
respect to a banking entity that is a foreign banking organization or a
subsidiary of a foreign banking organization, this threshold will be
applied on the basis of the combined U.S. operations of the top-tier
foreign banking organization (including all subsidiaries, affiliates,
branches, and agencies of the foreign banking organization operating,
located, or organized in the United States).
    The SEC continues to recognize that the 2013 rule may have resulted
in significant compliance burdens for banking entities that do not have
significant U.S. operations, even though such entities may not pose
substantial risks to the U.S. financial system because of their limited
presence in the U.S. The SEC estimates that the adopted definition of
limited trading assets and liabilities will allow 97 broker-dealers to
reduce compliance costs related to the 2013 rule as a result of the
final rule's presumption of compliance. In contrast, if the final rule
adopted the proposed calculation of limited trading assets and
liabilities, some foreign broker-dealers would not qualify as those
affiliated with entities with limited trading assets and liabilities,
even though the entities these broker-dealers are affiliated with may
have very limited activity in the U.S.
    Third, in the final rule the calculation of thresholds for limited
and significant trading assets and liabilities will exclude--in
addition to the proposed exclusion of trading assets and liabilities
involving obligations of, or guaranteed by, the United States, or any
agency of the United States--trading assets and liabilities involving
obligations, participations, or other instruments of, or issued or
guaranteed by, government-sponsored enterprises listed in Sec.
__.6(a)(2). Some commenters stated that the calculation of trading
assets and liabilities should exclude financial instruments that are
not regulated under the 2013 rule.\955\ The SEC recognizes that
inclusion of trading assets and liabilities involving obligations of,
participations by, or other instruments of, or issued or guaranteed by,
government-sponsored enterprises in the calculation of trading assets
and liabilities may inadvertently scope in entities whose trading
assets and liabilities primarily consist of financial instruments that
are excluded from the prohibition on proprietary trading under the 2013
rule.\956\ Accordingly, the final rule will better align the
application of the tiered compliance regime with trading activities
that are subject to the proprietary trading prohibitions. The SEC
estimates that the exclusion of the aforementioned trading assets and
liabilities from the calculation of the $1 billion and $20 billion
thresholds will not change the assignment of banking entities into the
tiered compliance groups.
---------------------------------------------------------------------------

    \955\ See, e.g., KeyCorp; BMO and Capital One et al.
    \956\ See Sec.  __.6(a)(2).
---------------------------------------------------------------------------

    The SEC continues to believe that the primary effect of these
amendments for SEC registrants is the reduced compliance burdens, as
discussed in more detail in later sections. To the extent that the
compliance costs are currently passed along to customers and
counterparties, some of the cost reductions for these entities
associated with the final rule may flow through to counterparties and
clients in the form of reduced transaction costs or a greater
willingness to engage in activity, including intermediation that
facilitates risk-sharing.
    The SEC notes that, from above, Group B and Group C broker-dealers
currently account for approximately 7% to 18% of total bank broker-
dealer holdings and that, to the extent that holdings reflect risk
exposure resulting from trading activity, current trading activity by
Group B and Group C entities may represent lower risks than the risks
posed by Group A entities' trading activities addressed in the 2013
rule. In addition, the SEC continues to recognize that some Group B and
Group C entities that currently exhibit low levels of trading activity
because of the costs of compliance may respond to the final rule by
increasing their trading assets and liabilities while still remaining
under the $20 billion or $1 billion threshold, as applicable. Increases
in aggregate risk exposure by Group B and Group C entities may be
magnified if trading activity becomes more highly correlated among such
entities, or dampened if trading activity becomes less correlated among
such entities. Since it is difficult to estimate the number of Group B
and Group C entities that may increase the riskiness of their
activities and the degree to which their trading activity would be
correlated, the implications of this effect for aggregate risk and
capital market activity are unclear.
    The shifts in risk exposure may have two competing effects. On the
one hand, if Group B and Group C entities are able to bear risk at a
lower cost than their customers, increased risk exposures could promote
secondary market trading activity and capital formation in primary
markets and increase access to capital for issuers, benefitting issuers
and investors. On the other hand, Group B and Group C firms may be
incentivized to increase their risk exposures, resulting in more
aggregate risk in the banking sector, greater market fragility, and
exacerbated conflicts of interest between banking entities and their
customers. This may ultimately adversely affect issuers and investors.
However, the SEC continues to recognize that the amendments are focused
on tailoring the compliance regime based on the amount of trading
activity engaged in by each banking entity, and all banking entities
would still be subject to the statutory prohibitions related to such
activities. Thus, the potential risk of increased market fragility and
the severity of conflicts of interest effects is mitigated.
    In response to the final rule, it is possible that trading activity
that was once consolidated within a small number of unaffiliated
banking entities may become fragmented among a larger number of
unaffiliated banking entities that each manage down their trading books
under the $20 billion and $1 billion trading assets and liabilities
thresholds to enjoy reduced hedging compliance and documentation
requirements and a less costly compliance and reporting regime
described in sections V.F.3.c, V.F.3.d, V.F.3.g, and V.F.3.h. The
extent to which banking entities may seek to manage down their trading
books will depend on a number of factors, such as the size and
complexity of each banking entity's trading activities and
organizational structure, along with those of its affiliated entities,
as well as forms of potential restructuring and the magnitude of
expected compliance savings from such restructuring relative to the
cost of restructuring. The SEC anticipates that the incentives to
manage the trading book under the $20 billion or $1 billion threshold,
as applicable, may be strongest for those holding companies that are
near or just above the thresholds. Such management of the trading book
may reduce the size of trading activity of some banking entities and
reduce the number of banking entities subject to more stringent
hedging, compliance, and reporting requirements. At the same time, if
the amendments incentivize banking entities to have smaller trading
books, they may mitigate moral hazard and reduce market impacts from
the failure of a given banking entity.

