solicited comment on whether exempting proprietary trading in options
or other derivatives referencing an obligation of a State or political
subdivision thereof was consistent with the terms and purpose of the
statute.\1408\ The Agencies did not receive persuasive information on
this topic and, for the same reasons discussed above related to
derivatives on U.S. government securities, the Agencies have determined
not to provide an exemption for proprietary trading in municipal
securities, beyond the underwriting, market-making, hedging and other
exemptions provided generally in the rule. The Agencies note that
banking entities may trade derivatives on municipal securities under
any other available exemption to the prohibition on proprietary
trading, providing the requirements of the relevant exemption are met.
---------------------------------------------------------------------------

    \1408\ See Joint Proposal, 76 FR 68,878.
---------------------------------------------------------------------------

d. Determination to Not Exempt Proprietary Trading in Multilateral
Development Bank Obligations
    The proposal did not exempt proprietary trading in obligations of
multilateral banks or derivatives on multilateral development bank
obligations but requested comment on this issue.\1409\ A number of
commenters argued that the final rule should include an exemption for
obligations of multilateral development banks.\1410\
---------------------------------------------------------------------------

    \1409\ See id.
    \1410\ Commenters argued that including obligations of
multilateral developments banks in a foreign sovereign debt
exemption is necessary to avoid endangering international
cooperation in financial regulation and potential retaliatory
prohibitions against U.S. government obligations. See Ass'n. of
German Banks; Sumitomo; SIFMA et al. (Prop. Trading) (Feb. 2012).
Additionally, some commenters represented that an exemption for
obligations of international and multilateral development banks is
appropriate for many of the same reasons provided for exempting U.S.
government obligations and foreign sovereign debt generally. See
Ass'n. of German Banks; Barclays; Goldman (Prop. Trading); IIB/EBF;
ICFR; ICI Global; FIA; Sumitomo Trust; Allen & Overy (Gov't.
Obligations); SIFMA et al. (Prop. Trading) (Feb. 2012).
---------------------------------------------------------------------------

    The Agencies have not included an exemption to permit banking
entities to engage in proprietary trading in obligations of
multilateral development banks at this time. The Agencies do not
believe that providing an exemption for

trading obligations of multilateral development banks will help enhance
the markets for these obligations and therefore promote and protect the
safety and soundness of banking entities and U.S. financial stability.
6. Section ----.6(c): Permitted Trading on Behalf of Customers
    Section 13(d)(1)(D) of the BHC Act provides an exemption from the
prohibition on proprietary trading for the purchase, sale, acquisition,
or disposition of financial instruments on behalf of customers.\1411\
The statute does not define when a transaction or activity is conducted
``on behalf of customers.''
---------------------------------------------------------------------------

    \1411\ 12 U.S.C. 1851(d)(1)(D).
---------------------------------------------------------------------------

a. Proposed Exemption for Trading on Behalf of Customers
    Section ----.6(b) of the proposed rule implemented the exemption
for trading on behalf of customers by exempting three types of trading
activity. Section ----.6(b)(i) of the proposed rule provided that a
purchase or sale of a financial instrument occurred on behalf of
customers if the transaction (i) was conducted by a banking entity
acting as investment adviser, commodity trading advisor, trustee, or in
a similar fiduciary capacity for the account of that customer, and (ii)
involved solely financial instruments for which the banking entity's
customer, and not the banking entity or any affiliate of the banking
entity, was the beneficial owner. This exemption was intended to permit
trading activity that a banking entity conducts in the context of
providing investment advisory, trust, or fiduciary services to
customers provided that the banking entity structures the activity so
that the customer, and not the banking entity, benefits from any gains
and suffers any losses on the traded positions.
    Section ----.6(b)(ii) of the proposed rule exempted the purchase or
sale of a covered financial position if the banking entity was acting
as riskless principal.\1412\ Under the proposed rule, a banking entity
qualified as a riskless principal if the banking entity, after having
received an order to purchase or sell a covered financial position from
a customer, purchased or sold the covered financial position for its
own account to offset a contemporaneous sale to or purchase from the
customer.\1413\
---------------------------------------------------------------------------

    \1412\ See Joint Proposal, 76 FR 68,879.
    \1413\ This language generally mirrors that used in the Board's
Regulation Y, OCC interpretive letters, and the SEC's Rule 3a5-1
under the Exchange Act. See 12 CFR 225.28(b)(7)(ii); 17 CFR 240.3a5-
1(b); OCC Interpretive Letter 626 (July 7, 1993).
---------------------------------------------------------------------------

    Section ----.6(b)(iii) of the proposed rule permitted trading by a
banking entity that was an insurance company for the separate account
of insurance policyholders. Under the proposed rule, only a banking
entity that is an insurance company directly engaged in the business of
insurance and subject to regulation by a State insurance regulator or
foreign insurance regulator was eligible for this prong of the
exemption for trading on behalf of customers. Additionally, the
purchase or sale of the covered financial position was exempt only if
it was solely for a separate account established by the insurance
company in connection with one or more insurance policies issued by
that insurance company under which all profits and losses arising from
the purchase or sale of the financial instrument were allocated to the
separate account and inured to the benefit or detriment of the owners
of the insurance policies supported by the separate account, and not
the banking entity. These types of transactions are customer-driven and
do not expose the banking entity to gains or losses on the value of
separate account assets even though the banking entity is treated as
the owner of those assets for certain purposes.
b. Comments on the Proposed Rule
    Several commenters contended that the Agencies construed the
statutory exemption too narrowly by limiting permissible proprietary
trading on behalf of customers to only three categories of
transactions.\1414\ Some of these commenters argued the exemption in
the proposal was not consistent with the statutory language or
Congressional intent to permit all transactions that are ``on behalf of
customers.'' \1415\ One of these commenters expressed concern that the
proposed exemption for trading on behalf of customers may be construed
to permit only customer-driven transactions involving securities and
not other financial instruments such as foreign exchange forwards and
other derivatives.\1416\
---------------------------------------------------------------------------

    \1414\ See, e.g., Am. Express; BoA; ISDA (Apr. 2012); RBC; SIMFA
et al. (Prop. Trading) (Feb. 2012); Wells Fargo (Prop. Trading).
    \1415\ See, e.g., Am. Express; SIMFA et al. (Prop. Trading)
(Feb. 2012).
    \1416\ See Am. Express.
---------------------------------------------------------------------------

    Several commenters urged the Agencies to expand the exemption for
trading on behalf of customers to permit other categories of customer-
driven transactions in which the banking entity may be acting as
principal but that serve legitimate customer needs including capital
formation. For example, one commenter urged the Agencies to permit
customer-driven transactions in which the banking entity has no ready
counterparty but that are undertaken at the instruction or request of a
customer or client or in anticipation of such an instruction or
request, such as facilitating customer liquidity needs or block
positioning transactions.\1417\ Other commenters urged the Agencies to
exempt transactions where the banking entity acts as principal to
accommodate a customer and substantially and promptly hedges the risks
of the transaction.\1418\ Commenters argued that these kinds of
transactions are similar in purpose and level of risk to riskless
principal transactions.\1419\ Commenters also argued that these
transactions could be viewed as market-making related activities, but
indicated that the potential uncertainty and costs of making that
determination would discourage banking entities from taking principal
risks to accommodate customer needs.\1420\ Commenters also requested
that the Agencies expressly permit transactions on behalf of customers
to create structured products, as well as for client funding needs,
customer clearing, and prime brokerage, if these transactions are
included within the trading account.\1421\
---------------------------------------------------------------------------

    \1417\ See RBC. The Agencies note that acting as a block
positioner is expressly contemplated and included as part of the
exemption for market making-related activities under the final rule.
    \1418\ See BoA; SIMFA et al. (Prop. Trading) (Feb. 2012).
    \1419\ See SIMFA et al. (Prop. Trading) (Feb. 2012).
    \1420\ See SIMFA et al. (Prop. Trading) (Feb. 2012).
    \1421\ See SIMFA et al. (Prop. Trading) (Feb. 2012).
---------------------------------------------------------------------------

    In contrast, some commenters supported the proposed approach for
implementing the exemption for trading on behalf of customers or urged
narrowing the exemption.\1422\ One commenter expressed general support
for the requirement that all profits (or losses) from the transaction
flow to the customer and not the banking entity providing the service
for a transaction to be exempt.\1423\ One commenter contended that the
statute did not permit transactions on behalf of customers to be
performed by an investment adviser.\1424\ Another commenter argued that
the final rule should permit a banking entity to engage in a riskless
principal transaction only where the banking entity has already
arranged for another customer to be on the other side of the
transaction.\1425\ Other commenters urged the Agencies to ensure that
both parties to the transaction agree

beforehand to the time and price of any relevant trade to ensure that
the banking entity solely stands in the middle of the transaction and
in fact passes on all gains (or losses) from the transaction to the
customers.\1426\ Commenters also urged the Agencies to define other key
terms used in the exemption. For instance, some commenters requested
that the final rule define which entities may qualify as a ``customer''
for purposes of the exemption.\1427\
---------------------------------------------------------------------------

    \1422\ See, e.g., Alfred Brock; ICBA; Occupy.
    \1423\ See ICBA.
    \1424\ See Occupy.
    \1425\ See Public Citizen.
    \1426\ See Occupy; Alfred Brock.
    \1427\ See Occupy; Public Citizen. Conversely, other commenters
supported the approach taken in the proposed rule without requesting
such a definition. See Alfred Brock.
---------------------------------------------------------------------------

    Some commenters urged the Agencies to provide uniform guidance on
how the Agencies will interpret the riskless principal exemption.\1428\
One commenter urged the Agencies to clarify how the riskless principal
exemption would be implemented with respect to transactions in
derivatives, including a hedged derivative transaction executed at the
request of a customer.\1429\
---------------------------------------------------------------------------

    \1428\ See, e.g., Am. Express; SIMFA et al. (Prop. Trading)
(Feb. 2012).
    \1429\ See Am. Express.
---------------------------------------------------------------------------

    Several commenters generally expressed support for the exemption
for trading for the separate account of insurance policyholders under
the proposed rule.\1430\ One commenter requested that the final rule
more clearly articulate who may qualify as a permissible owner of an
insurance policy to whom the profits and losses arising from the
purchase or sale of a financial instrument allocated to the separate
account may inure.\1431\
---------------------------------------------------------------------------

    \1430\ See ACLI; Chris Barnard; NAMIC; Fin. Services Roundtable
(Feb. 3, 2012).
    \1431\ See Chris Barnard.
---------------------------------------------------------------------------

    Several commenters argued that certain types of separate account
activities, including the allocation of seed money by an insurance
company to a separate account or the offering of certain non-variable
separate account contracts by the insurance company, would not appear
to be permitted under the proposal.\1432\ Commenters also expressed
concern that these separate account activities might not satisfy the
proposed requirement that all profits and losses arising from the
purchase or sale of the financial position inure to the benefit or
detriment of the owners of the insurance policies supported by the
separate account, and not the insurance company.\1433\ In addition,
commenters argued that under the proposed rule, these activities would
appear to fall outside of the exemption for activities in the general
account of an insurance company because the proposed rule defined a
general account as excluding a separate account.\1434\ Commenters urged
the Agencies to more closely align the exemptions for trading by an
insurance company for the general account and separate account.\1435\
According to these commenters, this change would permit insurance
companies to continue to engage in the business of insurance by
offering the full suite of insurance products to their customers.\1436\
---------------------------------------------------------------------------

    \1432\ See ACLI; Sutherland (on behalf of Comm. of Annuity
Insurers); Fin. Services Roundtable (Feb. 3, 2012); NAMIC.
    \1433\ See ACLI; Sutherland (on behalf of Comm. of Annuity
Insurers); Fin. Services Roundtable (Feb. 3, 2012); NAMIC.
    \1434\ See ACLI; Sutherland (on behalf of Comm. of Annuity
Insurers); Fin. Services Roundtable (Feb. 3, 2012); NAMIC.
    \1435\ See ACLI; Sutherland (on behalf of Comm. of Annuity
Insurers); Fin. Services Roundtable (Feb. 3, 2012); NAMIC.
    \1436\ See ACLI; Sutherland (on behalf of Comm. of Annuity
Insurers); Fin. Services Roundtable (Feb. 3, 2012); NAMIC.
---------------------------------------------------------------------------

c. Final Exemption for Trading on Behalf of Customers
    The Agencies have carefully considered the comments and are
adopting the exemption for trading on behalf of customers with several
modifications. The Agencies believe that the final rule implements the
exemption in section 13(d)(1)(D) in a manner consistent with the
legislative intent to allow banking entities to use their own funds to
purchase or sell financial instruments when acting on behalf of their
customers.\1437\ At the same time, the limited activities permitted
under the final rule limit the potential for abuse.\1438\
---------------------------------------------------------------------------

