(5) Training for trading personnel and managers, as well as other
appropriate personnel, to effectively implement and enforce the
compliance program; and
    (6) Making and keeping records sufficient to demonstrate compliance
with section 13 of the BHC Act and this part, which a covered banking
entity must promptly provide to [Agency] upon request and retain for a
period of no less than 5 years.
    (c) Additional standards. (1) In the case of any covered banking
entity described in paragraph (c)(2) of this section, the compliance
program required by paragraph (a) of this section shall also satisfy
the requirements and other standards contained in Appendix C to this
part.
    (2) A covered banking entity is subject to paragraph (c)(1) of this
section if:
    (i) The covered banking entity engages in proprietary trading and
has, together with its affiliates and subsidiaries, trading assets and
liabilities the average gross sum of which (on a worldwide consolidated
basis), as measured as of the last day of each of the four prior
calendar quarters:
    (A) Is equal to or greater than $1 billion; or
    (B) Equals 10 percent or more of its total assets;
    (ii) The covered banking entity invests in, or has relationships
with, a covered fund and:
    (A) The covered banking entity has, together with its affiliates
and subsidiaries, aggregate investments in one or more covered funds,
the average value of which is, as measured as of the last day of each
of the four prior calendar quarters, equal to or greater than $1
billion; or
    (B) Sponsors or advises, together with its affiliates and
subsidiaries, one or more covered funds, the average total assets of
which are, as measured as of the last day of each of the four prior
calendar quarters, equal to or greater than $1 billion; or
    (iii) [The Agency] deems it appropriate.
    (d) No program required for certain banking entities. To the extent
that a covered banking entity does not engage in activities or
investments prohibited or restricted by subpart B or subpart C of this
part, a covered banking entity will have satisfied the requirements of
this section if its existing compliance policies and procedures include
measures that are designed to prevent the covered banking entity from
becoming engaged in such activities or making such investments and
which require the covered banking entity to develop and provide for the
compliance program required under paragraph (a) of this section prior
to engaging in such activities or making such investments.

Sec.  --.21  Termination of activities or investments; penalties for
violations.

    (a) Any covered banking entity that engages in an activity or makes
an investment in violation of section 13 of the BHC Act or this part or
in a manner that functions as an evasion of the requirements of section
13 of the BHC Act or this part, including through an abuse of any
activity or investment permitted under subparts B or C, or otherwise
violates the restrictions and requirements of section 13 of the BHC Act
or this part, shall terminate the activity and, as relevant, dispose of
the investment.
    (b) After due notice and an opportunity for hearing, if [Agency]
finds reasonable cause to believe any covered banking entity has
engaged in an activity or made an investment described in paragraph
(a), the [Agency] may, by order, direct the banking entity to restrict,
limit, or terminate the activity and, as relevant, dispose of the
investment.
    (c) [Reserved]

Appendix A to Part [ ]--Reporting and Recordkeeping Requirements for
Covered Trading Activities

I. Purpose

    This appendix sets forth reporting and recordkeeping
requirements that certain covered banking entities must satisfy in
connection with the restrictions on proprietary trading set forth in
subpart B of this part (``proprietary trading restrictions'').
Pursuant to Sec.  --.7, this appendix generally applies to a covered
banking entity that has, together with its affiliates and
subsidiaries, trading assets and liabilities the average gross sum
of which (on a worldwide consolidated basis) is, as measured as of
the last day of each of the four prior calendar quarters, equal to
or greater than $1 billion. These entities are required to furnish
periodic reports to [Agency] regarding a variety of quantitative
measurements of their covered trading activities, which vary
depending on the scope and size of covered trading activities, and
create and maintain records documenting the preparation and content
of these reports. The requirements of this appendix should be
incorporated into the covered banking entity's internal compliance
program under Sec.  --.20 and appendix C to this part.
    The purpose of this appendix is to assist covered banking
entities and [Agency] in:
    (i) Better understanding and evaluating the scope, type, and
profile of the covered banking entity's trading activities;
    (ii) Monitoring the covered banking entity's trading activities;
    (iii) Identifying trading activities that warrant further review
or examination by the covered banking entity to verify compliance
with the proprietary trading restrictions;
    (iv) Evaluating whether the trading activities of trading units
engaged in market making-related activities subject to Sec.  --.4(b)
are consistent with the requirements governing permitted market
making-related activities;
    (v) Evaluating whether the covered trading activities of trading
units that are engaged in permitted trading activity subject to
Sec. Sec.  --.4, --.5, or --.6(a) (i.e., underwriting and market
making-related related activity, risk-mitigating hedging, or trading
in certain government obligations) are consistent with the
requirement that such activity not result, directly or indirectly,
in a material exposure to high-risk assets or high-risk trading
strategies;
    (vi) Identifying the profile of particular trading activities of
the covered banking entity, and the individual trading units of the
banking entity, to help establish the appropriate frequency and
scope of examination by [Agency] of such activities; and
    (vii) Assessing and addressing the risks associated with the
covered banking entity's covered trading activities.
    The quantitative measurements that must be furnished pursuant to
this appendix are not intended to serve as a dispositive tool for
the identification of permissible or impermissible activities.
    In addition to the quantitative measurements required in this
appendix, a covered banking entity may need to develop and implement
other quantitative measurements in order to effectively monitor its
covered trading activities for compliance with section 13 of the BHC
Act and this part and to have an effective compliance program, as
required by Sec.  --.20 and appendix C to this part. The
effectiveness of particular quantitative measurements may differ
based on the profile of the banking entity's businesses in general
and, more specifically, of the particular trading unit, including
types of instruments traded, trading activities and strategies, and
history and experience (e.g., whether the trading desk is an
established, successful market maker or a new entrant to a
competitive market). In all cases, covered banking entities must
ensure that they have robust measures in place to identify and
monitor the risks taken in their trading activities, to ensure that
the activities are within risk tolerances established by the covered
banking entity, and to monitor and examine for compliance with the
proprietary trading restrictions in this part.
    On an ongoing basis, covered banking entities should carefully
monitor, review, and evaluate all furnished quantitative
measurements, as well as any others that they choose to utilize in
order to maintain compliance with section 13 of the BHC Act and this
part. All measurement results that indicate a heightened risk of
impermissible proprietary trading, including with respect to
otherwise-permitted activities under Sec. Sec.  --.4 through --.6
that result in a material exposure to high-risk assets or high-risk
trading strategies, should be escalated within the banking entity
for review, further analysis, explanation to [Agency], and

remediation, where appropriate. Many of the quantitative
measurements discussed in this appendix will also be helpful to
covered banking entities in identifying and managing the risks
related to their covered trading activities.

II. Definitions

    The terms used in this appendix have the same meanings as set
forth in Sec. Sec.  --.2 and --.3. In addition, for purposes of this
appendix, the following definitions apply:
    Covered trading activity means proprietary trading, as defined
in paragraph (b)(1) of Sec.  --.3.
    Trading unit means each of the following units of organization
of a covered banking entity:
    (i) Each discrete unit that is engaged in the coordinated
implementation of a revenue-generation strategy and that
participates in the execution of any covered trading activity; \1\
---------------------------------------------------------------------------

    \1\ [The Agency] expects that this will generally be the
smallest unit of organization used by the covered banking entity to
structure and control its risk-taking activities and employees, and
will include each unit generally understood to be a single ``trading
desk.''
---------------------------------------------------------------------------

    (ii) Each organizational unit that is used to structure and
control the aggregate risk-taking activities and employees of one or
more trading units described in paragraph (i); \2\
---------------------------------------------------------------------------

    \2\ [The Agency] expects that this will generally include
management or reporting divisions, groups, sub-groups, or other
intermediate units of organization used by the covered banking
entity to manage one or more discrete trading units (e.g., ``North
American Credit Trading,'' ``Global Credit Trading,'' etc.).
---------------------------------------------------------------------------

    (iii) All trading operations, collectively; and
    (iv) Any other unit of organization specified by [Agency] with
respect to a particular banking entity.
    Calculation period means the period of time for which a
particular quantitative measurement must be calculated.

III. Reporting and Recordkeeping of Quantitative Measurements

A. Scope of Required Reporting

    General scope. The quantitative measurements that must be
furnished by a covered banking entity depend on the aggregate size
of the covered banking entity's trading activities and the
activities in which its trading units engage, as follows:
    (i) With respect to any covered banking entity that is engaged
in any covered trading activity, and has trading assets and
liabilities the average gross sum of which (on a worldwide
consolidated basis) is, as measured as of the last day of each of
the four prior calendar quarters, equal to or greater than $5
billion:
    (a) Each trading unit of the covered banking entity that is
engaged in market making-related activities subject to Sec.  --.4(b)
must furnish the following quantitative measurements, calculated in
accordance with this appendix:
     Value-at-Risk and Stress VaR;
     VaR Exceedance;
     Risk Factor Sensitivities;
     Risk and Position Limits;
     Comprehensive Profit and Loss;
     Portfolio Profit and Loss;
     Fee Income and Expense;
     Spread Profit and Loss;
     Comprehensive Profit and Loss Attribution;
     Pay-to-Receive Spread Ratio;
     Unprofitable Trading Days Based on Comprehensive Profit
and Loss and Unprofitable Trading Days Based on Portfolio Profit and
Loss;
     Skewness of Portfolio Profit and Loss and Kurtosis of
Portfolio Profit and Loss;
     Volatility of Comprehensive Profit and Loss and
Volatility of Portfolio Profit and Loss;
     Comprehensive Profit and Loss to Volatility Ratio and
Portfolio Profit and Loss to Volatility Ratio;
     Inventory Risk Turnover;
     Inventory Aging; and
     Customer-facing Trade Ratio; and
    (b) Each trading unit of the covered banking entity that is
engaged in permitted trading activity subject to Sec. Sec.  --.4(a),
--.5, or --.6(a) must furnish the following quantitative
measurements, calculated in accordance with this appendix:
     Value-at-Risk and Stress VaR;
     Risk Factor Sensitivities;
     Risk and Position Limits;
     Comprehensive Profit and Loss; and
     Comprehensive Profit and Loss Attribution; and
    (ii) With respect to any covered banking entity that is engaged
in any covered trading activity, and has trading assets and
liabilities the average gross sum of which (on a worldwide
consolidated basis) is, as measured as of the last day of each of
the four prior calendar quarters, equal to or greater than $1
billion and less than $5 billion, each trading unit of the covered
banking entity that is engaged in market making-related activities
under Sec.  --.4(b) must furnish the following quantitative
measurement, calculated in accordance with this appendix:
     Comprehensive Profit and Loss;
     Portfolio Profit and Loss;
     Fee Income and Expense;
     Spread Profit and Loss;
     Value-at-Risk;
     Comprehensive Profit and Loss Attribution;
     Volatility of Comprehensive Profit and Loss and
Volatility of Portfolio Profit and Loss; and
     Comprehensive Profit and Loss to Volatility Ratio and
Portfolio Profit and Loss to Volatility Ratio.