ii. Efficiency, Competition, and Capital Formation
    The 2013 rule imposes compliance burdens that may be particularly
significant for smaller market participants. Moreover, such compliance
burdens may be passed along to counterparties and customers in the form
of higher costs, reduced capital formation, or a reduced willingness to
transact. For example, in the proposal, the SEC cited one commenter's
estimate that the funding cost for an average non-financial firm may
have increased by as much as $30 million after the 2013 rule's
implementation.\957\ At the same time, and as discussed in section
V.F.2, the SEC continues to recognize that the 2013 rule may have
yielded important qualitative benefits, such as reducing certain types
of risks in the financial system and mitigating potential incentive
conflicts that could be posed by certain types of proprietary trading
by dealers, as well as enhancing oversight and supervision.
---------------------------------------------------------------------------

    \957\ See 83 FR at 33526.
---------------------------------------------------------------------------

    On one hand, as a result of the amendments, Group B and Group C
entities might enjoy a competitive advantage relative to similarly
situated Group A and Group B entities respectively. As noted, firms
that are near to the $20 billion threshold may actively manage their
trading book to avoid triggering stricter requirements, and some firms
above the threshold may seek to manage down the trading activity to
qualify for streamlined treatment under the amendments. As a result,
the amendments may result in greater competition between Group B and
Group A entities around the $20 billion threshold, and similarly,
between Group B and Group C entities around the $1 billion threshold,
to the extent that Group C and Group B entities will increase their
trading activity without reaching the $1 and $20 billion thresholds
respectively. On the other hand, to the extent that the risk exposure
of Group B and Group C entities increases as they compete with Group A
and Group B entities, respectively, investors may demand additional
compensation for bearing financial risk. A higher required rate of
return and higher cost of capital could therefore offset potential
competitive advantages for Group B and Group C entities.
    In addition, the adopted methods for the calculation of limited and
significant trading assets and liabilities may result in lower
compliance costs for foreign banking entities relative to the domestic
banking entities, increasing the competitive advantage of foreign Group
B and C entities.
    As in the proposal, the SEC recognizes that cost savings to Group B
and Group C entities related to the compliance requirements and
requirements described in sections V.F.3.g and V.F.3.h may be partially
or fully passed along to clients and counterparties. To the extent that
hedging documentation and compliance requirements for Group B and Group
C entities are currently resulting in a reduced willingness to make
markets or underwrite securities, the amendments may facilitate trading
activity and risk-sharing, as well as capital formation and reduced
costs of access to capital. Again, the SEC notes that the amendments do
not eliminate statutory prohibitions under section 13 of the BHC but
create a simplified compliance regime for banking entities that do not
have significant trading assets and liabilities. Thus, the statutory
prohibitions on proprietary trading and covered funds activities will
continue to apply to all affected entities, including Group B and Group
C entities.
iii. Alternatives
    Alternative approaches were considered. For example, the rule could
have used other values for thresholds for total consolidated trading
assets and liabilities in the definition of entities with significant
trading assets and liabilities. As noted in the discussion of the
economic baseline, using different thresholds would affect the scope of
application of compliance requirements and requirements described in
sections V.F.3.g and V.F.3.h by changing the number and size of
affected broker-dealers. For instance, using the proposed $10 billion
threshold or a lower threshold, such as $5 billion, in the definition
of significant trading assets and liabilities would scope a larger