    \1437\ See 156 Cong. Rec. S5896 (daily ed. July 15, 2010)
(statement of Sen. Merkley) (arguing that ``this permitted activity
is intended to allow financial firms to use firm funds to purchase
assets on behalf of their clients, rather than on behalf of
themselves.'').
    \1438\ Some commenters urged narrowing the exemption. See, e.g.,
Alfred Brock; ICBA; Occupy. The Agencies believe the final rule is
appropriately narrow to limit potential abuse.
---------------------------------------------------------------------------

    The final rule slightly modifies the proposed rule by providing
that a banking entity is not prohibited from trading on behalf of
customers when that activity is conducted by the banking entity as
trustee or in a similar fiduciary capacity for a customer and so long
as the transaction is conducted for the account of, or on behalf of the
customer and the banking entity does not have or retain a beneficial
ownership of the financial instruments. The final rule removes the
proposal's express exemption for investment advisers. After further
consideration, the Agencies do not believe an express reference to
investment advisers is necessary because investment advisers generally
act in a fiduciary capacity on behalf of clients in a manner that is
separately covered by other exclusions and exemptions in the final
rule. Additionally, the final rule deletes the proposal's express
exemption for commodity trading advisors because the legal relationship
between a commodity trading advisor and its client depends on the facts
and circumstances of each relationship. Therefore, the Agencies
determined that it was appropriate to limit the discussion to fiduciary
obligations generally and to omit any specific discussion of commodity
trading advisors. In order to ensure that a banking entity utilizes
this exemption to engage only in transactions for customers and not to
conduct its own trading activity, the final rule (consistent with the
proposed rule) requires that the purchase or sale of financial
instruments be conducted for the account of the customer and that it
involve solely financial instruments of which the customer, and not the
banking entity, is beneficial owner.\1439\ The final rule, like the
proposed rule, permits transactions in any financial instrument,
including derivatives such as foreign exchange forwards, so long as
those transactions are on behalf of customers.\1440\
---------------------------------------------------------------------------

    \1439\ See final rule Sec.  ----.6(c)(1)(ii)-(iii). See also
proposed rule Sec.  ----.6(b)(2)(i)(B)-(C).
    \1440\ Some commenters expressed concern that the proposed
exemption for trading on behalf of customers may be construed to not
permit transactions in foreign exchange forwards and other
derivatives. See Am. Express; SIFMA et al. (Prop. Trading) (Feb.
2012).
---------------------------------------------------------------------------

    While some commenters requested that the final rule define
``customer'' for purposes of this exemption,\1441\ the Agencies believe
the requirements of this exemption address commenters' underlying
concerns about what constitutes a ``customer.'' Specifically, the
Agencies believe that requiring a transaction relying on this exemption
to be conducted in a fiduciary capacity for a customer, to be conducted
for the account of the customer, and to involve solely financial
instruments of which the customer is beneficial owner address the
underlying concerns that a transaction could qualify for this exemption
if done on behalf of an indirect customer or on behalf of a customer
not served by the banking entity.
---------------------------------------------------------------------------

    \1441\ See Occupy; Public Citizen.
---------------------------------------------------------------------------

    The final rule also provides that a banking entity may act as
riskless principal in a transaction in which the banking entity, after
receiving an order to purchase (or sell) a financial instrument from a
customer, purchases (or sells) the financial instrument for its

own account to offset the contemporaneous sale of the financial
instrument to (purchase from) the customer.\1442\ Any transaction
conducted pursuant to the exemption for riskless principal activity
must be customer-driven and may not expose the banking entity to gains
(or losses) on the value of the traded instruments as principal.\1443\
Importantly, the final rule does not permit a banking entity to
purchase (or sell) a financial instrument without first having a
customer order to buy (sell) the instrument. While some commenters
requested that the Agencies modify the final rule to permit activity
without a customer order,\1444\ the Agencies are concerned that
broadening the exemption in this manner would enable banking entities
to evade the requirements of section 13 and engage in prohibited
proprietary trading under the guise of trading on behalf of customers.
---------------------------------------------------------------------------

    \1442\ See final rule Sec.  ----.6(c)(2).
    \1443\ Some commenters urged the Agencies to ensure that the
banking entity passes on all gains (or losses) from the transaction
to the customers. See Occupy; Public Citizen.
    \1444\ See RBC; SIFMA et al. (Prop. Trading) (Feb. 2012).
---------------------------------------------------------------------------

    Several commenters requested that the final rule explain how a
banking entity may determine when it is acting as riskless
principal.\1445\ The Agencies note that riskless principal transactions
typically are undertaken as an alternative method of executing orders
by customers to buy or sell financial instruments on an agency basis.
Acting as riskless principal does not include acting as underwriter or
market maker in the particular financial instrument and is generally
understood to be equivalent to agency or brokerage transactions in
which all of the risks associated with ownership of financial
instruments are borne by customers. The Agencies have generally
equivalent standards for determining when a banking entity acts as
riskless principal and require that the banking entity, after receiving
an order to buy (or sell) a financial instrument from a customer, buys
(or sells) the instrument for its own account to offset a
contemporaneous sale to (or purchase from) the customer.\1446\ The
Agencies intend to determine whether a banking entity acts as riskless
principal in accordance with and subject to the requirements of these
standards.
---------------------------------------------------------------------------

    \1445\ See, e.g., Am. Express; SIFMA et al. (Prop. Trading)
(Feb. 2012).
    \1446\ See, e.g., 12 CFR 225.28(b)(7)(ii); 17 CFR 240.3a5-1(b);
OCC Interpretive Letter 626 (July 7, 1993). One commenter stated
that a banking entity should only be allowed to engage in a riskless
principal transaction where the banking entity has already arranged
for another customer to be on the other side of the transaction. See
Public Citizen. The Agencies believe that the contemporaneous
requirement in the final rule addresses this comment.
---------------------------------------------------------------------------

    Some commenters requested that the final rule permit a greater
variety of transactions to be conducted on behalf of customers. Many of
these transactions, such as transactions that facilitate customer
liquidity needs or block positioning transactions \1447\ or
transactions in which the banking entity acts as principal to
accommodate a customer and substantially and promptly hedges the risks
of the transaction,\1448\ may be permissible under the market-making
exemption. To the extent these transactions are conducted by a market
maker, the Agencies believe that the restrictions and limits required
in connection with market making-related activities are important for
limiting the risks to the banking entity from these transactions.\1449\
While some commenters requested that clearing and settlement activities
and prime brokerage activities be viewed as permitted proprietary
trading on behalf of customers,\1450\ these transactions are not
considered proprietary trading as an initial matter under the final
rule.\1451\
---------------------------------------------------------------------------

    \1447\ One commenter requested an exemption for transactions at
the instruction or request of a customer or client or in
anticipation of such an instruction or request, such as facilitating
customer liquidity needs or block positioning transactions. See RBC.
    \1448\ Some commenters requested an exemption for these types of
transactions. See BoA; SIFMA et al. (Prop. Trading) (Feb. 2012).
    \1449\ Some commenters stated that the potential uncertainty and
costs of determining whether an activity qualifies for the market-
making exemption would discourage banking entities from taking
principal risks to accommodate customer needs. See, e.g., SIFMA et
al. (Prop. Trading) (Feb. 2012). The Agencies believe that
adjustments made to the market-making exemption in the final rule
help address this concern. Specifically, the final market-making
exemption better accounts for the varying characteristics of market-
making across markets and assets classes.
    \1450\ See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012).
    \1451\ See final rule Sec.  ----.3(d)(4)-(6). See also infra
Part IV.A.1.d.3-4.
---------------------------------------------------------------------------

    Finally, the Agencies have decided to move the exemption for
trading activity conducted by an insurance company for a separate
account into the provision exempting trading activity in an insurance
company's general account in order to better align the two
exemptions.\1452\ As discussed below in Part IV.A.7., the final rule
provides exemptions for trading activity conducted by an insurance
company that is a banking entity either in the general account or in a
separate account of customers in Sec.  ----.6(d). As explained below,
the statute specifically exempts trading activity that is conducted by
a regulated insurance company engaged in the business of insurance for
the general account of the company if conducted in accordance with
applicable state law and if not prohibited by the appropriate Federal
banking agencies.\1453\ Unlike activity for the general account of an
insurance company, investments made by regulated insurance companies in
separate accounts in accordance with applicable state law are made on
behalf of and for the benefit of customers of the insurance
company.\1454\ Also unlike general accounts (which are supported by all
of the assets of the insurance company), a separate account is
supported only by the assets in that account and does not have call on
the other assets of the company. The customer benefits (or loses) based
solely on the performance of the assets in the separate account. These
arrangements are the equivalent for insurance companies of fiduciary
accounts at banks. For these reasons, the final rule recognizes that
separate accounts at regulated insurance companies maintained in
accordance with applicable state insurance laws are exempt from the
prohibitions in section 13 as acquisitions on behalf of customers.
---------------------------------------------------------------------------

    \1452\ Some commenters requested that the Agencies more closely
align the exemptions for trading by an insurance company for the
general account and separate account. See ACLI; Sutherland (on
behalf of Comm. of Annuity Insurers); Fin. Services Roundtable (Feb.
3, 2012); NAMIC.
    \1453\ See 12 U.S.C. 1851(d)(1)(F).
    \1454\ One commenter requested clarification on who may qualify
as a permissible owner of an insurance policy to whom the profits
and losses arising from the purchase or sale of a financial
instrument allocated to the separate account may inure. See Chris
Barnard. The Agencies note that the proposed requirement that all
profits and losses arising from the purchase or sale of a financial
instrument inure to the benefit or detriment of the ``owners of the
insurance policies supported by the separate account'' has been
removed. See proposed rule Sec.  ----.6(b)(2)(iii)(C). Instead, the
final rule requires that the income, gains, and losses from assets
allocated to a separate account be credited to or charged against
the account without regard to other income, gains or losses of the
insurance company. See final rule Sec.  ----.2(z) (definition of
``separate account''). Thus, the final rule no longer references
``owners of the insurance policies supported by the separate
account.'' The Agencies note, however, that the final rule requires
exempted separate account transactions to be ``conducted in
compliance with, and subject to, the insurance company investment
laws, regulations, and written guidance of the State or jurisdiction
in which such insurance company is domiciled.'' See final rule Sec.
----.6(d)(3).
---------------------------------------------------------------------------

7. Section ----.6(d): Permitted Trading by a Regulated Insurance
Company
    Section 13(d)(1)(F) permits a banking entity that is a regulated
insurance company acting for its general account,

or an affiliate of an insurance company acting for the insurance
company's general account, to purchase or sell a financial instrument
subject to certain conditions (the ``general account
exemption'').\1455\ Section 13(d)(1)(D) permits a banking entity to
purchase or sell a financial instrument on behalf of customers.\1456\
In the proposed rule, the Agencies viewed Section 13(d)(1)(D) as
permitting an insurance company to purchase or sell a financial
instrument for certain separate accounts (the ``separate account
exemption''). The proposal implemented both these exemptions with
respect to activities of insurance companies, in each case subject to
the restrictions discussed below.\1457\
---------------------------------------------------------------------------

    \1455\ See 12 U.S.C. 1851(d)(1)(F).
    \1456\ See 12 U.S.C. 1851(d)(1)(D).
    \1457\ See proposed rule Sec. Sec.  ----.6(b)(2)(iii), --
--.6(c).
---------------------------------------------------------------------------

    Section ----.6(c) of the proposed rule implemented the general
account exemption by generally restating the statutory requirements of
the exemption that:
     The insurance company directly engage in the business of
insurance and be subject to regulation by a State insurance regulator
or foreign insurance regulator;
     The insurance company or its affiliate purchase or sell
the financial instrument solely for the general account of the
insurance company;
     The purchase or sale be conducted in compliance with, and
subject to, the insurance company investment laws, regulations, and
written guidance of the State or jurisdiction in which such insurance
company is domiciled; and
     The appropriate Federal banking agencies, after
consultation with the Council and the relevant insurance commissioners
of the States, must not have jointly determined, after notice and
comment, that a particular law, regulation, or written guidance
described above is insufficient to protect the safety and soundness of
the banking entity or of the financial stability of the United States.
    The proposed rule defined the term ``general account'' to include
all of the assets of the insurance company that are not legally
segregated and allocated to separate accounts under applicable State
law.\1458\
---------------------------------------------------------------------------