B. Frequency of Required Calculation and Reporting

    A covered banking entity must calculate any applicable
quantitative measurement for each trading day. A covered banking
entity must report each applicable quantitative measurement to
[Agency] on a monthly basis, or on any other reporting schedule
requested by [Agency]. All quantitative measurements for any
calendar month must be reported to [Agency] no later than 30 days
after the end of that calendar month or on any other time basis
requested by [Agency].\3\
---------------------------------------------------------------------------

    \3\ For example, under section IV.B.1 of this appendix, a
banking entity is required to report to [Agency] the Comprehensive
Profit and Loss quantitative measurement, as calculated for all
trading days in June of any year, no later than July 30 of that
year.
---------------------------------------------------------------------------

C. Recordkeeping

    A covered banking entity must, for any quantitative measurement
furnished to [Agency] pursuant to this appendix and Sec.  --.7,
create and maintain records documenting the preparation and content
of these reports, as well as such information as is necessary to
permit [Agency] to verify the accuracy of such reports, for a period
of 5 years.

IV. Quantitative Measurements

A. Risk-Management Measurements

1. Value-at-Risk and Stress Value-at-Risk

    Description: For purposes of this appendix, Value-at-Risk
(``VaR'') is the commonly used percentile measurement of the risk of
future financial loss in the value of a given portfolio over a
specified period of time, based on current market conditions. For
purposes of this appendix, Stress Value-at-Risk (``Stress VaR'') is
the percentile measurement of the risk of future financial loss in
the value of a given portfolio over a specified period of time,
based on market conditions during a period of significant financial
stress.
    General Calculation Guidance: Banking entities should compute
and report VaR and Stress VaR by employing generally accepted
standards and methods of calculation. VaR should reflect a loss in a
trading unit that is expected to be exceeded less than one percent
of the time over a one-day period. For those banking entities that
are subject to regulatory capital requirements imposed by a Federal
banking agency, VaR and Stress VaR should be computed and reported
in a manner that is consistent with such regulatory capital
requirements. In cases where a trading unit does not have a
standalone VaR or Stress VaR calculation but is part of a larger
portfolio for which a VaR or Stress VaR calculation is performed, a
VaR or Stress VaR calculation that includes only the trading unit's
holdings should be performed consistent with the VaR or Stress VaR
model and methodology used by the larger portfolio.
    Calculation Period: One trading day.

2. VaR Exceedance

    Description: For purposes of this appendix, VaR Exceedance is
the difference between VaR and Portfolio Profit and Loss, exclusive
of Spread Profit and Loss, for a trading unit for any given
calculation period.
    Calculation Period: One trading day.

3. Risk Factor Sensitivities

    Description: For purposes of this appendix, Risk Factor
Sensitivities are changes in a trading unit's Portfolio Profit and
Loss, exclusive of Spread Profit and Loss, that are expected to
occur in the event of a change in a trading unit's ``risk factors''
(i.e., one or more underlying market variables that are

significant sources of the trading unit's profitability and risk).
    General Calculation Guidance: A covered banking entity should
report the Risk Factor Sensitivities that are monitored and managed
as part of the trading unit's overall risk management policy. The
underlying data and methods used to compute a trading unit's Risk
Factor Sensitivities should depend on the specific function of the
trading unit and the internal risk management models employed. The
number and type of Risk Factor Sensitivities that are monitored and
managed by a trading unit, and furnished to [Agency], should depend
on the explicit risks assumed by the trading unit. In general,
however, reported Risk Factor Sensitivities should be sufficient to
account for a preponderance of the price variation in the trading
unit's holdings.
    Trading units should take into account any relevant factors in
calculating Risk Factor Sensitivities, including, for example, the
following with respect to particular asset classes:
     Commodity derivative positions: sensitivities with
respect to the related commodity type (e.g., precious metals, oil
and petroleum or agricultural products), the maturity of the
positions, volatility and/or correlation sensitivities (expressed in
a manner that demonstrates any significant non-linearities), and the
maturity profile of the positions;
     Credit positions: sensitivities with respect to credit
spread factors that are sufficiently granular to account for
specific credit sectors and market segments, the maturity profile of
the positions, and sensitivities to interest rates at all relevant
maturities;
     Credit-related derivative positions: credit positions
sensitivities and volatility and/or correlation sensitivities
(expressed in a manner that demonstrates any significant non-
linearities), and the maturity profile of the positions;
     Equity positions: sensitivity to equity prices and
sensitivities that differentiate between important equity market
sectors and segments, such as a small capitalization equities and
international equities;
     Equity derivative positions: equity position
sensitivities and volatility and/or correlation sensitivities
(expressed in a manner that demonstrates any significant non-
linearities), and the maturity profile of the positions;
     Foreign exchange derivative positions: sensitivities
with respect to major currency pairs and maturities, sensitivity to
interest rates at relevant maturities, and volatility and/or
correlation sensitivities (expressed in a manner that demonstrates
any significant non-linearities), as well as the maturity profile of
the positions; and
     Interest rate positions, including interest rate
derivative positions: sensitivities with respect to major interest
rate categories and maturities and volatility and/or correlation
sensitivities (expressed in a manner that demonstrates any
significant non-linearities), as well as the maturity profile of the
positions.
    The methods used by a covered banking entity to calculate
sensitivities to a common factor shared by multiple trading units,
such as an equity price factor, should be applied consistently
across its trading units so that the sensitivities can be compared
from one trading unit to another.
    Calculation Period: One trading day.

4. Risk and Position Limits

    Description: For purposes of this appendix, Risk and Position
Limits are the constraints that define the amount of risk that a
trading unit is permitted to take at a point in time, as defined by
the covered banking entity for a specific trading unit.
    General Calculation Guidance: Risk and Position Limits should be
reported in the format used by the covered banking entity for the
purposes of risk management of each trading unit. Risk and Position
Limits are often expressed in terms of risk measures, such as VaR
and Risk Factor Sensitivities, but may also be expressed in terms of
other observable criteria, such as net open positions. When criteria
other than VaR or Risk Factor Sensitivities are used to define the
Risk and Position Limits, both the value of the Risk and Position
Limits and the value of the variables used to assess whether these
limits have been reached should be reported.
    Calculation Period: One trading day.

B. Source-of-Revenue Measurements

1. Comprehensive Profit and Loss

    Description: For purposes of this appendix, Comprehensive Profit
and Loss is the net profit or loss of a trading unit's material
sources of trading revenue, including, for example, dividend and
interest income and expense, over a specific period of time. A
trading unit's Comprehensive Profit and Loss for any given
calculation period should generally equal the sum of the trading
unit's (i) Portfolio Profit and Loss and (ii) Fee Income.
    General Calculation Guidance: Comprehensive Profit and Loss
generally should be computed using data on the value of a trading
unit's underlying holdings, the prices at which those holdings were
bought and sold, and the value of any fees, commissions, sales
credits, spreads, dividends, interest income and expense, or other
sources of income from trading activities, whether realized or
unrealized. Comprehensive Profit and Loss should not include: (i)
compensation costs or other costs required to operate the unit, such
as information technology costs; or (ii) charges and adjustments
made for internal reporting and management purposes, such as
accounting reserves.
    Calculation Period: One trading day.

2. Portfolio Profit and Loss

    Description: For purposes of this appendix, Portfolio Profit and
Loss is a trading unit's net profit or loss on its underlying
holdings over a specific period of time, whether realized or
unrealized. Portfolio Profit and Loss should generally include any
increase or decrease in the market value of a trading unit's
holdings, including, for example, any dividend, interest income, or
expense of a trading unit's holdings. Portfolio Profit and Loss
should not include direct fees, commissions, sales credits, or other
sources of trading revenue that are not directly related to the
market value of the trading unit's holdings.
    General Calculation Guidance: In general, Portfolio Profit and
Loss should be computed using data on a trading unit's underlying
holdings and the prices at which those holdings are marked for
valuation purposes. Portfolio Profit and Loss should not include:
compensation costs or other costs required to operate the trading
unit, such as information technology costs; or charges and
adjustments made for internal reporting and management purposes,
such as accounting reserves.
    Calculation Period: One trading day.

3. Fee Income and Expense

    Description: For purposes of this appendix, Fee Income and
Expense generally includes direct fees, commissions and other
distinct income for services provided by or to a trading unit over a
specific period of time.
    General Calculation Guidance: Fee Income and Expense should be
computed using data on direct fees that are earned by the trading
unit for services it provides to clients, customers, or
counterparties, such as fees earned for structured transactions or
sales commissions and credits earned for fulfilling a customer
request, whether realized or unrealized, and similar fees paid by
the trading unit to other service providers.
    Calculation Period: One trading day.