number of entities into Group A, as compared to the final rule's $20
billion threshold, thereby subjecting a larger share of the dealer and
investment adviser industries to six-pillar compliance obligations.
However, the SEC continues to recognize that trading activity is
heavily concentrated in the right tail of the distribution and that
using a lower threshold would not significantly increase the volume of
trading assets and liabilities scoped into the Group A regime.\958\ For
example, Table 2 shows that 57 bank-affiliated broker-dealers that have
between $1 and $10 billion in consolidated trading assets and
liabilities and are subject to section 13 of the BHC Act account for
only approximately 10% of bank-affiliated broker-dealer assets and
between approximately 4% and 9% of holdings. In addition, 33 broker-
dealer affiliates of firms that have between $1 and $5 billion in
consolidated trading assets and liabilities and are subject to section
13 of the BHC Act account for only approximately 2% of bank-affiliated
broker-dealer assets and between approximately 1% and 2% of
holdings.\959\ At the same time, with a lower threshold, more banking
entities would face higher compliance burdens and related costs.
Therefore, as discussed in section IV.A.1.b, the agencies decided
against this alternative.
---------------------------------------------------------------------------

    \958\ Some commenters supported this view. See, e.g., Capital
One et al.
    \959\ In addition, one commenter stated that firms with $20
billion or more in trading assets and liabilities represented
approximately 94.80% of total reported U.S. trading assets and
liabilities and firms with $5 billion or less in trading assets and
liabilities represented approximately 1.32% of total reported U.S.
trading assets and liabilities. See BPI.
---------------------------------------------------------------------------

    A different threshold for the definition of banking entities with
limited trading assets and liabilities was also considered. As pointed
out by some commenters, a higher threshold, such as $5 billion, would
allow small and mid-size banking entities to have moderate growth over
time without triggering more costly compliance requirements.\960\ As
shown in Table 2, 33 more broker-dealers would qualify for presumed
compliance under this alternative. However, as discussed in section
IV.A.1.b, the agencies continue to believe that banking entities with
$1 billion or less in trading assets and liabilities differ from
banking entities with between $1 and $5 billion in trading assets and
liabilities in their business models and risk exposures, and that a $1
billion threshold appropriately accounts for the risks posed by Group B
and Group C entities; therefore, the agencies are not adopting this
alternative.
---------------------------------------------------------------------------

    \960\ See, e.g., ABA.
---------------------------------------------------------------------------

    An alternative of splitting banking entities into only two groups
according to their trading assets and liabilities--those with
significant trading assets and liabilities and those without, i.e.
joining the limited and moderate trading assets and liabilities groups
was also considered.\961\ This alternative could have reduced
compliance burdens for Group B entities if the threshold was set at $20
billion. But, if the threshold for this alternative would have been set
at $1 billion, the compliance burdens for Group B entities would have
been

higher than their compliance costs under the final rule. As shown in
Table 2, Group B broker-dealers represent approximately 16% of total
assets of bank-affiliated broker-dealers and approximately 16% of their
holdings, while Group C broker-dealers account for only 4% of total
assets of bank-affiliated broker-dealers and 2% of their holdings. The
SEC continues to believe that Groups B and C differ in their business
models (e.g., level of trading activity) and the risks posed to the
U.S. financial system. For these reasons, the agencies decided not to
adopt this alternative.
---------------------------------------------------------------------------

    \961\ This alternative approach was also suggested by some
commenters. See, e.g., Capital One et al.
---------------------------------------------------------------------------