    \1458\ See proposed rule Sec.  ----.3(c)(6).
---------------------------------------------------------------------------

    As noted above in Part IV.A.6.a., Sec.  ----.6(b)(iii) of the
proposed rule provided an exemption for a banking entity that is an
insurance company when it acted through a separate account for the
benefit of insurance policyholders. The proposed rule defined a
``separate account'' as an account established or maintained by a
regulated insurance company subject to regulation by a State insurance
regulator or foreign insurance regulator under which income, gains, and
losses, whether or not realized, from assets allocated to such account,
are, in accordance with the applicable contract, credited to or charged
against such account without regard to other income, gains, or losses
of the insurance company.\1459\
---------------------------------------------------------------------------

    \1459\ See proposed rule Sec.  ----.2(z).
---------------------------------------------------------------------------

    To limit the potential for abuse of the separate account exemption,
the proposed rule included requirements designed to ensure that the
separate account trading activity is subject to appropriate regulation
and supervision under insurance laws and not structured so as to allow
gains or losses from trading activity to inure to the benefit or
detriment of the banking entity.\1460\ In particular, the proposed rule
provided that a purchase or sale of a financial instrument qualified
for the separate account exemption only if:
---------------------------------------------------------------------------

    \1460\ The Agencies noted in the proposal they would not
consider profits to inure to the benefit of the banking entity if
the banking entity were solely to receive payment, out of separate
account profits, of fees unrelated to the investment performance of
the separate account.
---------------------------------------------------------------------------

     The banking entity is an insurance company directly
engaged in the business of insurance and subject to regulation by a
State insurance regulator or foreign insurance regulator; \1461\
---------------------------------------------------------------------------

    \1461\ The proposed rule provided definitions of the terms
``State insurance regulator'' and ``foreign insurance regulator.''
See proposed rule Sec. Sec.  ----.3(c)(4), (13).
---------------------------------------------------------------------------

     The banking entity purchases or sells the financial
instrument solely for a separate account established by the insurance
company in connection with one or more insurance policies issued by
that insurance company;
     All profits and losses arising from the purchase or sale
of the financial instrument are allocated to the separate account and
inure to the benefit or detriment of the owners of the insurance
policies supported by the separate account, and not the banking entity;
and
     The purchase or sale is conducted in compliance with, and
subject to, the insurance company investment and other laws,
regulations, and written guidance of the State or jurisdiction in which
such insurance company is domiciled.
    The proposal explained that the proposed separate account exception
represented transactions on behalf of customers because the insurance-
related transactions are generally customer-driven and do not expose
the banking entity to gains or losses on the value of separate account
assets, even though the banking entity may be treated as the owner of
those assets for certain purposes.
    Commenters generally supported the general account exemption and
the separate account exemption for regulated insurance companies as
consistent with both the statute and Congressional intent to
accommodate the business of insurance.\1462\ For instance, commenters
argued that the statute was designed to appropriately accommodate the
business of insurance, subject to regulation in accordance with
relevant insurance company investment laws, in recognition that
insurance company investment activities are already subject to
comprehensive regulation and oversight.\1463\
---------------------------------------------------------------------------

    \1462\ See, e.g., Alfred Brock; Chris Barnard; Fin. Services
Roundtable (Feb. 3, 2012); Sutherland (on behalf of Comm. of Annuity
Insurers); TIAA-CREF; NAMIC.
    \1463\ See, e.g., ACLI (Jan. 2012); Fin. Services Roundtable
(Feb. 3, 2012); Country Fin. et al.; Sutherland (on behalf of Comm.
of Annuity Insurers).
---------------------------------------------------------------------------

    A few commenters expressed concerns about the definition of
``general account'' and ``separate account.'' \1464\ One commenter
argued the definition of general account was unclear.\1465\ A few
commenters expressed concern that the proposed definition of separate
account inappropriately excluded some separate accounts, such as
certain insurance company investment activities such as guaranteed
investment contracts, which would also not fall within the proposed
definition of general account.\1466\ Several commenters argued that the
final rule should be modified so that all insurance company investment
activity permitted under applicable insurance laws would qualify for
either the general account exemption or the separate account
exemption.\1467\
---------------------------------------------------------------------------

    \1464\ See, e.g., Fin. Services Roundtable (Feb. 3, 2012); ACLI
(Jan. 2012); Sutherland (on behalf of Comm. of Annuity Insurers).
    \1465\ See Sutherland (on behalf of Comm. of Annuity Insurers).
    \1466\ See ACLI (Jan. 2012); NAMIC.
    \1467\ See Fin. Services Roundtable (Feb. 3, 2012); ACLI (Jan.
2012); NAMIC; See also Nationwide.
---------------------------------------------------------------------------

    Some commenters argued that the prohibition in the proposed
definition of separate account against any profits or losses from
activity in the account inuring to the benefit (or detriment) of the
insurance company would exclude some activity permitted by insurance
regulation in separate accounts.\1468\ For example, commenters
contended that an insurer may allocate its own funds to a separate
account as ``seed money'' and

the profits and losses on those funds inure to the benefit or detriment
of the insurance company.\1469\
---------------------------------------------------------------------------

    \1468\ See Fin. Services Roundtable (Feb. 3, 2012); ACLI (Jan.
2012); NAMIC; Sutherland (on behalf of Comm. of Annuity Insurers);
See also Nationwide.
    \1469\ See Fin. Services Roundtable (Feb. 3, 2012); ACLI (Jan.
2012).
---------------------------------------------------------------------------

    Some commenters expressed specific concerns about the scope or
requirements of the proposal. For instance, one commenter argued that
the final rule should provide that a trade is exempt if the trade is
made by an affiliate of the insurance company in accordance with state
insurance law.\1470\ Another commenter urged that the Agencies consult
with the foreign insurance supervisor of an insurance company regulated
outside of the United States before finding that an insurance activity
conducted by the foreign insurance company was inconsistent with the
safety and soundness or financial stability.\1471\
---------------------------------------------------------------------------

    \1470\ See USAA.
    \1471\ See HSBC Life.
---------------------------------------------------------------------------

    One commenter suggested that insurance company affiliates of
banking entities should expressly be made subject to data collection
and reporting requirements to prevent possible evasion of the
restrictions of section 13 and the final rule using their insurance
affiliates.\1472\ By contrast, other commenters argued that the
reporting and recordkeeping and compliance requirements of the rule
should not apply to permitted insurance company investment
activities.\1473\ These commenters argued that insurance companies are
already subject to comprehensive regulation of the kinds and amounts of
investments they can make under insurance laws and regulations and that
additional recordkeeping obligations would impose unnecessary
compliance burdens on these entities without producing significant
offsetting benefits.
---------------------------------------------------------------------------

    \1472\ See Sens. Merkley & Levin (Feb. 2012).
    \1473\ See ACLI (Jan. 2012); Fin. Services Roundtable (Feb. 3,
2012); Mutual of Omaha; NAMIC.
---------------------------------------------------------------------------

    After considering the comments received and the language and
purpose of the statute, the final rule has been modified to better
account for the language of the statute and more appropriately
accommodate the business of insurance.
    As explained in the proposal, section 13(d)(1)(F) of the BHC Act
specifically and broadly exempts the purchase, sale, acquisition, or
disposition of securities and other instruments by a regulated
insurance company engaged in the business of insurance for the general
account of the company (and by an affiliate solely for the general
account of the regulated insurance company). Section 13(d)(1)(D) of the
statute also specifically exempts the same activity when done on behalf
of customers. As explained in the proposal, separate accounts managed
and maintained by insurance companies as part of the business of
insurance are generally customer-driven and do not expose the banking
entity to gains or losses on the value of assets held in the separate
account, even though the banking entity may be treated as the owner of
the assets for certain purposes. Unlike the general account of the
insurance company, separate accounts are managed on behalf of specific
customers, much as a bank would manage a trust or fiduciary account.
    For these reasons, the final rule retains both the general account
exemption and the separate account exemption. The final rule removes
any gap between the definition of general account and the definition of
separate account by defining the general account to be all of the
assets of an insurance company except those allocated to one or more
separate accounts.\1474\
---------------------------------------------------------------------------

    \1474\ See final rule Sec. Sec.  ----.2(p), (bb). Some
commenters expressed concerns about the proposed definitions of
``general account'' and ``separate account,'' including that the
proposed definition of ``separate account'' excluded some legitimate
separate account activities that do not fall within the proposed
general account definition. See, e.g., ACLI (Jan. 2012); NAMIC;
Sutherland (on behalf of Comm. of Annuity Insurers). See also
proposed rule Sec. Sec.  ----.2(z), ----.3(c)(5).
---------------------------------------------------------------------------

    The final rule also combines the general account exemption and the
separate account exemption into a single section. This makes clear that
both exemptions are available only:
     If the insurance company or its affiliate purchases or
sells the financial instruments solely for the general account of the
insurance company or a separate account of the insurance company;
     The purchases or sales of financial instruments are
conducted in compliance with, and subject to, the insurance company
investment laws, regulations, and written guidance of the State or
jurisdiction in which such insurance company is domiciled; and
     The appropriate Federal banking agencies, after
consultation with the Financial Stability Oversight Council and the
relevant insurance commissioners of the States and relevant foreign
jurisdictions, as appropriate, have not jointly determined, after
notice and comment, that a particular law, regulation, or written
guidance regarding insurance is insufficient to protect the safety and
soundness of the banking entity, or the financial stability of the
United States.\1475\
---------------------------------------------------------------------------

    \1475\ The Federal banking agencies have not at this time
determined, as part of the final rule, that the insurance company
investment laws, regulations, and written guidance of any particular
State or jurisdiction are insufficient to protect the safety and
soundness of the banking entity, or of the financial stability of
the United States. The Federal banking agencies expect to monitor,
in conjunction with the FSOC, the insurance company investment laws,
regulations, and written guidance of States or jurisdictions to
which exempt transactions are subject and make such determinations
in the future, where appropriate. The Agencies believe the final
approach addresses one commenter's request that the Agencies consult
with the foreign insurance supervisor of an insurance company
regulated outside of the United States before finding that an
insurance activity conducted by the foreign company was inconsistent
with the safety and soundness or financial stability. See HSBC Life.
---------------------------------------------------------------------------

    Like section 13(d)(1)(F) of the BHC Act, the final rule permits an
affiliate of an insurance company to purchase and sell financial
instruments in reliance on the general account exemption, so long as
that activity is for the general account of the insurance company.
Similarly, the final rule implements section 13(d)(1)(D) and permits an
affiliate of an insurance company to purchase and sell financial
instruments for a separate account of the insurance company, so long as
the separate account is established and maintained at the insurance
company.
    Importantly, the final rule applies only to covered trading
activity in a general or separate account of a licensed insurance
company engaged in the business of insurance under the supervision of a
State or foreign insurance regulator. As in the statute, an affiliate
of an insurance company may not rely on this exemption for activity in
any account of the affiliate (unless it, too, meets the definition of
an insurance company). An affiliate may rely on the exemption to the
limited extent that the affiliate is acting solely for the account of
the insurance company.\1476\
---------------------------------------------------------------------------

    \1476\ Although one commenter requested that the final rule
exempt a trade as long as the trade is made by an affiliate of the
insurance company in accordance with state insurance law, the
Agencies believe the final approach properly implements the statute.
See USAA.
---------------------------------------------------------------------------

    As noted above, one commenter requested that the final rule impose
special data and reporting obligations on insurance companies. Other
commenters argued that insurance companies are already subject to
comprehensive regulation under insurance laws and regulations and that
additional recordkeeping obligations would impose unnecessary
compliance burdens on these entities without producing significant
offsetting benefits.