4. Spread Profit and Loss

    Description: For purposes of this appendix, Spread Profit and
Loss is the portion of Portfolio Profit and Loss that generally
includes revenue generated by a trading unit from charging higher
prices to buyers than the trading unit pays to sellers of comparable
instruments over the same period of time (i.e., charging a
``spread,'' such as the bid-ask spread).
    General Calculation Guidance: Spread Profit and Loss generally
should be computed using data on the prices at which comparable
instruments are either bought or sold by the trading unit, as well
as the turnover of these instruments. Spread Profit and Loss should
be measured with respect to both the purchase and the sale of any
position, and should include both (i) the spreads that are earned by
the trading unit to execute transactions (expressed as positive
amounts), and (ii) the spreads that are paid by the trading unit to
initiate transactions (expressed as negative amounts). Spread Profit
and Loss should be computed by calculating the difference between
the bid price or the ask price (whichever is paid or received) and
the mid-market price. The mid-market price is the average of bid and
ask.
    For some asset classes in which a trading unit is engaged in
market making-related activities, bid-ask or similar spreads are
widely disseminated, constantly updated, and readily available, or
otherwise reasonably ascertainable. For purposes of calculating the
Spread Profit and Loss attributable to a transaction in such asset
classes, the trading unit should utilize the prevailing bid-ask or
similar spread on the relevant position at the time the purchase or
sale is completed.
    For other asset classes in which a trading unit is engaged in
market making-related activities, bid-ask or similar spreads may not

be widely disseminated on a consistent basis or otherwise reasonably
ascertainable. A covered banking entity must identify any trading
unit engaged in market making-related activities in an asset class
for which the covered banking entity believes bid-ask or similar
spreads are not widely disseminated on a consistent basis or are not
otherwise reasonably ascertainable and must be able to demonstrate
that bid-ask or similar spreads for the asset class are not
reasonably ascertainable. In such cases, the trading unit should
calculate the Spread Profit and Loss for the relevant purchase or
sale of a position in a particular asset class by using whichever of
the following three alternatives the banking entity believes more
accurately reflects prevailing bid-ask or similar spreads for
transactions in that asset class:
    (i) End of Day Spread Proxy: A proxy based on the bid-ask or
similar spread that is used to estimate, or is otherwise implied by,
the market price at which the trading entity marks (or in the case
of a sale, would have marked) the position for accounting purposes
at the close of business on the day it executes the purchase or sale
(``End of Day Spread Proxy'');
    (ii) Historical Data Spread Proxy: A proxy based on historical
bid-ask or similar spread data in similar market conditions
(``Historical Data Spread Proxy''); or
    (iii) Any other proxy that the banking entity can demonstrate
accurately reflects prevailing bid-ask or similar spreads for
transactions in the specific asset class.
    A covered banking entity selecting any of these alternatives
should be able to demonstrate that the alternative it has chosen
most accurately reflects prevailing bid-ask or similar spreads for
the relevant asset class. If a covered banking entity chooses to
calculate Spread Profit and Loss for a particular trading unit using
the End of Day Spread Proxy, then the banking entity should
separately identify the portion of Spread Profit and Loss that is
attributable to positions acquired and disposed of on the same
trading day. If a banking entity chooses to calculate Spread Profit
and Loss for a particular trading unit using the Historical Data
Spread Proxy, the covered banking entity should be able to
demonstrate that the Historical Data Proxy is appropriate and
continually monitor market conditions and adjust, as necessary, the
Historical Data Proxy to reflect any changes.
    Calculation Period: One trading day.

5. Comprehensive Profit and Loss Attribution

    Description: For purposes of this appendix, Comprehensive Profit
and Loss Attribution is an attribution analysis that divides the
trading unit's Comprehensive Profit and Loss into the separate
sources of risk and revenue that have caused any observed variation
in Comprehensive Profit and Loss. This attribution analysis should
attribute Comprehensive Profit and Loss to specific market and risk
factors that can be accurately and consistently measured over time.
Any component of Comprehensive Profit and Loss that cannot be
specifically identified in the attribution analysis should be
identified as an unexplained portion of the Comprehensive Profit and
Loss.
    General Calculation Guidance: The specific market and risk
factors used by a trading unit in the attribution analysis should be
tailored to the trading activities undertaken by the unit. These
factors should be measured consistently over time to facilitate
historical comparisons. The attribution analysis should also
identify any significant factors that have a consistent and regular
influence on Comprehensive Profit and Loss, such as Risk Factor
Sensitivities that have a significant influence on portfolio income,
customer spreads, bid-ask spreads, or commissions that are earned.
Factors that influence Comprehensive Profit and Loss across
different trading units should be measured and included in the
attribution analysis in a comparable fashion.
    Calculation Period: One trading day.

C. Revenue-Relative-to-Risk Measurements

1. Volatility of Comprehensive Profit and Loss and Volatility of
Portfolio Profit and Loss

    Description: For purposes of this appendix, Volatility of
Comprehensive Profit and Loss generally is the standard deviation of
the trading unit's Comprehensive Profit and Loss estimated over a
given calculation period. For purposes of this appendix, Volatility
of Portfolio Profit and Loss generally is the standard deviation of
the trading unit's Portfolio Profit and Loss, exclusive of Spread
Profit and Loss, estimated over a given calculation period.
    Calculation Period: 30 days, 60 days, and 90 days.

2. Comprehensive Profit and Loss to Volatility Ratio and Portfolio
Profit and Loss to Volatility Ratio

    Description: For purposes of this appendix, Comprehensive Profit
and Loss to Volatility Ratio is a ratio of Comprehensive Profit and
Loss to the Volatility of Comprehensive Profit and Loss for a
trading unit over a given calculation period. For purposes of this
appendix, Portfolio Profit and Loss to Volatility Ratio is a ratio
of Portfolio Profit and Loss, exclusive of Spread Profit and Loss,
to the Volatility of Portfolio Profit and Loss, exclusive of Spread
Profit and Loss, for a trading unit over a given calculation period.
    Calculation Period: 30 days, 60 days, and 90 days.

3. Unprofitable Trading Days Based on Comprehensive Profit and Loss and
Unprofitable Trading Days Based on Portfolio Profit and Loss

    Description: For purposes of this appendix, Unprofitable Trading
Days Based on Comprehensive Profit and Loss is the number or
proportion of trading days on which a trading unit's Comprehensive
Profit and Loss is less than zero over a given calculation period.
For purposes of this appendix, Unprofitable Trading Days Based on
Portfolio Profit and Loss, exclusive of Spread Profit and Loss, is
the number or proportion of trading days on which a trading unit's
Portfolio Profit and Loss, exclusive of Spread Profit and Loss, is
less than zero over a given calculation period.
    Calculation Period: 30 days, 90 days, and 360 days.

4. Skewness of Portfolio Profit and Loss and Kurtosis of Portfolio
Profit and Loss

    Description: Skewness of Portfolio Profit and Loss and Kurtosis
of Portfolio Profit and Loss should be calculated using standard
statistical methods with respect to Portfolio Profit and Loss,
exclusive of Spread Profit and Loss.
    Calculation Period: 30 days, 60 days, and 90 days.

D. Customer-Facing Activity Measurements

1. Inventory Risk Turnover

    Description: For purposes of this appendix, Inventory Risk
Turnover is a ratio that measures the amount of risk associated with
a trading unit's inventory, as measured by Risk Factor
Sensitivities, that is turned over by the trading unit over a
specific period of time. For each Risk Factor Sensitivity, the
numerator of the Inventory Risk Turnover ratio generally should be
the absolute value of the Risk Factor Sensitivity associated with
each transaction over the calculation period. The denominator of the
Inventory Risk Turnover ratio generally should be the value of each
Risk Factor Sensitivity for all of the trading unit's holdings at
the beginning of the calculation period.
    General Calculation Guidance: As a general matter, a trading
unit should measure and report the Inventory Risk Turnover ratio for
each of the Risk Factor Sensitivities calculated and furnished for
that trading unit.
    Calculation Period: 30 days, 60 days, and 90 days.

2. Inventory Aging

    Description: For purposes of this appendix, Inventory Aging
generally describes the trading unit's aggregate assets and
liabilities and the amount of time that those assets and liabilities
have been held for the following periods: 0-30 days; 30-60 days; 60-
90 days; 90-180 days; 80-360 days; and greater than 360 days.
Inventory Aging should measure the age profile of the trading unit's
assets and liabilities.
    General Calculation Guidance: In general, Inventory Aging should
be computed using a trading unit's trading activity data and should
identify the trading unit's aggregate assets and liabilities. In
addition, Inventory Aging should include two schedules, an asset-
aging schedule and a liability-aging schedule. The asset-aging
schedule should record the value of the trading unit's assets that
have been held for: 0-30 days; 30-60 days; 60-90 days; 90-180 days;
180-360 days; and greater than 360 days. The liability-aging
schedule should record the value of the trading unit's liabilities
that have been held for: 0-30 days; 30-60 days; 60-90 days; 90-180
days; 180-360 days; and more than 360 days.
    Calculation Period: 30 days, 60 days, and 90 days.

3. Customer-Facing Trade Ratio

    Description: For purposes of this appendix, the Customer-Facing
Trade Ratio is a ratio comparing the number of transactions
involving a counterparty that is a customer of the trading unit to
the number of transactions involving a counterparty that is

not a customer of the trading unit. For purposes of calculating the
Customer-Facing Trade Ratio, a counterparty is considered to be a
customer of the trading unit if the counterparty is neither a
counterparty to a transaction executed on a designated contract
market registered under the Commodity Exchange Act or national
securities exchange registered under the Exchange Act, nor a broker-
dealer, swap dealer, security-based swap dealer, any other entity
engaged in market making-related activities, or any affiliate
thereof. A broker-dealer, swap dealer, or security-based swap
dealer, any other entity engaged in market making-related
activities, or any affiliate thereof may be considered a customer of
the trading unit for these purposes if the covered banking entity
treats that entity as a customer and has documented how and why the
entity is treated as such.
    Calculation Period: 30 days, 60 days, and 90 days.

E. Payment of Fees, Commissions, and Spreads Measurement

1. Pay-to-Receive Spread Ratio

    Description: For purposes of this appendix, the Pay-to-Receive
Spread Ratio is a ratio comparing the amount of Spread Profit and
Loss and Fee Income that is earned by a trading unit to the amount
of Spread Profit and Loss and Fee Income that is paid by the trading
unit.
    General Calculation Guidance: The Pay-to-Receive Spread Ratio
will depend on the amount of Spread Profit and Loss and Fee Income
that is earned by the trading unit for facilitating buy and sell
orders and the amount of Spread Profit and Loss that is paid by a
trading unit as it initiates buy and sell orders. The Pay-to-Receive
Spread Ratio generally should be computed using the calculation of
Spread Profit and Loss described in this appendix, except that
spread paid should include the aggregate Spread Profit and Loss of
all transactions producing a negative Spread Profit and Loss, and
spread received should include the aggregate Spread Profit and Loss
of all transactions producing a positive Spread Profit and Loss.
    Calculation Period: One trading day.

Appendix B: Commentary Regarding Identification of Permitted Market
Making-Related Activities

I. Purpose

    This appendix provides commentary describing the features of
permitted market making-related activities and distinctions between
permitted market making-related activities and prohibited
proprietary trading. The appendix applies to all covered banking
entities that are engaged in market making-related activities in
reliance on Sec.  --.4(b). The following commentary must be
incorporated into the covered banking entity's internal compliance
program under Sec.  --.20, as applicable.