    A percentage-based threshold for determining whether a banking
entity has significant trading assets and liabilities was also
considered. For example, the amendment could have relied exclusively on
a threshold where banking entities are considered to be entities with
significant trading assets and liabilities if the firm's total
consolidated trading assets and liabilities are above a certain
percentage (for example, 10% or 25%) of the firm's total consolidated
assets. Under this alternative, a greater number of entities could have
benefited from lower compliance costs and a streamlined regime for
Group B entities. In addition, as pointed out by a commenter, this
alternative could address risk for individual banking entities since it
would base the threshold on the materiality of trading activity to the
entity's business.\962\ However, under this approach, even firms in the
extreme right tail of the trading asset distribution could be
considered without significant trading assets and liabilities if they
are also in the extreme right tail of the total assets distribution.
Thus, without placing an additional limit on total assets within such
regime, entities with the largest trading books could have been scoped
into the Group B regime if they also had a sufficiently large amount of
total consolidated assets, while entities with significantly smaller
trading books could be categorized as Group A entities if they had
fewer assets overall. Thus, the SEC believes that this alternative
would not have appropriately accounted for the size of banking
entities' trading activity.
---------------------------------------------------------------------------

    \962\ See, e.g., KeyCorp.
---------------------------------------------------------------------------

    In addition, a threshold based on total assets could have been
adopted. It is possible that losses on small trading portfolios can be
amplified through their effect on non-trading assets held by a banking
entity. To that extent, a threshold based on total assets may be useful
in potentially capturing both direct and indirect losses that originate
from trading activity of a holding company.\963\ However, such
threshold may not be as meaningful as a threshold based on trading
assets and liabilities when applied in the context of section 13 of the
BHC Act. A threshold based on total assets would scope in entities
merely on the basis of their balance sheet size, even though they may
have little or no trading activity of the type that section 13 of the
BHC Act is intended to address. Therefore, the agencies decided against
this alternative.
---------------------------------------------------------------------------

    \963\ Some commenters supported this view. See, e.g., Data
Boiler.
---------------------------------------------------------------------------

    Thresholds based on the level of total revenues from permitted
trading activities could have been adopted. To the extent that revenues
could be a proxy for the structure of a banking entity's business and
the focus of its operations, this alternative may apply more stringent
compliance requirements to those entities that focus their business the
most on covered activities. However, revenues from trading activity
fluctuate over time, rising during economic booms and deteriorating
during crises and liquidity freezes. As a result, under the
alternative, a banking entity that is scoped into the regulatory regime
during normal times may be scoped out during a time of market stress
because of a decrease in the revenues from permitted activities. That
is, under such alternative, the weakest compliance regime may be
applied to banking entities with the largest trading books in times of
acute market stress, when the performance of trading desks is
deteriorating and the underlying requirements of the 2013 rule may be
the most valuable.
    Finally, the agencies could have excluded from the definition of
entities with significant trading assets and liabilities those entities
that may be affiliated with a firm with over $20 billion in
consolidated trading assets and liabilities but that are operated
separately and independently and are not consolidated with the parent
company that have total trading assets and liabilities (excluding
trading assets and liabilities involving obligations of or guaranteed
by the United States or any agency of the United States) under $20
billion. As shown in Table 8 below, the SEC estimates that there are 17
broker-dealers that have holdings of less than $20 billion and are
affiliated with bank holding companies that have trading assets and
liabilities in excess of $20 billion. The SEC does not have data on how
many of these 17 broker-dealers are operated separately and
independently and are not consolidated with affiliated entities with
significant trading assets and liabilities. However, the SEC notes
that, at a maximum, this alternative could decrease the scope of
application of the Group A regime for 17 broker-dealers.