In accordance with the statute,\1477\ the Agencies expect insurance
companies to have appropriate compliance programs in place for any
activity subject to section 13 of the BHC Act.
---------------------------------------------------------------------------

    \1477\ See 12 U.S.C. 1851(e)(1) (requiring that the Agencies
issue regulations regarding ``internal controls and recordkeeping,
in order to insure compliance with this section'').
---------------------------------------------------------------------------

    The final rule contains a number of other related definitions that
are intended to help make clear the limitations of the insurance
company exemption, including definitions of foreign insurance regulator
and State insurance regulator.
8. Section ----.6(e): Permitted Trading Activities of a Foreign Banking
Entity
    Section 13(d)(1)(H) of the BHC Act \1478\ permits certain foreign
banking entities to engage in proprietary trading that occurs solely
outside of the United States (the ``foreign trading exemption'').\1479\
The statute does not define when a foreign banking entity's trading
occurs solely outside of the United States.
---------------------------------------------------------------------------

    \1478\ Section 13(d)(1)(H) of the BHC Act provides an exemption
to the prohibition on proprietary trading for trading conducted by a
foreign banking entity pursuant to paragraph (9) or (13) of section
4(c) of the BHC Act, if the trading occurs solely outside of the
United States, and the banking entity is not directly or indirectly
controlled by a banking entity that is organized under the laws of
the United States or of one or more States. See 12 U.S.C.
1851(d)(1)(H).
    \1479\ This section's discussion of the concept ``solely outside
of the United States'' is provided solely for purposes of the rule's
implementation of section 13(d)(1)(H) of the BHC Act, and does not
affect a banking entity's obligation to comply with additional or
different requirements under applicable securities, banking, or
other laws.
---------------------------------------------------------------------------

    The proposed rule defined both the type of foreign banking entity
that is eligible for the exemption and activity that constitutes
trading solely outside of the United States. The proposed rule
effectively precluded a foreign banking entity from engaging in
proprietary trading through a transaction that had any connection with
the United States, including: Trading with any party located in the
United States; allowing U.S. personnel of the foreign banking entity to
be involved in the purchase or sale; or executing any transaction in
the United States (on an exchange or otherwise).\1480\
---------------------------------------------------------------------------

    \1480\ See proposed rule Sec.  ----.6(d).
---------------------------------------------------------------------------

    In general, commenters emphasized the importance of and supported
an exemption for foreign trading activities of foreign banking
entities. However, a number of commenters expressed concerns that the
proposed foreign trading exemption was too narrow and would not be
effective in permitting foreign banking entities to engage in foreign
trading activities.\1481\ For instance, many commenters stated that the
proposal's prohibition on trading activities that have any connection
to the U.S. was not consistent with the purpose of section 13 of the
BHC Act where the risk of the trading activity is taken or held outside
of the United States and does not implicate the U.S. safety net.\1482\
These commenters argued that, since one of the principal purposes of
section 13 of the BHC Act is to limit the risk posed by prohibited
proprietary trading to the federal safety net, the safety and soundness
of U.S. banking entities, and the financial stability of the United
States, the exemption for foreign trading activity should similarly
focus on whether the trading activity involves principal risk being
taken or held by the foreign banking entity inside the United
States.\1483\
---------------------------------------------------------------------------

    \1481\ See, e.g., IIB/EBF; ICI Global; ICI (Feb. 2012); Wells
Fargo (Prop. Trading); BoA.
    \1482\ See IIB/EBF; Ass'n. of Banks in Malaysia; EBF; Credit
Suisse (Seidel); Cadwalader (on behalf of Thai Banks).
    \1483\ See BaFin/Deutsche Bundesbank; ICSA; IIB/EBF; Allen &
Overy (on behalf of Canadian Banks); Credit Suisse (Seidel); George
Osbourne.
---------------------------------------------------------------------------

    Many commenters argued that the proposal's transaction-based
approach to implementing the foreign trading exemption would harm U.S.
markets and U.S. market participants. For example, some commenters
argued that the proposed exemption would cause foreign banks to exit
U.S. markets or shrink their U.S.-based operations, thereby resulting
in less liquidity and greater fragmentation in markets without
producing any significant offsetting benefit.\1484\ Commenters also
asserted that the proposal would impose significant compliance costs on
the foreign operations of foreign banking entities and would lead to
foreign firms refusing to trade with U.S. counterparties, including the
foreign operations of U.S. entities, to avoid compliance costs
associated with relying on another exemption under the proposed
rule.\1485\ Additionally, commenters argued that the proposal
represented an improper extraterritorial application of U.S. law that
could be found to violate international treaty obligations of the
United States, such as those under the North American Free Trade
Agreement, and might result in retaliation by foreign countries in
their treatment of U.S. banking entities abroad.\1486\
---------------------------------------------------------------------------

    \1484\ See ICE; ICI Global; BoA; Citigroup (Feb. 2012); British
Bankers' Ass'n.; IIB/EBF.
    \1485\ See BaFin/Deutsche Bundesbank; Norinchukin; IIF; Allen &
Overy (on behalf of Canadian Banks); ICFR; BoA; Citigroup (Feb.
2012). As discussed below in Part IV.C. of this SUPPLEMENTARY
INFORMATION, other parts of the final rule address commenters'
concerns regarding the compliance burden on foreign banking
entities.
    \1486\ See Norinchukin; Cadwalader (on behalf of Thai Banks);
Barclays; EBF; Commissioner Barnier; Ass'n. of German Banks;
Soci[eacute]t[eacute] G[eacute]n[eacute]rale; Chamber (Dec. 2012).
---------------------------------------------------------------------------

a. Foreign Banking Entities Eligible for the Exemption
    The statutory language of section 13(d)(1)(H) provides that, in
order to be eligible for the foreign trading exemption, the banking
entity must not be directly or indirectly controlled by a banking
entity that is organized under the laws of the United States or of one
or more States. The proposed rule limited the scope of the exemption to
banking entities that are organized under foreign law and, as
applicable, controlled only by entities organized under foreign law.
    Commenters generally supported this aspect of the proposal.\1487\
However, some commenters requested that the final rule be modified to
allow U.S. banking entities' affiliates or branches that are physically
located outside of the United States (``foreign operations of U.S.
banking entities'') to engage in proprietary trading outside of the
United States pursuant to this exemption.\1488\ These commenters argued
that, unless foreign operations of U.S. banking entities are provided
similar authority to engage in proprietary trading outside of the
United States, foreign operations of U.S. banking entities would be at
a competitive disadvantage abroad with respect to foreign banking
entities. One commenter also asserted that, unless foreign operations
of U.S. banking entities were able to effectively access foreign
markets, they could be shut out of those markets and would be unable to
effectively manage their risks in a safe and sound manner.\1489\
---------------------------------------------------------------------------

    \1487\ See Sens. Merkley & Levin (Feb. 2012) (arguing that the
final rule's foreign trading exemption should not exempt foreign
affiliates of U.S. banking entities when they engage in trading
activity abroad); See also Occupy; Alfred Brock.
    \1488\ See Citigroup (Feb. 2012); Sen. Carper; IIF; ABA
(Keating); Wells Fargo (Prop. Trading); Abbot Labs. et al. (Feb. 14,
2012).
    \1489\ See Citigroup (Feb. 2012).
---------------------------------------------------------------------------

    As noted above, section 13(d)(1)(H) of the BHC Act specifically
provides that its exemption is available only to a banking entity that
is not ``directly or indirectly'' controlled by a banking entity that
is organized under the laws of the United States or of one or more
States.\1490\ Because of this express statutory threshold requirement,
a foreign subsidiary controlled, directly or indirectly, by a banking
entity organized under the laws of the United States or

one of its States, and a foreign branch office of a banking entity
organized under the laws of the United States or one of the States, may
not take advantage of this exemption.
---------------------------------------------------------------------------

    \1490\ See 12 U.S.C. 1851(d)(1)(H).
---------------------------------------------------------------------------

    Like the proposal, the final rule incorporates the statutory
requirement that the banking entity conduct its trading activities
pursuant to sections 4(c)(9) or 4(c)(13) of the BHC Act.\1491\ The
final rule retains the tests in the proposed rule for determining when
a banking entity would meet that requirement. The final rule provides
qualifying criteria for both a banking entity that is a qualifying
foreign banking organization under the Board's Regulation K and a
banking entity that is not a foreign banking organization for purposes
of Regulation K.\1492\
---------------------------------------------------------------------------

    \1491\ See final rule Sec.  ----.6(e)(1)(ii).
    \1492\ Section ----.6(e)(2) addresses only when a transaction
will be considered to have been conducted pursuant to section
4(c)(9) of the BHC Act. Although the statute also references section
4(c)(13) of the BHC Act, the Board has to date applied the general
authority contained in that section solely to the foreign activities
of U.S. banking organizations which, by the express terms of section
13(d)(1)(H) of the BHC Act, are unable to rely on the foreign
trading exemption.
---------------------------------------------------------------------------

    Section 4(c)(9) of the BHC Act applies to any company organized
under the laws of a foreign country the greater part of whose business
is conducted outside the United States, if the Board by regulation or
order determines that, under the circumstances and subject to the
conditions set forth in the regulation or order, the exemption would
not be substantially at variance with the purposes of the BHC Act and
would be in the public interest.\1493\ The Board has implemented
section 4(c)(9) as part of subpart B of the Board's Regulation K,\1494\
which specifies a number of conditions and requirements that a foreign
banking organization must meet in order to act pursuant to that
authority.\1495\ The qualifying conditions and requirements include,
for example, that the foreign banking organization demonstrate that
more than half of its worldwide business is banking and that more than
half of its banking business is outside the United States.\1496\ Under
the final rule a banking entity that is a qualifying foreign banking
organization for purposes of the Board's Regulation K, other than a
foreign bank as defined in section 1(b)(7) of the International Banking
Act of 1978 that is organized under the laws of any commonwealth,
territory, or possession of the United States, will qualify for the
exemption for proprietary trading activity of a foreign banking
entity.\1497\
---------------------------------------------------------------------------

    \1493\ See 12 U.S.C. 1843(c)(9).
    \1494\ See 12 CFR 211.20 et seq.
    \1495\ Commenters noted that the Board's Regulation K contains a
number of limitations that may not be appropriate to include as part
of the requirements of the foreign trading exemption. See Allen &
Overy (on behalf of Foreign Bank Group); HSBC Life. Accordingly, the
final rule does not retain the proposal's requirement that the
activity be conducted in compliance with subpart B of the Board's
Regulation K (12 CFR 211.20 through 211.30). However, the exemption
in section 13(d)(1)(H) of the BHC Act and the final rule operates as
an exemption and is not a separate grant of authority to engage in
an otherwise impermissible activity. To the extent a banking entity
is a foreign banking organization, it remains subject to the Board's
Regulation K and must, as a separate matter, comply with any and all
applicable rules and requirements of that regulation.
    \1496\ See 12 CFR 211.23(a), (c), and (e). The proposed rule
referenced only the qualifying test under section 211.23(a) of the
Board's Regulation K; however, because there are two other methods
by which a foreign banking organization may meet the requirements to
be considered a qualified foreign banking organization, the final
rule incorporates a reference to those provisions as well.
    \1497\ This modification to the definition of foreign banking
organization is necessary because, under the International Banking
Act and the Board's Regulation K, depository institutions that are
located in, or organized under the laws of a commonwealth,
territory, or possession of the United States, are foreign banking
organizations. However, for purposes of the Federal securities laws
and certain banking statutes, such as section 2(c)(1) of the BHC Act
and section 3 of the FDI Act, these same entities are defined to be
and treated as domestic entities. For instance, these entities act
as domestic broker-dealers under U.S. securities laws and their
deposits are insured by the FDIC. Because one of the purposes of
section 13 is to protect insured depository institutions and the
U.S. financial system from the perceived risks of proprietary
trading and covered fund activities, the Agencies believe that these
entities should be considered to be located within the United States
for purposes of section 13. The final rule includes within the
definition of State a commonwealth, territory or possession of the
United States, the District of Columbia, the Commonwealth of Puerto
Rico, the Commonwealth of the Northern Mariana Islands, American
Samoa, Guam, or the United States Virgin Islands.
---------------------------------------------------------------------------