II. Definitions

    The terms used in this appendix have the same meanings as those
set forth in Sec. Sec.  --.2 and --.3 and Appendix A.

III. Commentary

    Section 13 of the BHC Act and Sec.  --.3 prohibit any covered
banking entity from engaging in proprietary trading, which is
generally defined as engaging as principal for the trading account
of the covered banking entity in any transaction to purchase or sell
a covered financial position. However, section 13(d)(1)(B) of the
BHC Act and Sec.  --.4(b) permit a covered banking entity to engage
in proprietary trading that would otherwise be prohibited if the
activity is conducted in connection with the covered banking
entity's market making-related activities, to the extent that such
activities are designed not to exceed the reasonably expected near
term demands of clients, customers, and counterparties. This
commentary is intended to assist covered banking entities in
identifying permitted market making-related activities and
distinguishing such activities from trading activities that, even if
conducted in the context of the covered banking entity's market
making operations, would constitute prohibited proprietary trading.

A. Overview of Market Making-Related Activities

    In the context of trading activities in which a covered banking
entity acts as principal, market making-related activities generally
involve the covered banking entity either (i) in the case of market
making in a security that is executed on an organized trading
facility or exchange, passively providing liquidity by submitting
resting orders that interact with the orders of others on an
organized trading facility or exchange and acting as a registered
market maker, where such exchange or organized trading facility
provides the ability to register as a market maker,\1\ or (ii) in
other cases, providing an intermediation service to its customers by
assuming the role of a counterparty that stands ready to buy or sell
a position that the customer wishes to sell or buy. A market maker's
``customers'' generally vary depending on the asset class and market
in which the market maker is providing intermediation services. In
the context of market making in a security that is executed on an
organized trading facility or an exchange, a ``customer'' is any
person on behalf of whom a buy or sell order has been submitted by a
broker-dealer or any other market participant. In the context of
market making in a covered financial position in an over-the-counter
market, a ``customer'' generally would be a market participant that
makes use of the market maker's intermediation services, either by
requesting such services or entering into a continuing relationship
with the market maker with respect to such services.\2\
---------------------------------------------------------------------------

    \1\ The status of being a registered market maker is not, on its
own, a sufficient basis for relying on the exemption for market
making-related activity contained in Sec.  --.4(b). Registration as
a market maker generally involves filing a prescribed form with an
exchange or organized trading facility, in accordance with its rules
and procedures, and complying with the applicable requirements for
market makers set forth in the rules of that exchange or organized
trading facility. See, e.g., Nasdaq Rule 4612, New York Stock
Exchange Rule 104, CBOE Futures Exchange Rule 515, BATS Exchange
Rule 11.5.
    \2\ In certain cases, depending on the conventions of the
relevant market (e.g., the over-the-counter derivatives market),
such a ``customer'' may consider itself or refer to itself more
generally as a ``counterparty.''
---------------------------------------------------------------------------

    The primary purpose of market making-related activities is to
intermediate between buyers and sellers of similar positions, for
which service market makers are compensated, resulting in more
liquid markets and less volatile prices. The purpose of such
activities is not to earn profits as a result of movements in the
price of positions and risks acquired or retained; rather, a market
maker generally manages and limits the extent to which it is exposed
to movements in the price of principal positions and risks that it
acquires or retains, or in the price of one or more material
elements of those positions. To the extent that it can, a market
maker will eliminate some or all of the price risks to which it is
exposed. However, in some cases, the risks posed by one or more
positions may be sufficiently complex or specific that the risk
cannot be fully hedged. In other cases, although it may be possible
to hedge the risks posed by one or more positions, the cost of doing
so may be so high as to effectively make market making in those
positions uneconomic if complete hedges were acquired. In such
cases, in order to provide effective intermediation services, market
makers are required to retain at least some risk for at least some
period of time with respect to price movements of retained principal
positions and risks. The size and type of risk that must be retained
in such cases may vary widely depending on the type and size of the
positions, the liquidity of the specific market, and the market's
structure. As the liquidity of positions increases, the frequency
with which a market maker must take or retain risk in order to make
a market in those positions generally decreases.
    The profitability of market making-related activities relies on
forms of revenue that reflect the value of the intermediation
services that are provided to the market maker's customers. These
revenues typically take the form of explicit fees and commissions
or, in markets where no such fees or commission are charged, a bid-
ask or similar spread that is generated by charging higher prices to
buyers than is paid to sellers of comparable instruments. In the
case of a derivative contract, these revenues reflect the difference
between the cost of entering into the derivative contract and the
cost of hedging incremental, residual risks arising from the
contract. These types of ``customer revenues'' provide the primary
source of a market maker's profitability. Typically, a market maker
holds at least some risk with respect to price movements of retained
principal positions and risks. As a result, the market maker also
incurs losses or generates profits as price movements actually
occur, but such losses or profits are incidental to customer
revenues and significantly limited by the banking entity's hedging
activities. Customer revenues, not revenues from price movements,
predominate. The appropriate proportion of ``customer revenues'' to
profits

and losses resulting from price movements of retained principal
positions and risks varies depending on the type of positions
involved, the typical fees, commissions, and spreads payable for
transactions in those positions, and the risks of those positions.
As a general matter, the proportion of ``customer revenues''
generated when making a market in certain positions increases as the
fees, commissions, or spreads payable for those positions increase,
the volatility of those positions' prices decrease, and the prices
for those positions are less transparent.
    Because a market maker's business model entails managing and
limiting the extent to which it is exposed to movements in the
prices of retained principal positions and risks while generating
customer revenues that are earned, regardless of movements in the
price of retained principal positions and risks, a market maker
typically generates significant revenue relative to the risks that
it retains. Accordingly, a market maker will typically demonstrate
consistent profitability and low earnings volatility under normal
market conditions. The appropriate extent to which a market maker
will demonstrate consistent profitability and low earnings
volatility varies depending on the type of positions involved, the
liquidity of the positions, the price transparency of the positions,
and the volatility of the positions' prices. As a general matter,
consistent profitability will decrease and earnings volatility will
increase as the liquidity of the positions decrease, the volatility
of the positions' prices increase, and the prices for the positions
are less transparent.
    As the primary purpose of market making-related activities is to
provide intermediation services to its customers, market makers
focus their activities on servicing customer demands and typically
only engage in transactions with non-customers to the extent that
these transactions directly facilitate or support customer
transactions. In particular, a market maker generally only transacts
with non-customers to the extent necessary to hedge or otherwise
manage the risks of its market making-related activities, including
managing its risk with respect to movements of the price of retained
principal positions and risks, to acquire positions in amounts
consistent with reasonably expected near term demand of its
customers, or to sell positions acquired from its customers. The
appropriate proportion of a market maker's transactions that are
with customers versus non-customers varies depending on the type of
positions involved and the extent to which the positions are
typically hedged in non-customer transactions. In the case of a
derivatives market maker that engages in dynamic hedging, the number
of non-customer transactions significantly outweighs the number of
customer transactions, as the derivatives market maker must
constantly enter into transactions to appropriately manage its
retained principal positions and risks as market prices for the
positions and risks move and additional transactions with customers
change the risk profile of the market maker's retained principal
positions.
    Because a market maker generates revenues primarily by
transacting with, and providing intermediation services to,
customers, a market maker typically engages in transactions that
earn fees, commissions, or spreads as payment for its services.
Transactions in which the market maker pays fees, commissions, or
spreads--i.e., where it pays another market maker for providing it
with liquidity services--are much less frequent, although in some
cases obtaining liquidity services from another market maker and
paying fees, commissions, or spreads may be necessary to prudently
manage its risk with respect to price movements of retained
principal positions and risks. The appropriate proportion of a
market maker's transactions that earn, rather than pay, fees,
commissions or spreads varies depending on the type of positions
involved, the liquidity of the positions, and the extent to which
market trends increase the volatility of its risk with respect to
price movements of retained principal positions and risks. As a
general matter, the proportion of a market maker's transactions that
earn rather than pay fees, commissions or spreads decreases as the
liquidity of the positions decreases, and the extent to which the
price volatility of retained principal positions and risks
increases.
    Finally, because the primary purpose of market making-related
activities is to provide intermediation services to its customers, a
market maker does not provide compensation incentives to its
personnel that primarily reward proprietary risk-taking. Although a
market maker may take into account revenues resulting from movements
in the price of retained principal positions and risks to the extent
that such revenues reflect the effectiveness with which personnel
have effectively managed the risk of movements in the price of
retained principal positions and risks, a market maker that provides
compensation incentives relating to revenues generally does so
through incentives that primarily reward customer revenues and
effective customer service.

B. Overview of Prohibited Proprietary Trading Activities

    Like permitted market making-related activities, prohibited
proprietary trading involves the taking of principal positions by a
covered banking entity. Unlike permitted market making-related
activities, the purpose of prohibited proprietary trading is to
generate profits as a result of, or otherwise benefit from, changes
in the price of positions and risks taken. Whereas a market maker
attempts to eliminate some or all of the price risks inherent in its
retained principal positions and risks by hedging or otherwise
managing those risks in a reasonable period of time after positions
are acquired or risks arise, a proprietary trader seeks to
capitalize on those risks, and generally only hedges or manages a
portion of those risks when doing so would improve the potential
profitability of the risk it retains. A proprietary trader does not
have ``customers'' because a proprietary trader simply seeks to
obtain the best price and execution in purchasing or selling its
proprietary positions. A proprietary trader generates few if any
fees, commissions, or spreads from its trading activities because it
is not providing an intermediation service to any customer or other
third party. Instead, a proprietary trader is likely to pay fees,
commissions, or spreads to other market makers when obtaining their
liquidity services is beneficial to execution of its trading
strategy. Because a proprietary trader seeks to generate profits
from changes in the price of positions taken, a proprietary trader
typically provides compensation incentives to its personnel that
primarily reward successful proprietary risk taking.