   Table 8--Broker-Dealer Assets and Holdings, by Gross Trading Assets and Liabilities Threshold of Affiliated
                                                Banking Entities
----------------------------------------------------------------------------------------------------------------
                                                                                Holdings
              Type of broker-dealer                   Number       Total assets,  Holdings, $mln    (altern.),
                                                                       $mln                            $mln
----------------------------------------------------------------------------------------------------------------
Holdings >=$20bln and affiliated with firms with              19       2,225,989         594,513         514,360
 gross trading assets and liabilities >=$20bln..
Holdings <$20bln and affiliated with firms with               17         275,951          31,328          13,576
 gross trading assets and liabilities >=$20bln..
Affiliated with firms with gross trading assets              163         640,840         135,691          39,451
 and liabilities <$20bln \964\..................
                                                 ---------------------------------------------------------------
    Total.......................................             199       3,142,780         761,532         567,387
----------------------------------------------------------------------------------------------------------------

    Some commenters indicated that this alternative may be beneficial
for banking entities.\965\ The SEC recognizes that this alternative
would increase the number of entities able to avail themselves of the
reduced compliance, documentation, and metrics reporting requirements,
potentially resulting in cost reductions flowing through to

customers and counterparties. At the same time, this alternative would
permit more trading activities by entities affiliated with firms that
have gross trading assets and liabilities in excess of $20 billion. In
addition, it could encourage such firms to fragment their trading
activity, for instance, across multiple dealers, and operate them
separately and independently, thereby relieving such firms of the
requirement to comply with the hedging, compliance, and reporting
regime of the 2013 rule. This alternative may, therefore, reduce the
regulatory oversight and compliance benefits of the full hedging,
documentation, reporting, and compliance requirements for Group A
banking entities. The feasibility and costs of such fragmentation would
depend, in part, on the organizational complexity of a firm's trading
activity, the architecture of trading systems, the location and
skillsets of personnel across various dealers affiliated with such
entities, and current inter-affiliate hedging and risk mitigation
practices.
---------------------------------------------------------------------------

    \965\ See, e.g., JBA.
---------------------------------------------------------------------------

    Some commenters suggested that periodic adjustment to thresholds to
account for inflation should be adopted.\966\ This alternative would
account for changing market conditions in the absence of any changes in
a banking entity's business and level of trading activities. In an
environment with a moderate level of inflation, Group B and Group C
banking entities that are situated just below the thresholds may reduce
their level of activity to avoid triggering a more costly compliance
regime. However, the agencies do not believe that the additional
complexity associated with inflation-indexing the thresholds in the
final rule is necessary in light of the other changes to the thresholds
and calculation methodologies described above. Therefore, the agencies
decided against this alternative.
---------------------------------------------------------------------------

    \964\ This category excludes SEC-registered broker-dealers
affiliated with banks that have consolidated total assets less than
or equal to $10 billion and trading assets and liabilities less than
or equal to 5% of total assets, as well as firms for which bank
trading assets and liabilities data was not available.
    \966\ See, e.g., BPI and Capital One et al.
---------------------------------------------------------------------------

b. Proprietary Trading
    Under section 13 of the BHC act and the 2013 rule, proprietary
trading is defined as engaging as principal for the ``trading account''
of a banking entity.\967\ Thus, the definition of the trading account
determines the trading activity that falls within the scope of the
statutory prohibitions and the compliance regime in the 2013 rule
associated with such activity. The definition of trading account in the
2013 rule has three prongs, including the dealer prong. The final
amendments introduce certain changes to the definition of trading
account; however, these amendments do not remove or modify the dealer
prong. In addition, the amendments introduce new exclusions from the
trading account and a new definition of the trading desk.
---------------------------------------------------------------------------

    \967\ See 2013 rule Sec.  __.3(b).
---------------------------------------------------------------------------

i. Trading Account
(1) Costs and Benefits
    Under the final rule, the definition of ``trading account''
continues to include purchases and sales of financial instruments by
banking entities engaged in the business of a dealer, swap dealer, or
security-based swap dealer outside of the United States, to the extent
these instruments are purchased or sold in connection with the
activities of such business.\968\ Thus, the SEC expects that most (if
not substantially all) trading activity by SEC-regulated dealers that
are banking entities will continue to be captured by the dealer prong
of a banking entity, notwithstanding any of the changes made to the
definition of the trading account.
---------------------------------------------------------------------------

    \968\ See 2013 rule Sec.  __.3(b)(1)(iii).
---------------------------------------------------------------------------