    Section 13 of the BHC Act also applies to foreign companies that
control a U.S. insured depository institution but that are not
currently subject to the BHC Act generally or to the Board's Regulation
K--for example, because the foreign company controls a savings
association or an FDIC-insured industrial loan company. Accordingly,
the final rule also provides that a foreign banking entity that is not
a foreign banking organization would be considered to be conducting
activities ``pursuant to section 4(c)(9)'' for purposes of this
exemption \1498\ if the entity, on a fully-consolidated basis, meets at
least two of three requirements that evaluate the extent to which the
foreign banking entity's business is conducted outside the United
States, as measured by assets, revenues, and income.\1499\ This test
largely mirrors the qualifying foreign banking organization test that
is made applicable under section 4(c)(9) of the BHC Act and section
211.23(a), (c), or (e) of the Board's Regulation K, except that the
test does not require the foreign entity to demonstrate that more than
half of its banking business is outside the United States.\1500\ This
difference reflects the fact that foreign entities subject to section
13 of the BHC Act, but not the BHC Act generally, are likely to be, in
many cases, predominantly commercial firms. A requirement that such
firms also demonstrate that more than half of their banking business is
outside the United States would likely make the exemption unavailable
to such firms and subject their global activities to the prohibition on
proprietary trading.
---------------------------------------------------------------------------

    \1498\ This clarification would be applicable solely in the
context of section 13(d)(1) of the BHC Act. The application of
section 4(c)(9) to foreign companies in other contexts is likely to
involve different legal and policy issues and may therefore merit
different approaches.
    \1499\ See final rule Sec.  ----.6(e)(2)(ii)(B). For purposes of
determining whether, on a fully consolidated basis, it meets the
requirements under Sec.  ----.6(e)(2)(ii)(B), a foreign banking
entity that is not a foreign banking organization should base its
calculation on the consolidated global assets, revenues, and income
of the top-tier affiliate within the foreign banking entity's
structure.
    \1500\ See 12 U.S.C. 1843(c)(9); 12 CFR 211.23(a), (c), and (e);
final rule Sec.  ----.6(e)(2)(ii)(B).
---------------------------------------------------------------------------

b. Permitted Trading Activities of a Foreign Banking Entity
    As noted above, the proposed rule laid out a transaction-based
approach to implementing the foreign trading exemption and provided
that a transaction would be considered to qualify for the exemption
only if (i) the transaction was conducted by a banking entity not
organized under the laws of the United States or of one or more States;
(ii) no party to the transaction was a resident of the United States;
(iii) no personnel of the banking entity that was directly involved in
the transaction was physically located in the United States; and (iv)
the transaction was executed wholly outside the United States.\1501\
---------------------------------------------------------------------------

    \1501\ See proposed rule Sec.  ----.6(d).
---------------------------------------------------------------------------

    Many commenters objected to the proposed exemption, arguing that it
was unworkable and would have unintended consequences. For example,
commenters argued that prohibiting a foreign banking entity from
conducting a proprietary trade with a resident of the United States,
including a subsidiary or branch of a U.S. banking entity, wherever
located, would likely cause foreign banking entities to be unwilling to
enter into permitted trading transactions with foreign subsidiaries or
branches of U.S. firms.\1502\ In addition,

some commenters represented that it would be difficult to determine and
track whether a party is a resident of the United States or that this
requirement would require non-U.S. banking entities to inefficiently
bifurcate their activities into U.S.-facing and non-U.S.-facing trading
desks.\1503\ For example, one commenter noted that trading on many
exchanges and platforms is anonymous (i.e., each party to the trade is
unaware of the identity of the other party to the trade), so a foreign
banking entity would likely have to avoid U.S. trading platforms and
exchanges entirely to avoid transactions with any resident of the
United States.\1504\ Further, commenters stated that the proposed rule
could deter foreign banking entities from conducting business with U.S.
parties outside of the United States, which could also incentivize
foreign market centers to limit participation by U.S. parties on their
markets.\1505\
---------------------------------------------------------------------------

    \1502\ See BoA; Citigroup (Feb. 2012); British Bankers' Ass'n.;
Credit Suisse (Seidel); George Osbourne; IIB/EBF.
    \1503\ See Cadwalader (on behalf of Singapore Banks); Ass'n. of
Banks in Malaysia; Cadwalader (on behalf of Thai Banks); IIF; ICE;
Banco de M[eacute]xico; ICFR; Australian Bankers Ass'n. (Feb. 2012);
BAROC.
    \1504\ See ICE.
    \1505\ See, e.g., RBC.
---------------------------------------------------------------------------

    Commenters also expressed concern about the requirement that
transactions be executed wholly outside of the United States in order
to qualify for the proposed foreign trading exemption. Commenters
represented that foreign banking entities currently use U.S. trading
platforms to trade in certain products (such as U.S.-listed securities
or a variety of derivatives contracts), to take advantage of robust
U.S. infrastructure, and for time zone reasons.\1506\ Commenters
indicated that the proposed requirement could harm the competitiveness
of U.S. trading platforms and the liquidity available on such
facilities.\1507\ Some commenters stated that this requirement would
effectively result in most foreign banking entities moving their
trading operations and personnel outside of the United States and
executing transactions on exchanges outside of the United States.\1508\
These commenters stated that the relocation of these activities would
reduce trading activity in the United States that supports the
financial stability and efficiency of U.S. markets. Moreover, these
commenters argued that, if foreign banking entities relocate their
personnel from the United States to overseas, this would diminish U.S.
jobs with no concomitant benefit. They also contended that the proposal
was at cross purposes with other parts of the Dodd-Frank Act and would
hinder growth of market infrastructure being developed under the
requirements of Title VII of that Act, including use of swap execution
facilities and security-based swap execution facilities to enhance
transparency in the swaps markets and use of central clearinghouses to
reduce counterparty risk for the parties to a swap transaction.\1509\
For example, one commenter represented that the proposed exemption
could make it difficult for non-U.S. swap entities to comply with
potential mandatory execution requirements under Title VII of the Dodd-
Frank Act and could cause market fragmentation across borders through
the creation of parallel execution facilities outside of the United
States, which would result in less transparency and greater systemic
risk.\1510\ In addition, another commenter stated that the proposed
requirement would force issuers to dually list their securities to
permit trading on non-U.S. exchanges and, further, clearing and
settlement systems would have to be set up outside of the United
States, which would create inefficiencies, operational risks, and
potentially systemic risk by adding needless complexity to the
financial system.\1511\
---------------------------------------------------------------------------

    \1506\ See, e.g., IIF; ICE; Soci[eacute]t[eacute]
G[eacute]n[eacute]rale; Mexican Banking Comm'n.; Australian Bankers
Ass'n. (Feb. 2012); Banco de M[eacute]xico; OSFI. In addition, a few
commenters argued that Canadian and Mexican financial firms
frequently use U.S. infrastructure to conduct their trading
activities in Canada or Mexico. See, e.g., OSFI; Banco de
M[eacute]xico; Mexican Banking Comm'n.
    \1507\ See, e.g., ICE; Soci[eacute]t[eacute]
G[eacute]n[eacute]rale (arguing that the requirement would impair
capital raising efforts of many U.S. companies); Australian Bankers
Ass'n. (Feb. 2012); Canadian Minister of Fin.; Ass'n. of German
Banks.
    \1508\ See IIB/EBF.
    \1509\ See Bank of Canada; Banco de M[eacute]xico; Allen & Overy
(on behalf of Canadian Banks).
    \1510\ See Allen & Overy (on behalf of Candian Banks).
    \1511\ See IIF.
---------------------------------------------------------------------------

    Instead of the proposal's transaction-based approach to
implementing the foreign trading exemption, many commenters suggested
the final rule adopt a risk-based approach.\1512\ These commenters
noted that a risk-based approach would prohibit or significantly limit
the amount of financial risk from such activities that could be
transferred to the United States by the foreign trading activity of
foreign banking entities.\1513\ Commenters also noted that foreign
trading activities of most foreign banking entities are already subject
to activities limitations, capital requirements, and other prudential
requirements of their home-country supervisor(s).\1514\
---------------------------------------------------------------------------

    \1512\ See BaFin/Deutsche Bundesbank; ICSA; IIB/EBF; Allen &
Overy (on behalf of Canadian Banks); Credit Suisse (Seidel); George
Osbourne.
    \1513\ See IIB/EBF.
    \1514\ See IIB/EBF.
---------------------------------------------------------------------------

    The Agencies have carefully considered these comments and have
determined to modify the approach in the final rule. The Agencies
believe that the revisions mitigate the potential adverse impacts of
the proposed approach while still remaining faithful to the overall
purpose of section 13(d)(1)(H). Also, the Agencies believe that section
13(d)(1)(J) of the BHC Act, which authorizes the Agencies to provide an
exemption from the prohibition on proprietary trading for any activity
the Agencies determine by rule ``would promote and protect the safety
and soundness of the banking entity and the financial stability of the
United States,'' \1515\ supports allowing foreign banking entities to
use U.S. infrastructure and trade with certain U.S. counterparties in
certain circumstances, which will promote and protect the safety and
soundness of banking entities and U.S. financial stability.
---------------------------------------------------------------------------

    \1515\ See 12 U.S.C. 1851(d)(1)(J).
---------------------------------------------------------------------------

    Overall, the comments illustrated that both the mechanical steps of
the specified transactions to purchase or sell various instruments
(e.g., execution, clearing), and the identity of the entity for whose
trading account the specified trading is conducted are important.\1516\
Consistent with the comments described above, the Agencies believe that
the application of section 13(d)(1)(H) and their exemptive authority
under section 13(d)(1)(J) should focus on both how the transaction
occurs and which entity will bear the risk of those transactions.
Although the statute does not define expressly what it means to act
``as a principal'' (acting as principal ordinarily means acting for
one's own account), the combination of references to engaging as
principal and to a trading account focuses on an entity's incurring
risks of profit and loss through taking ownership of securities and
other instruments. Thus, the final rule provides an exemption for
trading activities of foreign banking entities that addresses both the
location of the facilities that effect the acquisition, holding, and
disposition of such positions, and the location of the banking entity
that incurs such risks through acquisition, holding, and disposition of
such positions.
    The Agencies believe this approach is consistent with one of the
principal purposes of section 13, which is to limit risks that
proprietary trading poses to

the U.S. financial system.\1517\ Further, the purpose of section
13(d)(1)(H) is to limit the extraterritorial application of section 13
as it applies to foreign banking entities.\1518\
---------------------------------------------------------------------------

    \1517\ See, e.g., 12 U.S.C. 1851(b)(1) (directing the FSOC to
study and make recommendations on implementing section 13 so as to,
among other things, protect taxpayers and consumers and enhance
financial stability by minimizing the risk that insured depository
institutions and the affiliates of insured depository institutions
will engage in unsafe and unsound activities).
    \1518\ See, e.g., 156 Cong. Rec. S5897 (daily ed. July 15, 2010)
(statement of Sen. Merkley) (stating that the foreign trading
exemption ``recognize[s] rules of international comity by permitting
foreign banks, regulated and backed by foreign taxpayers, in the
course of operating outside of the United States to engage in
activities permitted under relevant foreign law.'').
---------------------------------------------------------------------------

    In addition, prohibiting foreign banking entities from using U.S.
infrastructure or trading with all U.S. counterparties could cause
certain trading activities to move offshore, with corresponding
negative impacts on U.S. market participants, including U.S. banking
entities. For example, movement of trading activities offshore,
particularly in U.S. financial instruments, could result in bifurcated
markets for these instruments that are less efficient and less liquid
and could reduce transparency for oversight of trading in these
instruments. In addition, reducing access to foreign counterparties for
U.S. instruments could concentrate risks in the United States and to
its financial system. Moreover, the statute provides separate
exemptions for U.S. banking entities to engage in underwriting and
market making-related activities, subject to certain requirements, and
there is no evidence that limiting the range of potential customers for
these entities would further the purposes of the statute. In fact, it
is possible that limiting the customer bases of U.S. banking entities,
as well as other U.S. firms that are not banking entities, could reduce
their ability to effectively manage their inventories and risks and
could also result in concentration risk.
    These potential effects of the approach taken in the proposal
appear to be inconsistent with the statute's goals, including the
promotion and protection of the safety and soundness of banking
entities and U.S. financial stability. To the contrary, the exemptive
approach taken in the final rule appears to be more consistent with the
goals of the statute and would promote and protect the safety and
soundness of banking entities and U.S. financial stability by limiting
the risks of foreign banking entities' proprietary trading activities
to the U.S. financial system, while also allowing U.S. markets to
continue to operate efficiently in conjunction with foreign markets
(rather than creating incentives to establish barriers between U.S. and
foreign markets).\1519\
---------------------------------------------------------------------------