C. Distinguishing Permitted Market Making-Related Activities From
Prohibited Proprietary Trading

    Because both permitted market making-related activities and
prohibited proprietary trading involve the taking of principal
positions, certain challenges arise in distinguishing permitted
market making-related activities and prohibited proprietary trading,
particularly in cases where both of these activities occur in the
context of a market making operation. Particularly during periods of
significant market disruption, it may be difficult to distinguish
between retained principal positions and risks that appropriately
support market making-related activities and positions taken, or
positions or risks not hedged, for proprietary purposes.
    In connection with these challenges, [Agency] will apply the
following factors in distinguishing permitted market making-related
activities from trading activities that, even if conducted in the
context of the covered banking entity's market making operations,
would constitute prohibited proprietary trading. The particular
types of trading activity described in this appendix may involve the
aggregate trading activities of a single trading unit, a significant
number or series of transactions occurring at one or more trading
units, or a single significant transaction, among other potential
scenarios. In addition to meeting the terms of this appendix, any
transaction or activity for which a covered banking entity intends
to rely on the market making exemption in Sec.  --.4(b) must also
satisfy all the requirements specified in Sec.  --.4(b), as well as
the other applicable requirements and conditions of this part.

1. Risk Management

    Absent explanatory facts and circumstances, particular trading
activity in which a trading unit retains risk in excess of the size
and type required to provide intermediation services to customers
will be considered to be prohibited proprietary trading, and not
permitted market making-related activity.
    [The Agency] will base a determination of whether a trading unit
retains risk in excess of the size and type required for these
purposes on all available facts and circumstances, including a
comparison of retained principal risk to: The amount of risk that is
generally required to execute a particular market making function;
hedging options that are available in the market and permissible
under the covered banking entity's hedging policy at the time the
particular trading activity occurred; the trading unit's prior
levels of retained risk and its hedging practices with respect to
similar

positions; and the levels of retained risk and the hedging practices
of other trading units with respect to similar positions.
    To help assess the extent to which a trading unit's risks are
potentially being retained in excess of amounts required to provide
intermediation services to customers, [Agency] will utilize the VaR
and Stress VaR, VaR Exceedance, and Risk Factor Sensitivities
quantitative measurements, as applicable, among other risk
measurements described in appendix A to this part and any other
relevant factor. This assessment will focus primarily on the risk
measurements relative to: The risk required for conducting market
making-related activities, and any significant changes in the risk
over time and across similarly situated trading units and banking
entities.
    Explanatory facts and circumstances might include, among other
things, market-wide changes in risk, changes in the specific
composition of market making-related activities, temporary market
disruptions, or other market changes that result in previously used
hedging or other risk management techniques no longer being possible
or cost-effective.

2. Source of Revenues

    Absent explanatory facts and circumstances, particular trading
activity in which a trading unit primarily generates revenues from
price movements of retained principal positions and risks, rather
than customer revenues, will be considered to be prohibited
proprietary trading, and not permitted market making-related
activity.
    [The Agency] will base a determination of whether a trading
activity primarily generates revenues from price movements of
retained principal positions and risks, rather than customer
revenues, on all available facts and circumstances, including: an
evaluation of the revenues derived from price movements of retained
principal positions and risks relative to its customer revenues; and
a comparison of these revenue figures to the trading unit's prior
revenues with respect to similar positions, and the revenues of
other covered banking entities' trading units with respect to
similar positions.
    To help assess the extent to which a trading unit's revenues are
potentially derived from movements in the price of retained
principal positions and risks, [Agency] will utilize the
Comprehensive Profit and Loss, Portfolio Profit and Loss, Fee Income
and Expense, and Spread Profit and Loss quantitative measurements,
as applicable, both individually and in combination with one another
(e.g., by comparing the ratio of Spread Profit and Loss to Portfolio
Profit and Loss), and any other relevant factor.
    Explanatory facts and circumstances might include, among other
things: general upward or downward price trends in the broader
markets in which the trading unit is making a market, provided
revenues from price movements in retained principal positions and
risks are consistent; sudden market disruptions or other changes
causing significant, unanticipated alterations in the price of
retained principal positions and risks; sudden and/or temporary
changes in the market (e.g., narrowing of bid/ask spreads) that
cause significant, unanticipated reductions in customer revenues; or
efforts to expand or contract a trading unit's market share.

3. Revenues Relative to Risk

    Absent explanatory facts and circumstances, particular trading
activity will be considered to be prohibited proprietary trading,
and not permitted market making-related activity, if the trading
unit: generates only very small or very large amounts of revenue per
unit of risk taken; does not demonstrate consistent profitability;
or demonstrates high earnings volatility.
    [The Agency] will base such a determination on all available
facts and circumstances, including: an evaluation of the amount of
revenue per unit of risk taken, earnings volatility, profitability,
exposure to risks, and overall level of risk taking for the
particular trading activities; and a comparison of these figures to
the trading unit's prior results with respect to similar positions,
and the results of other covered banking entities' trading units
with respect to similar positions.
    To help assess the riskiness of revenues and the amount of
revenue per unit of risk taken, [Agency] will utilize the Volatility
of Comprehensive Profit and Loss and Volatility of Portfolio Profit
and Loss, Comprehensive Profit and Loss to Volatility Ratio and
Portfolio Profit and Loss to Volatility Ratio, and Comprehensive
Profit and Loss Attribution quantitative measurements, as
applicable, and any other relevant factor.
    To help assess the extent to which a trading unit demonstrates
consistent profitability, [Agency] will utilize the Unprofitable
Trading Days Based on Comprehensive Profit and Loss and Unprofitable
Trading Days Based on Portfolio Profit and Loss quantitative
measurements, as applicable, and any other relevant factor.
    To help assess the extent to which a trading unit is exposed to
outsized risk, [Agency] will utilize the Skewness of Portfolio
Profit and Loss and Kurtosis of Profit and Loss quantitative
measurements, as applicable, and any other relevant factor.
    Explanatory facts and circumstances might include, among other
things: market disruptions or other changes causing significant,
unanticipated increases in a trading unit's risk with respect to
movements in the price of retained principal positions and risks;
market disruptions or other changes causing significant,
unanticipated increases in the volatility of positions in which the
trading unit makes a market; sudden and/or temporary changes in the
market (e.g., narrowing of bid-ask spreads) that cause significant,
unanticipated reductions in customer revenues and decrease overall
profitability; or efforts to expand or contract a trading unit's
market share.

4. Customer-Facing Activity

    Absent explanatory facts and circumstances, particular trading
activity will be considered to be prohibited proprietary trading,
and not permitted market making-related activity, if the trading
unit: does not transact through a trading system that interacts with
orders of others or primarily with customers of the banking entity's
market making desk to provide liquidity services; or retains
principal positions and risks in excess of reasonably expected near
term customer demands.
    [The Agency] will base such a determination on all available
facts and circumstances, including, among other things: An
evaluation of the extent to which a trading unit's transactions are
with customers versus non-customers and the frequency with which the
trading unit's retained principal positions and risks turn over; and
a comparison of these figures to the trading unit's prior results
with respect to similar positions and market situations, and the
results of other covered banking entities' trading units with
respect to similar positions.
    To help assess the extent to which a trading unit's transactions
are with customers versus non-customers, [Agency] will utilize the
Customer-Facing Trade Ratio quantitative measurement, as applicable,
and any other relevant factor. To help assess the frequency with
which the trading unit's retained principal positions and risks turn
over, [Agency] will utilize the Inventory Risk Turnover and
Inventory Aging quantitative measurements, as applicable, and any
other relevant factor.
    With respect to a particular trading activity in which a trading
unit either does not transact through a trading system that
interacts with orders of others or primarily with customers of the
banking entity's market making desk to provide liquidity services,
explanatory facts and circumstances might include, among other
things: sudden market disruptions or other changes causing
significant increases in a trading unit's hedging transactions with
non-customers; or substantial intermediary trading required to
satisfy customer demands and hedging management. With respect to
particular trading activity in which a trading unit retains
principal positions and risks in excess of reasonably expected near
term customer demands, explanatory facts and circumstances might
include, among other things: sudden market disruptions or other
changes causing a significant reduction in actual customer demand
relative to expected customer demand; documented and reasonable
expectations for temporary increases in customer demand in the near
term; and sudden market disruptions or other changes causing a
significant reduction in the value of retained principal positions
and risks, such that it would be imprudent for the trading unit to
dispose of the positions in the near term.

5. Payment of Fees, Commissions, and Spreads

    Absent explanatory facts and circumstances, particular trading
activity in which a trading unit routinely pays rather than earns
fees, commissions, or spreads will be considered to be prohibited
proprietary trading, and not permitted market making-related
activity.
    [The Agency] will base such a determination on all available
facts and circumstances, including, among other things: An
evaluation of the frequency with which the trading unit pay fees,

commissions, or spreads and the relative amount of fees,
commissions, or spreads that is paid versus earned; and a comparison
of these figures to the trading unit's prior results with respect to
similar positions, and the results of other covered banking
entities' trading units with respect to similar positions.
    To help assess the extent to which a trading unit is paying
versus earning fees, commissions, and spreads, [Agency] will utilize
the Pay-to-Receive Spread Ratio quantitative measurement, as
applicable, and any other relevant factor.
    Explanatory facts and circumstances might include, among other
things, sudden market disruptions or other changes causing
significant, increases in a trading unit's hedging transactions with
non-customers for which it must pay fees, commissions, or spreads,
sudden, unanticipated customer demand for liquidity that requires
the trading unit itself to pay fees, commissions, or spreads to
other market makers for liquidity services to obtain the inventory
needed to meet that customer demand, or significant, unanticipated
reductions in fees, commissions, or spreads earned by the trading
unit. Explanatory facts and circumstances might also include a
trading unit's efforts to expand or contract its market share.