    Some commenters pointed out that not all of dealers' trading
activity is conducted in a dealer capacity.\969\ The SEC recognizes the
possibility that some dealers engage in transaction activity that, by
itself, would not trigger a dealer registration requirement.\970\ Under
the baseline, such activity may be scoped into the ``trading account''
definition by the short-term prong or the market risk capital prong.
Thus, as discussed below, the SEC believes that only a small subset of
trading activity by dealers may be affected by the changes to the
definition of the trading account.
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    \969\ See, e.g., SIFMA and BPI.
    \970\ See 79 FR at 5549 (``The Agencies believe the scope of the
dealer prong is appropriate because, as noted in the proposal,
positions held by a registered dealer in connection with its dealing
activity are generally held for sale to customers upon request or
otherwise support the firm's trading activities (e.g., by hedging
its dealing positions), which is indicative of short term
intent.'').
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    The agencies are adopting three changes to the definition of the
trading account. First, the applicability of the short-term prong and
the market risk capital prong is changed under the final rule. In
particular, for dealers that are subject to the market risk capital
prong, trading activity outside of the dealer prong will be scoped into
the trading account only if it is a covered position for the purposes
of the market risk capital rule. That is, if the activity is not
captured by the dealer prong or the market risk capital prong, it would
be scoped out from the definition of the trading account under the
final rule. This is in contrast to the 2013 rule, under which, for
banking entities that are subject to the market risk capital prong,
trading activity that is not captured by the dealer prong or the market
risk capital prong could still be captured by the short-term
prong.\971\ Thus, under the 2013 rule, bank dealers that are subject to
the market risk capital prong have to apply three prongs: The dealer
prong, the market risk capital prong, and the short-term prong. Under
the final rule, these same entities will apply only two prongs: The
dealer prong and the market-risk capital prong. To the extent that
dealers subject to the market risk capital prong have trading
activities that are not captured by the dealer prong currently
experience organizational inefficiencies or duplicative costs as a
result of being subject to both short-term and market risk capital
prongs, this amendment may benefit such dealers by decreasing their
compliance costs, as discussed in section V.F.3.g, and decreasing the
regulatory complexity, consequently increasing operational efficiency.
The SEC expects that these benefits are likely to be greater for
banking entities that are not subject to the dealer prong, although, as
noted above, the SEC does not analyze those potential benefits here.
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    \971\ As noted in section IV.B.1.a.iii, the scope of activities
captured by the short-term intent prong substantially overlaps with
the scope of activities captured by the market risk capital prong.
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    In addition, to the extent that the definition of trading account
in the 2013 rule involves position-by-position analysis of financial
instruments which may be costly, and to the extent that the costs of
such analysis discourage dealers that are subject to the market risk
capital prong from conducting activities that could be scoped in by the
short-term intent prong, this amendment may promote trading activities
that would not be captured by the dealer prong or the market risk
capital prong. On the one hand, such trading activities may allow
dealers that are subject to the market risk capital rule to manage
their business more efficiently. On the other hand, to the extent that,
under the final rule, trading activity that is not captured by either
the dealer prong or the market risk capital prong would have been
captured by the short-term intent prong, and to the extent that this
activity exposes dealers to additional risks, this amendment may
increase risk exposure of dealers that are subject to the market risk
capital rule. The SEC does not have information about the amount of
trading activity of SEC-registered broker-dealers

that is not captured by the dealer prong or the market risk capital
prong and about the prevalence of the current application of the market
risk capital prong and the short-term prong under the 2013 rule. As
shown in Table 9 below, the SEC estimates that there are 100 broker-
dealers that in aggregate hold between 98% and 99% of holdings by
broker-dealers affected by the final rule that are subject to the
market risk capital rule and may be affected by this amendment. The SEC
continues to believe that the largest share of dealers' trading
activity will continue to be captured by the dealer prong. Thus, the
SEC expects that the effects of this amendment on SEC-regulated dealers
will be modest.