    \1519\ 12 U.S.C. 1851(d)(1)(J).
---------------------------------------------------------------------------

    Thus, in response to commenter concerns, the final rule has been
modified to better reflect the text and achieve the overall purposes of
the statute (by ensuring that the principal risks of proprietary
trading by foreign banking entities allowed under the foreign trading
exemption remain solely outside of the United States) while mitigating
potentially adverse effects on competition.\1520\ In order to ensure
these risks remain largely outside of the United States, and to limit
potential risk that could flow to the U.S. financial system through
trades by foreign banking entities with or through U.S. entities, the
final rule includes several conditions on the availability of the
exemption. Specifically, in addition to limiting the exemption to
foreign banking entities, the final rule provides that the exemption
for the proprietary trading activity of a foreign banking entity is
available only if:
---------------------------------------------------------------------------

    \1520\ The proposed rule also contained a definition of
``resident of the United States'' that was designed to capture the
scope of U.S. counterparties that, if involved in the transaction,
would preclude that transaction from being considered to have
occurred solely outside the United States. The final rule addresses
this point by including a definition, for purposes of Sec.  --
--.6(e) only, of the term ``U.S. entity.''
---------------------------------------------------------------------------

    (i) The banking entity engaging as principal in the purchase or
sale (including any personnel of the banking entity or its affiliate
that arrange, negotiate or execute such purchase or sale) is not
located in the United States or organized under the laws of the United
States or of any State; \1521\
---------------------------------------------------------------------------

    \1521\ Personnel that arrange, negotiate, or execute a purchase
or sale conducted under the exemption for trading activity of a
foreign banking entity must be located outside of the United States.
Thus, for example, personnel in the United States cannot solicit or
sell to or arrange for trades conducted under this exemption.
Personnel in the United States also cannot serve as decision makers
in transactions conducted under this exemption. Personnel that
engage in back-office functions, such as clearing and settlement of
trades, would not be considered to arrange, negotiate, or execute a
purchase or sale for purposes of this provision.
---------------------------------------------------------------------------

    (ii) The banking entity (including relevant personnel) that makes
the decision to purchase or sell as principal is not located in the
United States or organized under the laws of the United States or of
any State;
    (iii) The purchase or sale, including any transaction arising from
risk-mitigating hedging related to the instruments purchased or sold,
is not accounted for as principal directly or on a consolidated basis
by any branch or affiliate that is located in the United States or
organized under the laws of the United States or of any State;
    (iv) No financing for the banking entity's purchase or sale is
provided, directly or indirectly, by any branch or affiliate that is
located in the United States or organized under the laws of the United
States or of any State; \1522\
---------------------------------------------------------------------------

    \1522\ This provision is not intended to restrict the ability of
a U.S. branch or affiliate of a foreign banking entity to provide
funds collected in the United States to its foreign parent for
general purposes.
---------------------------------------------------------------------------

    (v) The purchase or sale is not conducted with or through any U.S.
entity,\1523\ other than:
---------------------------------------------------------------------------

    \1523\ ``U.S. entity'' is defined for purposes of this provision
as any entity that is, or is controlled by, or is acting on behalf
of, or at the direction of, any other entity that is, located in the
United States or organized under the laws of the United States or of
any State. See final rule Sec.  ----.6(e)(4).
---------------------------------------------------------------------------

    (A) A purchase or sale with the foreign operations of a U.S.
entity, if no personnel of such U.S. entity that are located in the
United States are involved in the arrangement, negotiation or execution
of such purchase or sale.
    The Agencies believe it is appropriate to exercise their exemptive
authority under section 13(d)(1)(J) to also allow, under clause (vi) of
the final rule, the following types of purchases or sales conducted
with a U.S. entity:
    (B) A purchase or sale with an unaffiliated market intermediary
acting as principal,\1524\ provided the purchase or sale is promptly
cleared and settled through a clearing agency or derivatives clearing
organization acting as a central counterparty; or
---------------------------------------------------------------------------

    \1524\ This provision would generally allow market
intermediaries to engage in market-making, underwriting or similar
market intermediation functions.
---------------------------------------------------------------------------

    (C) A purchase or sale through an unaffiliated market intermediary,
provided the purchase or sale is conducted anonymously (i.e. each party
to the purchase or sale is unaware of the identity of the other
party(ies) to the purchase or sale) on an exchange or similar trading
facility and promptly cleared and settled through a clearing agency or
derivatives clearing organization acting as a central counterparty.
    The requirements are designed to ensure that any foreign banking
entity engaging in trading activity under this exemption does so in a
manner that ensures the risk, decision-making, arrangement,
negotiation, execution and financing of the activity resides solely
outside the United States and limits the risk to the U.S. financial
system from trades by foreign banking entities with or through U.S.
entities.
    The final rule specifically recognizes that, for purposes of the
exemption for

trading activity of a foreign banking entity, a U.S. branch, agency, or
subsidiary of a foreign bank, or any subsidiary thereof, is located in
the United States; however, a foreign bank that operates or controls
that branch, agency, or subsidiary is not considered to be located in
the United States solely by virtue of operation of the U.S. branch,
agency, or subsidiary.\1525\ This provision helps give effect to the
statutory language limiting the foreign trading exemption to activities
of foreign banking entities that occur solely outside of the United
States by clarifying that the U.S. operations of foreign banking
entities may not conduct proprietary trading based on this exemption.
---------------------------------------------------------------------------

    \1525\ See final rule Sec.  ----.6(e)(5).
---------------------------------------------------------------------------

    The Agencies have considered whether the concerns raised by
commenters that the foreign operations of U.S. banking entities would
be disadvantaged in competing outside the United States warrant an
exemption under section 13(d)(1)(J) of the BHC Act that extends to
foreign operations of U.S. banking entities. The competitiveness of
U.S. banking entities outside the United States often improves the
potential for the operations of U.S. firms outside the United States to
succeed and be profitable, and thereby, often improves the safety and
soundness of the entity and financial stability in the United States.
    However, Congress has determined to generally prohibit U.S. banking
entities (including foreign branches and subsidiaries thereof) from
engaging in proprietary trading because of the perceived risks of those
activities to banking entities and the U.S. economy.\1526\ Allowing
U.S. banking entities to conduct, through branches or subsidiaries that
are physically located outside the United States, the same proprietary
trading activities those U.S. firms are expressly prohibited from
conducting directly through their operations located within the United
States would subject U.S. banking entities and the U.S. economy to the
very risks section 13 is designed to avoid. The risks of proprietary
trading would continue to be borne by the U.S. banking entity whether
the activity is conducted by the U.S. banking entity through units
physically located inside or outside of the United States. Moreover,
the robust trading markets that exist overseas could allow U.S. banking
entities to shift their prohibited proprietary trading activities to
branches or subsidiaries that are physically located outside the United
States under such an exemption, without achieving a meaningful
elimination of risk. Accordingly, the Agencies have not exercised their
authority under section 13(d)(1)(J) at this time to allow U.S. banking
entities to conduct otherwise prohibited proprietary trading activities
through operations located outside the United States. As a consequence,
and consistent with the statutory language and purpose of section
13(d)(1)(H) of the BHC Act, the final rule provides that the exemption
is available only if the banking entity is not organized under, or
directly or indirectly controlled by a banking entity that is organized
under, the laws of the United States or of one or more States.\1527\
---------------------------------------------------------------------------

    \1526\ See, e.g., 156 Cong. Rec. S5897 (daily ed. July 15, 2010)
(statement of Sen. Merkley) (``However, these subparagraphs are not
intended to permit a U.S. banking entity to avoid the restrictions
on proprietary trading simply by setting up an offshore subsidiary
or reincorporating offshore, and regulators should enforce them
accordingly.'').
    \1527\ See final rule Sec.  ----.6(e)(1)(i).
---------------------------------------------------------------------------

    As discussed above, many commenters requested that the final rule
permit a foreign banking entity to engage in proprietary trading
transactions with a greater variety of counterparties, including
counterparties that are located in or organized and incorporated under
the laws of the United States or of one or more States.\1528\ These
commenters also requested that the final rule not require that any
purchase or sale under the exemption be executed wholly outside of the
United States.
---------------------------------------------------------------------------

    \1528\ A number of commenters also requested that the foreign
trading exemption permit proprietary trading of foreign sovereign
debt or similar obligations of foreign governments. As discussed in
Part IV.A.5.b. of this SUPPLEMENTARY INFORMATION, the final rule
addresses banking entities' ability to engage in transaction in
these types of instruments in Sec.  ----.6(b).
---------------------------------------------------------------------------

    As described above and in response to commenters' concerns, the
final rule provides that a foreign banking entity generally may engage
in trading activity under the exemption with U.S. entities, provided
the transaction is with the foreign operations of an unaffiliated U.S.
firm (whether or not the U.S. firm is a banking entity subject to
section 13 of the BHC Act) and does not involve any personnel of the
U.S. entity that are in the United States and involved in the
arrangement, negotiation, or execution of the transaction. The Agencies
have also exercised their exemptive authority under section 13(d)(1)(J)
to allow foreign banking entities to engage in a transaction that is
either through an unaffiliated market intermediary and executed
anonymously on an exchange or similar trading facility (regardless of
whether the ultimate counterparty is a U.S. entity or not) or is
executed with a U.S. entity that is an unaffiliated market intermediary
acting as principal, provided in either case that the transaction is
promptly cleared and settled through a clearing agency or derivatives
clearing organization acting as a central counterparty.
    For purposes of the final rule, market intermediary is defined as
an unaffiliated entity, acting as an intermediary, that is: (i) A
broker or dealer registered with the SEC under section 15 of the
Exchange Act or exempt from registration or excluded from regulation as
such; (ii) a swap dealer registered with the CFTC under section 4s of
the Commodity Exchange Act or exempt from registration or excluded from
regulation as such; (iii) a security-based swap dealer registered with
the SEC under section 15F of the Exchange Act or exempt from
registration or excluded from regulation as such; or (iv) a futures
commission merchant registered with the CFTC under section 4f of the
Commodity Exchange Act or exempt from registration or excluded from
regulation as such.\1529\
---------------------------------------------------------------------------

    \1529\ See final rule Sec.  ----.6(e)(5). For example, under
this definition, a bank that is exempt from registration as a swap
dealer under the de minimis exception to swap dealer registration
requirements could be a market intermediary for transactions in
swaps. See 17 CFR 1.3(ggg)(4).
---------------------------------------------------------------------------

    These provisions of the final rule, viewed as a whole, prevent the
exemption for trading of foreign banking entities from weakening U.S.
trading markets and U.S. firms that are either not subject to the
provisions of section 13 or that conduct activities in compliance with
other parts of section 13. For instance, the final rule permits a
foreign banking entity to trade under the exemption with the foreign
operations of a U.S. firm, so long as the purchase or sale does not
involve any personnel of the U.S. firm who are located in the United
States and involved in arranging, negotiating or executing the
trade.\1530\ Transactions that occur outside of the United States
between foreign operations of U.S. entities and foreign banking
entities improve access to and functioning of liquid markets without
raising the concerns for increased risk to banking entities in the U.S.
that motivated enactment of section 13 of the BHC Act. The final rule
permits a foreign banking entity to engage in transactions with the
foreign operations of both U.S. non-banking and U.S. banking entities.
Among other things, this approach will ensure that the foreign
operations of

U.S. banking entities continue to be able to access foreign
markets.\1531\ The language of the exemption expressly requires that
trading with the foreign operations of a U.S. entity may not involve
the use of personnel of the U.S. entity who are located in the United
States for purposes of arranging, negotiating, or executing
transactions.
---------------------------------------------------------------------------

    \1530\ See final rule Sec.  ----.6(e)(3)(v)(A).
    \1531\ The Agencies believe that this provision should address
commenters' concerns that the proposed rule could cause foreign
banking entities to avoid conducting business with U.S. firms
outside the United States or could incentivize foreign market places
to restrict access to U.S. firms. See, e.g., RBC.
---------------------------------------------------------------------------