6. Compensation Incentives

    Absent explanatory facts and circumstances, the trading activity
of a trading unit that provides compensation incentives to employees
that primarily reward proprietary risk taking will be considered to
be prohibited proprietary trading, and not permitted market making-
related activity.
    [The Agency] will base such a determination on all available
facts and circumstances, including, among other things, an
evaluation of: the extent to which compensation incentives are
provided to trading unit personnel that reward revenues from
movements in the price of retained principal positions and risks;
the extent to which compensation incentives are provided to trading
unit personnel that reward customer revenues; and the compensation
incentives provided by other covered banking entities to similarly-
situated personnel.
* * * * *

Appendix C: Minimum Standards for Programmatic Compliance

I. Overview

A. Purpose

    This appendix sets forth the minimum standards with respect to
the establishment, maintenance, and enforcement by banking entities
of internal compliance programs for ensuring and monitoring
compliance with the prohibitions and restrictions on proprietary
trading and covered fund activities or investments set forth in
section 13 of the BHC Act and this part.
    This appendix requires that banking entities establish,
maintain, and enforce an effective compliance program, consisting of
written policies and procedures, internal controls, a management
framework, independent testing, training, and recordkeeping, that:
     Is reasonably designed to clearly document, describe,
and monitor the covered trading and covered fund activities or
investments and the risks of the covered banking entity related to
such activities or investments, identify potential areas of
noncompliance, and prevent activities or investments prohibited by,
or that do not comply with, section 13 of the BHC Act and this part;
     Specifically addresses the varying nature of activities
or investments conducted by different units of the covered banking
entity's organization, including the size, scope, complexity, and
risks of the individual activities or investments;
     Subjects the effectiveness of the compliance program to
independent review and testing;
     Makes senior management and intermediate managers
accountable for the effective implementation of the compliance
program, and ensures that the board of directors and CEO review the
effectiveness of the compliance program; and
     Facilitates supervision and examination of the covered
banking entity's covered trading and covered fund activities or
investments by the Agencies.

B. Definitions

    The terms used in this Appendix have the same meanings as set
forth in Sec. Sec.  --.2, --.3, and --.10. In addition, for purposes
of this appendix, the following definitions apply:
    Asset management unit means any unit of organization of a
covered banking entity that makes investments in, or acts as sponsor
to, covered funds, or has relationships with covered funds, that the
covered banking entity (or an affiliate of subsidiary thereof) has
sponsored, organized and offered, or in which a covered fund
sponsored or advised by the covered banking entity invests.
    Compliance program means the internal compliance program
established by a covered banking entity in accordance with Sec.
--.20 and this appendix.
    Covered fund activity or investment means sponsoring any covered
fund or making investments in, or otherwise having relationships
with, any covered fund for which the covered banking entity (or an
affiliate or subsidiary thereof) acts as sponsor or organizes and
offers.
    Covered fund restrictions means the restrictions on covered fund
activities or investments set forth in subpart C.
    Covered trading activity means proprietary trading, as defined
in Sec.  --.3(b)(1).
    Trading unit means each of the following units of organization
of a covered banking entity:
    (i) Each discrete unit that is engaged in the coordinated
implementation of a revenue-generation strategy and that
participates in the execution of any covered trading activity; \1\
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    \1\ [The Agency] expects that this will generally be the
smallest unit of organization used by the covered banking entity to
structure and control its risk-taking activities and employees, and
will include each unit generally understood to be a single ``trading
desk.''
---------------------------------------------------------------------------

    (ii) Each organizational unit that is used to structure and
control the aggregate risk-taking activities and employees of one or
more trading units described in paragraph (i); \2\
---------------------------------------------------------------------------

    \2\ [The Agency] expects that this will generally include
management or reporting divisions, groups, sub-groups, or other
intermediate units of organization used by the covered banking
entity to manage one or more discrete trading units (e.g., ``North
American Credit Trading,'' ``Global Credit Trading,'' etc.).
---------------------------------------------------------------------------

    (iii) All trading operations, collectively; and
    (iv) Any other unit of organization specified by [Agency] with
respect to a particular banking entity.

C. Required Elements

    Section --.20 requires that covered banking entities establish,
maintain, and enforce a compliance program reasonably designed to
ensure and monitor compliance with the prohibitions and restrictions
on proprietary trading and covered fund activities or investments
that effectively implements, at a minimum, the six elements required
under paragraph (b) of Sec.  --.20.

D. Compliance Program Structure

    Each covered banking entity subject to Sec.  --.20(c) must be
governed by a compliance program meeting the requirements of this
appendix. A covered banking entity may establish a compliance
program on an enterprise-wide basis to satisfy the requirements of
Sec.  --.20 and this appendix with respect to the covered banking
entity and all of its affiliates and subsidiaries collectively,
provided that: the program is clearly applicable, both by its terms
and in operation, to all such affiliates and subsidiaries; the
program specifically addresses the requirements set forth in this
appendix; the program takes into account and addresses the
consolidated organization's business structure, size, and
complexity, as well as the particular activities, risks, and
applicable legal requirements of each subsidiary and affiliate; and
the program is determined through periodic independent testing to be
effective for the covered banking entity and all of its subsidiaries
and affiliates. An enterprise-wide program established pursuant to
this Appendix will be subject to supervisory review and examination
by any Agency vested with rulewriting authority under section 13 of
the BHC Act with respect to the compliance program and the
activities or investments of any banking entity for which the Agency
has such authority. Further, such Agency will have access to all
records related to the enterprise-wide compliance program pertaining
to any banking entity that is supervised by the Agency vested with
such rulewriting authority.

E. Applicability

    This appendix applies only to covered banking entities described
in Sec.  --.20(c)(2). In addition, [Agency] may require any covered
banking entity to comply with all or portions of this appendix if
[Agency] deems it appropriate for purposes the covered banking
entity's compliance with this part.

    Nothing in this appendix limits the authority of [Agency] under
any other provision of law or regulation to take supervisory,
examination, or enforcement action, including action to address
unsafe or unsound practices or conditions, deficient capital levels,
or violations of law.

II. Internal Policies and Procedures

A. Covered Trading Activities

    A covered banking entity must establish, maintain, and enforce
written policies and procedures reasonably designed to document,
describe, and monitor the covered banking entity's covered trading
activities and the risks taken in these activities, as follows:\3\
---------------------------------------------------------------------------

    \3\ These policies and procedures must be updated with a
frequency sufficient for the covered banking entity to adequately
control the applicable trading unit for purposes of this part.
---------------------------------------------------------------------------

    Identification of trading account: The covered banking entity's
policies and procedures must specify how the banking entity
evaluates the covered financial positions it acquires or takes and
determines which of its accounts are trading accounts for purposes
of subpart B of this part.
    Identification of trading units and organization structure: The
covered banking entity's written policies and procedures must
identify and document each trading unit within the organization and
map each trading unit to the division, business line, or other
organizational structure that the covered banking entity uses to
manage or oversee the trading unit's activities.
    Description of missions and strategies: The covered banking
entity's written policies and procedures for each trading unit must
clearly articulate and document a comprehensive description of the
mission (i.e., the nature of the business conducted) and strategy
(i.e., business model for the generation of revenues) of the trading
unit, and include a description of:
     How revenues are intended to be generated by the
trading unit;
     The activities that the trading unit is authorized to
conduct, including (i) authorized instruments and products and (ii)
authorized hedging strategies and instruments;
     The expected holding period of, and the market risk
associated with, covered financial positions in its trading account;
     The types of clients, customers, and counterparties
with whom trading is conducted by the trading unit;
     How the trading unit, if engaged in market making-
related activity under Sec.  --.4(b) of this part, identifies its
customers for purposes of computing the Customer-Facing Trade Ratio,
if applicable, including documentation explaining when, how, and why
a broker-dealer, swap dealer, security-based swap dealer, any other
entity engaged in market making-related activities, or any affiliate
thereof is considered to be a customer of the trading unit for those
purposes; and
     The compensation structure of the employees associated
with the trading unit.
    Trader mandates: The covered banking entity must establish,
maintain, document, and enforce trader mandates for each trading
unit. At a minimum, trader mandates must:
     Clearly inform each trader of the prohibitions and
requirements set forth in section 13 of the BHC Act and this part
and his or her responsibilities for compliance with such
requirements;
     Set forth appropriate parameters for each trader
engaged in covered trading activities, including:
    [cir] The conditions for relying on the applicable exemptions in
Sec. Sec.  --.4 through --.6;
    [cir] The financial contracts, products, and underlying assets
that the trader is permitted to trade pursuant to the covered
banking entity's internal controls;
    [cir] The risk limits of the trader's trading unit, and the
types and levels of risk that may be taken; and
    [cir] The applicable trading unit's hedging policy.
    Description of risks and risk management processes: The written
policies and procedures for each trading unit must clearly
articulate and document a comprehensive description of the risks
associated with the trading unit. Such descriptions must include, at
a minimum, the following elements:
     A description of the supervisory and risk management
structure governing the trading units, including a description of
processes for initial and senior-level review of new products and
new strategies;
     A description of the types of risks that may be taken
to implement the mission and strategy of the trading unit, including
an enumeration of material risks resulting from the activities in
which the trading unit is engaged (including but not limited to all
significant price risks, such as basis, volatility and correlation
risks, as well as any significant counterparty credit risk
associated with the trading activity);
     An articulation of the amount of risk allocated by the
covered banking entity to such trading unit to implement the
documented mission and strategy of the trading unit;
     An explanation of how the risks allocated to such
trading unit will be measured; and
     An explanation of why the allocated risk levels are
appropriate to the mission and strategy of the trading unit.
    Hedging policies and procedures. The covered banking entity must
establish, maintain, and enforce policies and procedures for all of
its trading units regarding the use of risk-mitigating hedging
instruments and strategies. At a minimum, these hedging policies and
procedures must articulate the following:
     The manner in which the covered banking entity will
determine that the risks generated by each trading unit have been
properly and effectively hedged;
     The instruments, techniques and strategies the covered
entity will use to hedge the risk of the positions or portfolios;
     The level of the organization at which hedging activity
and management will occur;
     The manner in which hedging strategies will be
monitored;
     The risk management processes used to control unhedged
or residual risks; and
     The independent testing of hedging techniques and
strategies.
    Explanation of compliance. The covered banking entity's written
policies and procedures must clearly articulate and document a
comprehensive explanation of how the mission and strategy of each
trading unit, and its related risk levels, comply with this part.
Such explanation must:
     Identify which portions of the risk-taking activity of
the trading unit would or would not constitute covered trading
activity;
     Identify activities of the trading unit that will be
conducted in reliance on exemptions contained in Sec. Sec.  --.4
through --.6, including an explanation of:
    o How and where the activity occurs; and
    o Which exemption is being relied on and how the activity meets
the specific requirements for reliance on the applicable exemption.
     Describe how the covered banking entity monitors for
and prohibits potential or actual material exposure to high-risk
assets or high-risk trading strategies presented by each trading
unit, which must take into account potential or actual exposure to:
    [cir] Assets whose values cannot be externally priced or, where
valuation is reliant on pricing models, whose model inputs cannot be
externally validated;
    [cir] Assets whose changes in values cannot be adequately
mitigated by effective hedging;
    [cir] New products with rapid growth, including those that do
not have a market history;
    [cir] Assets or strategies that include significant embedded
leverage;
    [cir] Assets or strategies that have demonstrated significant
historical volatility;
    [cir] Assets or strategies for which the application of capital
and liquidity standards would not adequately account for the risk;
and
    [cir] Assets or strategies that result in large and significant
concentrations to sectors, risk factors, or counterparties;
     Explain how each trading unit will comply with the
reporting and recordkeeping requirements of Sec.  --.7 and Appendix
A ;
     Describe how the covered banking entity monitors for
and prohibits potential or actual material conflicts of interest
between the covered banking entity and its clients, customers, or
counterparties present in each trading unit; and
     Describe how the covered banking entity monitors for
and prohibits potential or actual transactions or activities that
may threaten the safety and soundness of the covered banking entity.
    Remediation of violations. The covered banking entity's written
policies and procedures must require the covered banking entity to
promptly document, address and remedy any violation of section 13 of
the BHC Act or this part, and document all proposed and actual
remediation efforts. Further, such policies and procedures must
include specific procedures that are reasonably designed to
implement and monitor any required remediation and that assess the
extent to which any violation indicates that modification to the
covered banking entity's compliance program is warranted.