                                  Table 9--Market Risk Capital Rule Application
----------------------------------------------------------------------------------------------------------------
                                                     Number of     Total assets,                     Holdings
      Market risk capital rule application        broker-dealers       $mln          Holdings        (altern.)
----------------------------------------------------------------------------------------------------------------
Subject to the market risk capital rule.........             100       3,002,834         749,867         562,515
Not subject to the market risk capital rule.....              99         139,946          11,665           4,872
                                                 ---------------------------------------------------------------
    Total.......................................             199       3,142,780         761,532         567,387
----------------------------------------------------------------------------------------------------------------

    The second change to the definition of trading account affects
banking entities that are not subject to the market risk capital rule
and cannot apply the market risk capital prong under the 2013 rule.
Under the final rule, these entities will be able to elect to apply the
market risk capital prong instead of the short-term prong to determine
the scope of the banking entity's trading account. This amendment will
affect those dealers that have trading activity that is not captured by
the dealer prong and instead captured by the short-term prong. To the
extent that the market risk capital prong is less costly to comply
with, relative to the short-term prong, this amendment may benefit
dealers that are not subject to the market risk capital rule and have
trading activity that is not captured by the dealer prong by providing
them with flexibility to apply the prong that is more cost-effective.
This amendment may particularly benefit foreign banking entities that
are not subject to the market risk capital rule but are applying a
different market risk framework, to the extent that this framework is
similar to the market risk capital rule. To the extent that foreign
dealers with frameworks similar to the framework of the market risk
capital rule are currently experiencing inefficiencies because they
cannot apply the market risk capital prong of the trading account
definition, this amendment may reduce the compliance costs of these
dealers. The SEC estimates that, at most, 99 broker-dealers that are
not subject to the market risk capital rule may be affected by this
amendment, to the extent that they have trading activity that is
captured by the short-term prong under the 2013 rule. However, the SEC
continues to believe that the largest share of dealers' trading
activity will continue to be captured by the dealer prong. Thus, the
SEC expects that the effects of this amendment for dealers will be
modest.
    The third amendment to the trading account definition will
eliminate the 60-day rebuttable presumption in the short-term prong and
instead establish a new rebuttable presumption that financial
instruments held for 60 days or more are not within the short-term
prong. Many commenters supported the proposed rule's elimination of the
60-day rebuttable presumption,\972\ and some commenters suggested that
the agencies should presume, for banking entities not subject to the
market risk capital rule, that financial instruments held for longer
than 60 days, or that have an original maturity or remaining maturity
upon acquisition, of fewer than 60 days to their stated maturities, are
not for the banking entity's trading account.\973\ As recognized in
section IV.B.1.a.iv, the agencies have found that the rebuttable
presumption has captured many activities that should not be included in
the definition of proprietary trading. In addition, as stated by some
commenters, the presumption may be difficult to rebut.\974\ Therefore,
the SEC believes that the reversal of the presumption in the 2013 rule
would reduce the compliance burdens for dealers that conduct trading
activity that is not otherwise captured by the dealer prong or the
market risk capital prong. To the extent that the compliance burdens
related to the rebuttable presumption of the 2013 rule limit dealers'
ability to conduct customer-accommodating transactions or liquidity
management activities, the cost reductions of the amendment may flow
through to customers and counterparties and increase operational
efficiency of dealers. The SEC estimates that this amendment may affect
99 broker-dealers--the broker-dealers that are not subject to the
market risk capital rule--which on aggregate have 1.5% of broker-dealer
holdings. However, the SEC expects that the largest share of dealing
activity subject to SEC oversight will continue to be captured by the
dealer prong. Thus, the SEC expects that the effects of this amendment
for dealers will be modest.
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    \972\ See, e.g., State Street; Chatham; BPI; FSF; CCMR and CFA.
    \973\ See, e.g., ABA; Arvest; BPI; SIFMA and IIB.
    \974\ See, e.g., State Street; Chatham; BPI; FSF; CCMR and CFA.
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(2) Efficiency, Competition, and Capital Formation
    To the extent that the compliance related to the rebuttable
presumption of the 2013 rule limits dealers' ability to conduct
customer-accommodating transactions, or liquidity management or risk
management activities that are covered by the short-term prong, the
amendments to the definition of trading account may facilitate such
activities, which could, in turn, promote capital formation. In
addition, to the degree that the amendments to the trading account may
provide banking entities with more flexibility to underwrite, market
make, and hedge, and to the extent these activities facilitate capital
formation, these amendments may improve allocative efficiency. To the
extent that the amendments to the short-term prong reduce compliance
costs and to the extent that the short-term prong primarily applies to
smaller dealers (i.e., those not covered by the market risk capital