    Under the final rule, the exemption in no way exempts the U.S. or
foreign operations of the U.S. banking entities from having to comply
with the restrictions and limitations of section 13. Thus, the U.S. and
foreign operations of a U.S. banking entity that is engaged in
permissible market making-related activities or other permitted
activities may engage in those transactions with a foreign banking
entity that is engaged in proprietary trading in accordance with the
exemption under Sec.  ----.6(e) of the final rule. Importantly, the
final rule does not impose a duty on the foreign banking entity or the
U.S. banking entity to ensure that its counterparty is conducting its
activity in conformance with section 13 of the BHC Act and the final
rule. Rather, that burden is at all times on each party subject to
section 13 to ensure that it is conducting its activities in accordance
with section 13 and this implementing rule.
    The final rule also permits, pursuant to section 13(d)(1)(J), a
foreign banking entity to trade through an unaffiliated market
intermediary if the trade is conducted anonymously on an exchange or
similar trading facility and is promptly cleared and settled through a
clearing agency or derivatives clearing organization.\1532\ Allowing
foreign banking entities to generally conduct anonymous proprietary
trades on U.S. exchanges and similar anonymous trading facilities
allows these exchanges and facilities--which are generally not subject
to section 13 and do not take the risks section 13 is designed to
address--to serve the widest possible range of counterparties. This
prevents the potential adverse impacts from possible reductions in
competitiveness of or liquidity available on these regulated exchanges
and facilities, which could also harm other U.S. market participants
who trade on these exchanges and facilities. In addition, the Agencies
recognize that anonymous trading on exchanges and similar anonymous
trading facilities promotes transparency and that prohibiting foreign
banking entities from trading on U.S. exchanges and similar anonymous
trading facilities under this exemption would likely reduce
transparency for trading in U.S. financial instruments. All of these
considerations support the Agencies' exercise of their exemptive
authority under section 13(d)(1)(J) to allow such trading by foreign
banking entities.
---------------------------------------------------------------------------

    \1532\ Under the final rule, ``anonymous'' means that each party
to a purchase or sale is unaware of the identity of the other
party(ies) to the purchase or sale. See final rule Sec.  --
--.3(e)(1).
---------------------------------------------------------------------------

    The final rule requires that foreign banking entities trade through
an unaffiliated market intermediary to access a U.S. exchange or
trading facility in recognition that existing laws and regulations
generally require this structure.\1533\ For purposes of this exemption,
an exchange would include, unless the context otherwise requires, any
designated contract market, swap execution facility, or foreign board
of trade registered with the CFTC, and any exchange or security-based
swap execution facility, as such terms are defined under the Exchange
Act.\1534\
---------------------------------------------------------------------------

    \1533\ See, e.g., 15 U.S.C. 78f(c)(1) (providing that a national
securities exchange shall deny membership to (A) any person, other
than a natural person, which is not a registered broker or dealer or
(B) any natural person who is not, or is not associated with, a
registered broker or dealer).
    \1534\ See final rule Sec.  ----.3(e)(6) (defining the term
``exchange''). The rule refers to an ``exchange or similar trading
facility.'' A similar trading facility for these purposes may
include, for example, an alternative trading system.
---------------------------------------------------------------------------

    This provision of the final rule requires that foreign banking
entities trade anonymously and that the trade be centrally cleared and
settled. The Agencies understand that in these circumstances, the
foreign banking entity would not have any prior information regarding
its counterparty to the trade. Requiring that the trade be executed
anonymously preserves the benefits of allowing U.S. entities to
participate in such trades, while reducing the potential for evasion of
section 13 that could occur if foreign banking entities directly
arranged purchases and sales with U.S. entities.\1535\ The final rule
specifies that a trade is anonymous if each party to the purchase or
sale is unaware of the identity of the other party(ies) to the purchase
or sale. That is, it is lack of knowledge of the identity of the
counteryparty(ies) to the trade that is relevant. The final rule does
not prohibit foreign banking entities from accessing a trading facility
through an unaffiliated U.S. market intermediary (which the foreign
banking entity would necessarily know), so long as the foreign banking
entity is not aware of the identity of the counterparty to the
transaction.
---------------------------------------------------------------------------

    \1535\ In addition, allowing a foreign banking entity to trade
directly with a U.S. end user customer under the foreign trading
exemption could give the foreign banking entity a competitive
advantage over U.S. banking entities with respect to trading in the
United States.
---------------------------------------------------------------------------

    Similarly, also pursuant to section 13(d)(1)(J), the final rule
allows a foreign banking entity to trade with an unaffiliated market
intermediary acting in a principal capacity and effecting a market
intermediation function, in a transaction that is not conducted on an
exchange or similar anonymous trading facility, as long as the trade is
promptly cleared and settled through a clearing agency or derivatives
clearing organization. This provision recognizes that not all financial
instruments are traded on an exchange or similar anonymous trading
facility and, thus, allows foreign banking entities to trade and
contribute to market liquidity in all types of U.S. financial
instruments without requiring separate market infrastructure to be
developed outside the U.S. for such trading activity, which could
result in inefficiencies and reduce U.S. market liquidity. Market
intermediaries can serve the same general purpose as exchanges or
similar trading facilities in intermediating between buyers and
sellers, particularly in asset classes that do not generally trade on
these exchanges or facilities, although this intermediation function
may not be as immediate in the case of market intermediaries.
    In either case (i.e., for either an anonymous trade or a trade with
an unaffiliated market intermediary), if the U.S. counterparty to the
transaction is a banking entity subject to section 13 and these rules,
it must comply with an exemption to the prohibition on proprietary
trading, such as the market-making exemption or the exemption for
riskless principal transactions. Allowing foreign banking entities to
trade with unaffiliated U.S. market intermediaries, including banking
entities engaged in permitted market making-related activities, expands
the range of potential buyers and sellers for which the U.S. entities
can trade and may result in more efficient and timely matching of
trades, reducing inventory risks to the U.S. market intermediary. At
the same time, this exemption does not permit a U.S. market
intermediary that is subject to section 13 of the BHC Act to conduct
trading activities other than in compliance with the provisions of
section 13. Thus, the Agencies believe it is appropriate to allow
foreign banking entities to conduct such trading under the exemption in
section 13(d)(1)(J).
    To reduce risks to U.S. entities and the potential for evasion, the
provisions

allowing trading with U.S. entities include two additional protections.
First, the final rule does not allow a foreign banking entity to trade
through an affiliated U.S. entity under the exemption out of concern
that it could increase the risk of evasion.\1536\ Second, a foreign
banking entity's trades conducted through an unaffiliated market
intermediary on an exchange or conducted directly with an unaffiliated
market intermediary must be promptly cleared and settled through a
clearing agency or derivatives clearing organization acting as central
counterparty. Consistent with the goals of section 13 to reduce risk to
banking entities and the U.S. financial system, this requirement is
designed to reduce risk to U.S. entities arising from foreign banking
entities' proprietary trading activity, particularly counterparty risk,
and preclude foreign banking entities from relying on the exemption for
trading that creates exposure of U.S. counterparties pursuant to
bilateral, uncleared transactions, which poses heightened counterparty
credit risks.\1537\ This condition is also consistent with the systemic
risk benefits of central clearing and may incentivize the use of
central clearing for trading by foreign banking entities and foreign
affiliates of U.S. banking entities. The Agencies believe this approach
is consistent with and reinforces the goals of the central clearing
framework of Title VIII of the Dodd-Frank Act.
---------------------------------------------------------------------------

    \1536\ In addition, allowing a foreign banking entity to trade
through or with a U.S. affiliate under the exemption for trading
activity of a foreign banking entity could give the foreign banking
entity a competitive advantage over U.S. banking entities that are
subject to limitations on their trading activities. Thus, the
Agencies are not permitting a foreign banking entity to trade
through a U.S. affiliate as agent, as requested by some commenters.
See, e.g., IIB/EBF. However, the Agencies recognize that, with
respect to trading anonymously, there is no way to know the identity
of the counterparty to the trade. Thus, a foreign banking entity
would not be in violation of this rule if it traded through an
unaffiliated market intermediary on an exchange, in accordance with
the exemption for trading activity of a foreign banking entity, and
the counterparty to its trade happened to be an affiliated entity.
    \1537\ As discussed above, centralized clearing redistributes
counterparty risk among members of a clearing agency or derivatives
clearing organization through mutualization of losses, reducing the
likelihood of sequential counterparty failure and contagion. See
supra note 266 and accompanying text.
---------------------------------------------------------------------------

    The final rule does not allow a foreign banking entity to trade
with a broader range of U.S. entities under the exemption because the
Agencies are concerned such an approach may result in adverse
competitive impacts between U.S. banking entities and foreign banking
entities with respect to their trading in the United States, which
could harm the safety and soundness of banking entities and U.S.
financial stability. For example, such an approach could allow foreign
banking entities to act as market makers for U.S. customers under the
exemption in Sec.  ----.6(e) of the final rule so long as the foreign
banking entity held the risk of its market-making trades outside the
United States. In turn, this could give foreign banking entities a
competitive advantage over U.S. banking entities with respect to U.S.
market-making activities because foreign banking entities could trade
directly with U.S. non-banking entities without incurring the
additional costs, or being subject to the limitations, associated with
the market-making or other exemptions under the rule. This competitive
disparity in turn could create a significant potential for regulatory
arbitrage. The Agencies do not believe this result was intended by the
statute. Instead, the final rule seeks to alleviate the concern that an
overly broad approach to the exemption (e.g., permitting trading with
all U.S. counterparties) may result in competitive impacts and
increased risks to the U.S. financial system, while mitigating the
concern that an overly narrow approach to the exemption (e.g.,
prohibiting trading with any U.S. counterparty) may cause market
bifurcations, reduce the efficiency and liquidity of markets, and harm
U.S. market participants.
9. Section ----.7: Limitations on Permitted Trading Activities
    Section ----.8 of the proposed rule implemented section 13(d)(2) of
the BHC Act,\1538\ which provides that a banking entity may not engage
in certain exempt activities (e.g., permitted market making-related
activities, risk-mitigating hedging, etc.) if the activity would
involve or result in a material conflict of interest between the
banking entity and its clients, customers, or counterparties; result,
directly or indirectly, in a material exposure by the banking entity to
a high-risk asset or a high-risk trading strategy; or pose a threat to
the safety and soundness of the banking entity or U.S. financial
stability.\1539\ The Agencies sought comment on proposed definitions of
the terms ``material conflict of interest,'' ``high-risk asset,'' and
``high-risk trading strategy'' for these purposes.
---------------------------------------------------------------------------

    \1538\ Section ----.8 of the proposed rule regarding limitations
on permitted trading activities is consistent with Sec.  ----.17 of
the proposed rule regarding other limitations on permitted covered
funds activities. Accordingly, the discussion regarding proposed
rule Sec.  ----.8 and final rule Sec.  ----.7 in this part also
pertain to Sec.  ----.17 of the proposed rule and Sec.  ----.16 of
the final rule. See also Part IV.B.6., infra.
    \1539\ See 12 U.S.C. 1851(d)(2).
---------------------------------------------------------------------------