    With respect to any trading unit that is either used by the
covered banking entity to structure and control the aggregate risk-
taking activities and employees of one or more other trading units,
or comprised of the entire trading operation of the covered banking
entity, the description of missions and strategies, description of
risks and risk management processes, and explanation of compliance
for such trading units may incorporate by reference the policies and
procedures of the underlying trading units that the trading unit
oversees and manages in the aggregate.

B. Covered Fund Activities or Investments

    A covered banking entity must establish, maintain, and enforce
written policies and procedures that are reasonably designed to
document, describe, and monitor the covered banking entity's covered
fund activities or investments and the risks taken in these
activities or investments, as follows.
    Identification of covered funds: The covered banking entity's
policies and procedures must specify how the covered banking entity
identifies covered funds that the covered banking entity sponsors,
organizes and offers, or in which covered banking entity invests.
    Identification of asset management units and organization
structure: The covered banking entity's written policies and
procedures must identify and document each asset management unit
within the organization and map each asset management unit to the
division, business line, or other organizational structure that the
covered banking entity uses to manage or oversee the asset
management unit's activities or investments.
    Description of sponsorship activities related to covered funds:
The covered banking entity's written policies and procedures for
each asset management unit must clearly articulate and document a
comprehensive description of the mission (i.e., the nature of the
business conducted) and strategy (i.e., business model for the
generation of revenues) of the asset management unit related to its
sponsorship or organizing and offering of covered funds, including a
description of how such activities comply with this part and, in
particular:
     The activities that the asset management unit is
authorized to conduct, including the nature of any trust, fiduciary,
investment advisory, or commodity trading advisory services offered
to customers of the covered banking entity;
     The types of customers to whom the asset management
unit provides such services and to whom ownership interests in
covered funds are sold;
     The extent of any co-investment activities of the
covered banking entity (including its directors or employees) in
covered funds offered to such customers; and
     How the asset management unit complies with the
requirements of subpart C of this part.
    Description of investment activities of covered funds: The
covered banking entity's written policies and procedures for each
asset management unit must clearly articulate and document a
comprehensive description of the mission (i.e., the nature of the
business conducted) and strategy (i.e., business model for the
generation of revenues) of the asset management unit related to its
investments in covered funds, including a description of how such
activities comply with this part and, in particular:
     The asset management unit's practices with respect to
seed capital investments in covered funds, including how the asset
management unit reduces its investments in covered funds to amounts
that are permitted de minimis investments within the required period
of time;
     The asset management unit's practices with respect to
co-investments in covered funds, including certain parallel
investments as identified in Sec.  --.12;
     How the asset management unit complies with the
requirements of Sec.  --.12 with respect to individual and aggregate
investments in covered funds;
     With respect to other permitted covered fund activities
or investment, how the asset management unit complies with the
requirements of Sec. Sec.  --.13 and --.14;
     How the asset management unit complies with the
limitations on relationships with a covered fund under Sec.  --.16;
     How the covered banking entity monitors for and
prohibits potential or actual material conflicts of interest between
the covered banking entity and its clients, customers, or
counterparties related to the asset management unit;
     How the covered banking entity monitors for and
prohibits potential or actual transactions or activities that may
threaten the safety and soundness of the covered banking entity
related to the asset management unit; and
     How the covered banking entity monitors for and
prohibits potential or actual material exposure to high-risk assets
or high-risk trading strategies presented by each asset management
unit.
    Remediation of violations. The covered banking entity's written
policies and procedures must require the covered banking entity to
promptly document, address and remedy any violation of section 13 of
the BHC Act or this part, and document all proposed and actual
remediation efforts. Further, such policies and procedures must
include specific procedures that are designed to implement, monitor,
and enforce any required remediation and that assess the extent to
which any violation indicates that modification to the covered
banking entity's compliance program is warranted.

III. Internal Controls

A. Covered Trading Activities

    A covered banking entity must establish, maintain, and enforce
written internal controls that are reasonably designed to ensure
that the trading activity of each trading unit is appropriate and
consistent with the description of mission, strategy, and risk
mitigation for each trading unit contained in its written policies
and procedures. These written internal controls must also be
reasonably designed and established to effectively monitor and
identify for further analysis any covered trading activity that may
indicate potential violations of section 13 of the BHC Act and this
part and to prevent actual violations of section 13 of the BHC Act
and this part. Further, the internal controls must describe
procedures for remedying violations of section 13 of the BHC Act and
this part. The written internal controls must include, at a minimum,
the following.
    Authorized risks, instruments, and products. The covered banking
entity must implement and enforce internal controls for each trading
unit that are reasonably designed to ensure that trading activity is
conducted in conformance with the trading unit's authorized risks,
instruments, and products, as documented in the covered banking
entity's written policies and procedures and trader mandates. At a
minimum, these internal controls must monitor and govern:
     The types and levels of risks that may be taken by each
trading unit, consistent with the covered banking entity's written
policies and procedures;
     The type of hedging instruments used, hedging
strategies employed, and the amount of risk effectively hedged,
consistent with the covered banking entity's written policies and
procedures; and
     The financial contracts, products and underlying assets
that the trading unit may trade, consistent with covered banking
entity's written policies and procedures.
    Risk limits. The covered banking entity must establish and
enforce risk limits appropriate for each trading unit, which shall
include limits based on probabilistic and non-probabilistic measures
of potential loss (e.g., Value-at-Risk and notional exposure,
respectively), measured under normal and stress market conditions.
    Analysis and quantitative measurements. The covered banking
entity must perform robust analysis and quantitative measurement of
its covered trading activities that is reasonably designed to ensure
that the trading activity of each trading unit is consistent with
its mission, strategy and risk management process, as documented in
the covered banking entity's written policies and procedures;
monitor and assist in the identification of potential and actual
prohibited proprietary trading activity; and prevent the occurrence
of prohibited proprietary trading. In addition to the quantitative
measurements reported by the covered banking entity to [Agency]
pursuant to appendix A to this part, each covered banking must
develop and implement, to the extent necessary to facilitate
compliance with this part, additional quantitative measurements
specifically tailored to the particular risks, practices, and
strategies of its trading units. The covered banking entity's
analysis and quantitative measurement must incorporate the
quantitative measurements reported by the covered banking entity to
[Agency] pursuant to Appendix A and include, at minimum, the
following:
     Internal controls and written policies and procedures
reasonably designed to ensure the accuracy and integrity of
quantitative measurements;

     Ongoing, timely monitoring and review of calculated
quantitative measurements;
     Heightened review of a quantitative measurement when
such quantitative measurement raises any question regarding
compliance with section 13 of the BHC Act and this part, which shall
include in-depth analysis, appropriate escalation procedures, and
documentation related to the review, including the establishment of
numerical thresholds for each trading unit for purposes of
triggering such heightened review; and
     Immediate review and compliance investigation of the
trading unit's activities, escalation to senior management with
oversight responsibilities for the applicable trading unit, timely
notification to [Agency], appropriate remedial action (e.g.,
divesting of impermissible positions, cessation of impermissible
activity, disciplinary actions), and documentation of the
investigation findings and remedial action taken when the
quantitative measurement, considered together with the facts and
circumstances, suggests a reasonable likelihood that the trading
unit has violated any part of section 13 of the BHC Act and this
part.
    Surveillance of compliance program effectiveness. The covered
banking entity must regularly monitor the effectiveness of its
compliance program and take prompt action to address and remedy any
deficiencies identified. Any actions taken to remedy deficiencies
and violations shall be documented and maintained as a record of the
banking entity.

B. Covered Fund Activities

    A covered banking entity must establish, maintain, and enforce
internal controls that are reasonably designed to ensure that the
covered fund activities or investments of its asset management units
are appropriate and consistent with the description of the asset
management unit's mission, strategy, and risk management process
contained in the covered banking entity's written policies and
procedures. The internal controls must, at a minimum, be designed to
ensure that the covered banking entity complies with the
requirements of Sec.  --.11 for any covered fund in which it
invests, acts as sponsor, or organizes and offers, as well as the
following:
    Monitoring investments in a covered fund. The covered banking
entity must implement and enforce internal controls in a way that
monitors and limits the covered banking entity's individual and
aggregate investments in covered funds. At a minimum, the covered
banking entity shall establish, maintain, and enforce internal
controls reasonably designed to ensure that such investments are in
compliance with section 13 of the BHC Act and this part at all
times, including:
     Monitoring the amount and timing of seed capital
investments for compliance with the limitations (including but not
limited to the redemption, sale or disposition requirements of Sec.
--.12);
     Calculating the individual and aggregate levels of
ownership interests in covered funds required by Sec.  --.12;
     Describing procedures for remedying violations of
section 13 of the BHC Act and this part;
     Attributing the appropriate instruments to the
individual and aggregate ownership interest calculations above; and
     Making the appropriate required disclosures, in
writing, to prospective and actual investors in any covered fund
organized and offered or sponsored by the covered banking entity, as
provided under Sec.  --.11(h).
    Monitoring relationships with a covered fund. The covered
banking entity must implement and enforce internal controls in a way
that monitors and limits the covered banking entity's sponsorship
of, and relationships with, covered funds. At a minimum, the covered
banking entity shall establish, maintain, and enforce internal
controls reasonably designed to ensure that such activities and
relationships are in compliance with section 13 of the BHC Act and
this part at all times, including monitoring for and preventing any
relationship or transaction between the covered banking entity and a
covered fund that is prohibited under Sec.  --.16.
    Surveillance of compliance program effectiveness. The covered
banking entity must regularly monitor the effectiveness of its
compliance program and take prompt action to address and remedy any
deficiencies identified. Any actions taken to remedy deficiencies
and violations shall be documented and maintained as a record of the
covered banking entity.