    With respect to general comments regarding the proposed rule,
commenters generally agreed on the need to limit banking entities'
proprietary trading activities so as to avoid material conflicts of
interest and material exposures to high-risk trading strategies and
high-risk assets.\1540\ One commenter expressed support for the
Agencies' proposed approach, stating that the proposed rule was clear
and structured in such a manner so that it should remain effective even
as financial markets evolve and change.\1541\ As discussed in greater
detail below, most commenters suggested amendments, clarification, or
alternative approaches. For example, some commenters expressed concern
regarding the application of the prudential backstops to the activities
of foreign banking entities.\1542\ The Agencies did not receive any
comments on the prohibition against transactions or activities that
pose a threat to the safety or soundness of the banking entity or the
financial stability of the United States.
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    \1540\ See, e.g., Sens. Merkley & Levin (Feb. 2012); Public
Citizen; Paul Volcker.
    \1541\ See Alfred Brock.
    \1542\ See IIB/EBF; Ass'n. of German Banks.
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    As explained in detail below, the Agencies have carefully reviewed
comments on the proposed rule's implementation of the prudential
backstops under section 13(d)(2) of the BHC Act, including commenters'
suggestions for expanding, contracting, or revising the proposed rule.
After carefully considering these comments, the Agencies continue to
believe the expansive scope of section 13 of the BHC Act supports a
similarly inclusive approach focusing on the facts and circumstances of
each potential conflict or high-risk activity. Therefore, and in
consideration of all issues discussed below, the Agencies are adopting
the final rule substantially as proposed.\1543\ The Agencies intend to
develop additional guidance regarding best practices for addressing
potential material conflicts of interest, high-risk assets and trading
strategies and practices that pose significant risks to safety and
soundness and to the U.S. financial system as the Agencies and banking
entities gain experience with implementation of the requirements and

limitations in section 13 of the BHC Act and this rule, which are all
generally designed to limit risky behavior in trading and investment
activities.
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    \1543\ The Agencies note that proposed Appendix C, which
required banking entities to describe how they comply with these
provisions, will be adopted as Appendix B with similar requirements
regarding compliance with the limitations on permitted activities.
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a. Scope of ``Material Conflict of Interest''
1. Proposed Rule
    Section ----.8(b) of the proposed rule defined the scope of
material conflicts of interest which, if arising in connection with a
permitted trading activity, were prohibited under the proposal.\1544\
As noted in the proposal, conflicts of interest may arise in a variety
of circumstances related to permitted trading activities. For example,
a banking entity may acquire substantial amounts of nonpublic
information about the financial condition of a particular company or
issuer through its lending, underwriting, investment advisory or other
activities which, if improperly transmitted to and used in trading
operations, would permit the banking entity to use such information to
its customers', clients' or counterparties' disadvantage. Similarly, a
banking entity may conduct a transaction that places the banking
entity's own interests ahead of its obligations to its customers,
clients or counterparties, or it may seek to gain by treating one
customer involved in a transaction more favorably than another customer
involved in that transaction. Concerns regarding conflicts of interest
are likely to be elevated when a transaction is complex, highly
structured or opaque, involves illiquid or hard-to-value instruments or
assets, requires the coordination of multiple internal groups (such as
multiple trading desks or affiliated entities), or involves a
significant asymmetry of information or transactional data among
participants.\1545\ In all cases, the existence of a material conflict
of interest depends on the specific facts and circumstances.\1546\
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    \1544\ Section ----.17(b) of the proposed rule defined the scope
of material conflicts of interest which, if arising in connection
with permitted covered fund activities, are prohibited.
    \1545\ See, e.g., U.S. Senate Permanent Subcommittee on
Investigations, Wall Street and the Financial Crisis: Anatomy of a
Financial Collapse (Apr. 13, 2011), available at http://hsgac.senate.gov/public/_files/Financial_Crisis/FinancialCrisisReport.pdf.
    \1546\ See Joint Proposal, 76 FR 68,893.
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    To address these types of material conflicts of interest, Sec.  --
--.8(b) of the proposed rule specified that a material conflict of
interest between a banking entity and its clients, customers, or
counterparties exists if the banking entity engages in any transaction,
class of transactions, or activity that would involve or result in the
banking entity's interests being materially adverse to the interests of
its client, customer, or counterparty with respect to such transaction,
class of transactions, or activity, unless the banking entity has
appropriately addressed and mitigated the conflict of interest, and
subject to specific requirements provided in the proposal, through
either (i) timely and effective disclosure, or (ii) information
barriers.\1547\ Unless the conflict of interest is addressed and
mitigated in one of the two ways specified in the proposal, the related
transaction, class of transactions or activity would be prohibited
under the proposed rule, notwithstanding the fact that it may be
otherwise permitted under Sec. Sec.  ----.4 through ----.6 of the
proposed rule.\1548\
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    \1547\ See proposed rule Sec.  ----.8(b)(1).
    \1548\ See Joint Proposal, 76 FR 68,893.
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    However, the Agencies determined that while these conflicts may be
material for purposes of the proposed rule, the mere fact that the
buyer and seller are on opposite sides of a transaction and have
differing economic interests would not be deemed a ``material''
conflict of interest with respect to transactions related to bona fide
underwriting, market making, risk-mitigating hedging or other permitted
activities, assuming the activities are conducted in a manner that is
consistent with the proposed rule and securities, derivatives, and
banking laws and regulations.
    Section ----.8(b)(1) of the proposed rule described the two
requirements that must be met in cases where a banking entity addresses
and mitigates a material conflict of interest through timely and
effective disclosure. First, Sec.  ----.8(b)(1)(A)(i) of the proposed
rule required that the banking entity, prior to effecting the specific
transaction or class or type of transactions, or engaging in the
specific activity, for which a conflict may arise, make clear, timely
and effective disclosure of the conflict or potential conflict of
interest, together with any other necessary information. This would
also require such disclosure to be provided in reasonable detail and in
a manner sufficient to permit a reasonable client, customer, or
counterparty to meaningfully understand the conflict of interest.\1549\
Disclosure that is only general or generic, rather than specific to the
individual, class, or type of transaction or activity, or that omits
details or other information that would be necessary to a reasonable
client's, customer's, or counterparty's understanding of the conflict
of interest, would not meet this standard. Second, Sec.  --
--.8(b)(1)(ii) of the proposed rule required that the disclosure be
made explicitly and effectively, and in a manner that provides the
client, customer, or counterparty the opportunity to negate, or
substantially mitigate, any materially adverse effect on the client,
customer, or counterparty that was created or would be created by the
conflict or potential conflict.\1550\
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    \1549\ See id.
    \1550\ See proposed rule Sec.  ----.8(b)(1)(B).
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    The Agencies noted that, in order to provide the requisite
opportunity for the client, customer or counterparty to negate or
substantially mitigate the disadvantage created by the conflict, the
disclosure would need to be provided sufficiently close in time to the
client's, customer's, or counterparty's decision to engage in the
transaction or activity to give the client, customer, or counterparty
an opportunity to meaningfully evaluate and, if necessary, take steps
that would negate or substantially mitigate the conflict. Disclosure
provided far in advance of a particular transaction, such that the
client, customer, or counterparty is unlikely to take that disclosure
into account when evaluating the transaction, would not suffice.
Conversely, disclosure provided without a sufficient period of time for
the client, customer, or counterparty to evaluate and act on the
information it receives, or disclosure provided after the fact, would
also not suffice under the proposal. The Agencies note that the
proposed definition would not prevent or require disclosure with
respect to transactions or activities that align the interests of the
banking entity with its clients, customers, or counterparties or that
otherwise do not involve ``material'' conflicts of interest as
discussed above.
    The proposed disclosure standard reflected the fact that some types
of conflicts may be appropriately resolved through the disclosure of
clear and meaningful information to the client, customer, or
counterparty that provides such party with an informed opportunity to
consider and negate or substantially mitigate the conflict. However, in
the case of a conflict in which a client, customer, or counterparty
does not have sufficient information and opportunity to negate or
mitigate the materially adverse effect on the client, customer, or
counterparty created by the conflict, the existence of that conflict of
interest would prevent the banking entity from availing itself of any
exemption (e.g., the underwriting or market-making exemptions) with
respect to the relevant transaction, class of transactions, or
activity. The

Agencies note that the proposed disclosure provisions were provided
solely for purposes of the proposed rule's definition of material
conflict of interest, and did not affect a banking entity's obligation
to comply with additional or different disclosure or other requirements
with respect to a conflict under applicable securities, banking, or
other laws (e.g., section 27B of the Securities Act, which governs
conflicts of interest relating to certain securitizations; section 206
of the Investment Advisers Act of 1940, which governs conflicts of
interest between investment advisers and their clients; or 12 CFR 9.12,
which applies to conflicts of interest in the context of a national
bank's fiduciary activities).
    Section ----.8(b)(2) of the proposed rule described the
requirements that must be met in cases where a banking entity uses
information barriers that are reasonably designed to prevent a material
conflict of interest from having a materially adverse effect on a
client, customer or counterparty. Information barriers can be used to
restrict the dissemination of information within a complex organization
and to prevent material conflicts by limiting knowledge and
coordination of specific business activities among units of the entity.
Examples of information barriers include, but are not limited to,
restrictions on information sharing, limits on types of trading, and
greater separation between various functions of the firm. Information
barriers may also require that banking entity units or affiliates have
no common officers or employees. Such information barriers have been
recognized in Federal securities laws and rules as a means to address
or mitigate potential conflicts of interest or other inappropriate
activities.\1551\
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    \1551\ See, e.g., 15 U.S.C. 78c(a)(4)(B)(i)(I)-(IV) (finding
that disclosure and physical separation of personnel and activities
addresses the potential that consumers might be misled by the
broker-dealer activities of banks). 15 U.S.C. 80b-6(3) (``It shall
be unlawful for any investment adviser, by use of the mails or any
means or instrumentality of interstate commerce, directly or
indirectly . . . acting as principal for his own account, knowingly
to sell any security to or purchase any security from a client, or
acting as broker for a person other than such client, knowingly to
effect any sale or purchase of any security for the account of such
client, without disclosing to such client in writing before the
completion of such transaction the capacity in which he is acting
and obtaining the consent of the client to such transaction.''). See
also Form ADV, the form used by investment advisers to register with
the Securities and Exchange Commission and state securities
authorities, and, in particular, Form ADV Part 2: Uniform
Requirements for the Investment Adviser Brochure and Brochure
Supplements. A registered investment adviser generally must deliver
the Form ADV brochure, which contains disclosure about conflicts of
interest, to its prospective and existing clients. See 17 CFR
275.204-3; Amendments to Form ADV, Investment Advisers Act Release
No. 3060 (July 28, 2010), 75 FR 49234 (Aug. 12, 2010) (``We are
adopting a requirement that investment advisers registered with us
provide prospective and existing clients with a narrative brochure
written in plain English . . . We believe these amendments will
greatly improve the ability of clients and prospective clients to
evaluate firms offering advisory services and the firms' personnel,
and to understand relevant conflicts of interest that the firms and
their personnel face and their potential effect on the firms'
services.'').
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    In order to address and mitigate a conflict of interest through the
use of the information barriers pursuant to Sec.  ----.8(b)(2) of the
proposed rule, a banking entity would be required to establish,
maintain, and enforce information barriers that are memorialized in
written policies and procedures, including physical separation of
personnel, functions, or limitations on types of activity, that are
reasonably designed, taking into consideration the nature of the
banking entity's business, to prevent the conflict of interest from
involving or resulting in a materially adverse effect on a client,
customer, or counterparty. Importantly, the proposed rule also provided
that, notwithstanding a banking entity's establishment of such
information barriers if the banking entity knows or should reasonably
know that a material conflict of interest arising out of a specific
transaction, class or type of transactions, or activity may involve or
result in a materially adverse effect on a client, customer, or
counterparty, the banking entity may not rely on those information
barriers to address and mitigate any conflict of interest. In such
cases, the transaction or activity would be prohibited, unless the
banking entity otherwise complied with the requirements of proposed
Sec.  ----.8(b)(1).\1552\ This aspect of the proposal was intended to
make clear that, in specific cases in which a banking entity has
established an information barrier but knows or should reasonably know
that it has failed or will fail to prevent a conflict of interest
arising from a specific transactions or activity that disadvantages a
client, customer, or counterparty, the information barrier is
insufficient to address that conflict and the transaction would be
prohibited, unless the banking entity is otherwise able to address and
mitigate the conflict through timely and effective disclosure under the
proposal.\1553\
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    \1552\ See proposed rule Sec.  ----.8(b)(2).
    \1553\ See Joint Proposal, 76 FR 68,894.
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    The proposed definition of material conflict of interest did not
address instances in which a banking entity has made a material
misrepresentation to its client, customer, or counterparty in
connection with a transaction, class of transactions, or activity, as
such transactions or activity appears to involve fraud rather than a
conflict of interest. This is because such misrepresentations are
generally illegal under a variety of Federal and State regulatory
schemes (e.g., the Federal securities laws).\1554\ In addition, the
Agencies noted that any activity involving a material misrepresentation
to, or other fraudulent conduct with respect to, a client, customer, or
counterparty would not be permitted under the proposed rule in the
first instance.
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    \1554\ See 12 U.S.C. 1851(g)(3).
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2. Comments on the Proposed Limitation on Material Conflicts of
Interest
    Commenters expressed a variety of views regarding the treatment of
material conflicts of interest under the proposal, including the manner
in which conflicts may be mitigated or eliminated. One commenter
believed that the proposed material conflict of interest provisions
would be effective.\1555\ Another commenter stated that conflicts of
interest were unavoidable but that the final rule should ensure that
institutional investors have confidence that the banking entities they
are dealing with are not operating at a conflict with investors'
goals.\1556\
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    \1555\ See Alfred Brock.
    \1556\ See Paul Volcker.
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    Other commenters expressed differing views on whether the proposed
rule's provisions for addressing conflicts of interest through
disclosure or information barriers were appropriate. A few commenters