IV. Responsibility and Accountability for the Compliance Program

    A covered banking entity must establish, maintain, and enforce a
management framework to manage its business and employees with a
view to preventing violations of section 13 of the BHC Act and this
part. A covered banking entity must have an appropriate management
framework reasonably designed to ensure that: appropriate personnel
are made responsible and accountable for the effective
implementation and enforcement of the compliance program; a clear
reporting line with a chain of responsibility is delineated; and the
board of directors, or similar corporate body, and CEO reviews and
approves the compliance program. This management framework must
include, at a minimum:
    Corporate governance. The covered banking entity must ensure
that its compliance program is reduced to writing, approved by the
board of directors or similar corporate body, and noted in the
minutes.
    Trader mandates. The covered banking entity must establish,
maintain, and enforce the trader mandates required by this appendix
to clearly inform each trader within a trading unit of his or her
responsibilities for compliance with section 13 of the BHC Act and
this part.
    Management procedures. The covered banking entity must
establish, maintain, and enforce management procedures that are
reasonably designed to achieve compliance with section 13 of the BHC
Act and this part, which, at a minimum, provide for:
     The designation of at least one person with authority
to carry out the management responsibilities of the covered banking
entity for each trading unit;
     Written procedures addressing the management of the
activities of the covered banking entity that are reasonably
designed to achieve compliance with section 13 of the BHC Act and
this part, including:
    [cir] Procedures for the review by a manager of activities of
the trading unit and the quantitative measurements pursuant to
appendix A and any other quantitative measurements developed and
tailored to the particular risks, practices, and strategies of the
covered banking entity's trading units;
    [cir] A description of the management system, including the
titles, qualifications, and locations of managers and the specific
responsibilities of each person with respect to the covered banking
entity's trading units; and
    [cir] Procedures for determining compensation arrangements for
traders engaged in underwriting or market making-related activities
under Sec.  --.4 or risk-mitigating hedging activities under Sec.
--.5 so that such compensation arrangements are designed not to
reward proprietary risk taking.
    Business line managers. Managers with responsibility for one or
more trading units or asset management units of the covered banking
entity engaged in covered trading activities or covered fund
activities or investments are accountable for the effective
implementation and enforcement of the compliance program with
respect to the applicable trading unit or asset management unit.
    Senior management. Senior management is responsible for
communicating and reinforcing the culture of compliance with section
13 of the BHC Act and this part, as established by the board of
directors or similar corporate body, and implementing and enforcing
the approved compliance program. Senior management must also ensure
that effective corrective action is taken when failures in
compliance with section 13 of the BHC Act and this part are
identified.\4\ Senior management and control personnel charged with
overseeing compliance with section 13 of the BHC Act and this part
should report to the board, or an appropriate committee thereof, on
the effectiveness of the compliance program and compliance matters
with a frequency appropriate to the size, scope, and risk profile of
the covered banking entity's covered trading activities and covered
fund activities or investments, which shall be at least once every
twelve months.
---------------------------------------------------------------------------

    \4\ Such corrective action may include, among other things
divesture of the position, cessation of the activity, or
disciplinary measures.
---------------------------------------------------------------------------

    Board of directors, or similar corporate body, and CEO. The
board of directors, or similar corporate body, and CEO are
responsible for setting an appropriate culture of compliance with
this part and establishing clear policies regarding the management
of covered trading activities and covered fund activities or
investments in compliance with section 13 of the BHC Act and this
part. The board of directors or similar corporate body must ensure
that senior management is fully capable, qualified, and properly
motivated to manage compliance with this part in light of

the organization's business activities. The board of directors or
similar corporate body must also ensure that senior management has
established appropriate incentives to support compliance with this
part, including the implementation of a compliance program meeting
the requirements of this appendix into management goals and
compensation structures across the covered banking entity.

V. Independent Testing

    A covered banking entity must ensure that independent testing is
conducted by a qualified independent party, such as the covered
banking entity's internal audit department, outside auditors,
consultants, or other qualified independent parties, regarding the
effectiveness of the covered banking entity's compliance program
established pursuant to this appendix and Sec.  --.20 and the
covered banking entity's compliance with this part. A banking entity
must take appropriate action to remedy any concerns identified by
the independent testing (e.g., remedying deficiencies in its written
policies and procedures and internal controls, etc.).
    The required independent testing must occur with a frequency
appropriate to the size, scope, and risk profile of the covered
banking entity's covered trading and covered fund activities or
investments, which shall be no less than once every twelve months.
This independent testing must include an evaluation of:
     The overall adequacy and effectiveness of the covered
banking entity's compliance program, including an analysis of the
extent to which the program contains all the required elements of
this appendix;
     The effectiveness of the covered banking entity's
written policies and procedures;
     The effectiveness of the covered banking entity's
internal controls, including an analysis and documentation of
instances in which such internal controls have been breached, and
how such breaches were addressed and resolved; and
     The effectiveness of the covered banking entity's
management procedures.

VI. Training

    Covered banking entities must provide adequate training to
trading personnel and managers of the covered banking entity, as
well as other appropriate personnel, as determined by the covered
banking entity, in order to effectively implement and enforce the
compliance program. This training should occur with a frequency
appropriate to the size and the risk profile of the covered banking
entity's covered trading activities and covered fund activities or
investments. The training may be conducted by internal personnel or
independent parties deemed appropriate by the covered banking entity
based on its size and risk profile.

VII. Recordkeeping

    Covered banking entities must create and retain records
sufficient to demonstrate compliance and support the operations and
effectiveness of the compliance program. A covered banking entity
must retain these records for a period that is no less than 5 years
in a form that allows it to promptly produce such records to
[Agency] on request.

END OF COMMON RULE

[END OF COMMON TEXT]

Adoption of the Common Rule Text

    The proposed adoption of the common rules by the agencies, as
modified by agency-specific text, is set forth below:

DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Chapter I

List of Subjects in 12 CFR Part 44

    Banks, Banking, Compensation, Credit, Derivatives, Government
securities, Insurance, Investments, National banks, Penalties,
Reporting and recordkeeping requirements, Risk, Risk retention,
Securities, Trusts and trustees.

Authority and Issuance

    For the reasons stated in the Common Preamble, the Office of the
Comptroller of the Currency proposes to amend chapter I of Title 12,
Code of Federal Regulations as follows:

PART 44--PROPRIETARY TRADING AND CERTAIN INTEREST IN AND
RELATIONSHIPS WITH COVERED FUNDS

    1. The authority citation for part 44 is added to read as follows:

    Authority: 7 U.S.C. 27 et seq., 12 U.S.C. 1, 24, 92a, 93a, 161,
1461, 1462a, 1463, 1464, 1813(q), 1818, 1851, 3101 3102, 3108, 5412.

    2. Part 44 is added as set forth at the end of the Common Preamble.
    3. Part 44 is amended by
    a. Removing ``[Agency]'' wherever it appears and adding in its
place ``the OCC''; and
    b. Removing ``[The Agency]'' wherever it appears and adding in its
place ``The OCC''.
    4. Section 44.1 is added to read as follows:

Sec.  44.1  Authority, purpose, and scope.

    (a) Authority. This part is issued by [Agency] under section 13 of
the Bank Holding Company Act of 1956, as amended (12 U.S.C. 1851).
    (b) Purpose. Section 13 of the Bank Holding Company Act establishes
prohibitions and restrictions on proprietary trading and investments in
or relationships with covered funds by certain banking entities,
including national banks, Federal branches and agencies of foreign
banks, Federal savings associations, and certain subsidiaries thereof.
This part implements section 13 of the Bank Holding Company Act by
defining terms used in the statute and related terms, establishing
prohibitions and restrictions on proprietary trading and investments in
or relationships with covered funds, and explaining the statute's
requirements.
    (c) Scope. This part implements section 13 of the Bank Holding
Company Act with respect to covered banking entities described in Sec.
44.2(j). This part takes effect on July 21, 2012.
    (d) Relationship to other authorities. Except as otherwise provided
under section 13 of the Bank Holding Company Act, and notwithstanding
any other provision of law, the prohibitions and restrictions under
section 13 of Bank Holding Company Act shall apply to the activities of
a covered banking entity, even if such activities are authorized for a
covered banking entity under other applicable provisions of law.
    (e) Preservation of authority. Nothing in this part limits in any
way the authority of the OCC to impose penalties for violation of this
part by any covered banking entity provided under any other applicable
statute.
    5. Paragraph (j) of Sec.  44.2 is added to read as follows:

Sec.  44.2  Definitions.

* * * * *
    (j) Covered banking entity means any banking entity that is:
    (1) A national bank;
    (2) A Federal branch or agency of a foreign bank;
    (3) A Federal savings association or a Federal savings bank; and
    (4) Any subsidiary of a company described in paragraph (j)(1)
through (3) of this section, other than a subsidiary for which the CFTC
or SEC is the primary financial regulatory agency as defined in section
2(12) of the Dodd-Frank Wall Street Reform and Consumer Protection Act
(12 U.S.C. 5301(12)).
* * * * *

BOARD OF GOVERNORS OF THE FEDERAL RESERVE

12 CFR Chapter II

List of Subjects in 12 CFR Part 248

    Administrative practice and procedure, Banks and banking, Capital,
Compensation, Conflict of interests, Credit, Derivatives, Foreign
banking, Government securities, Holding companies, Insurance, Insurance
companies, Investments, Penalties, Reporting and recordkeeping
requirements, Risk, Risk retention, Securities, Trusts and trustees.

Authority and Issuance

    For the reasons set forth in the Supplementary Information, the
Board of Governors of the Federal Reserve System proposes to add the
text of the common rule as set forth at the end of the Supplementary
Information as Part 248 to 12 CFR Chapter II as follows:

PART 248--PROPRIETARY TRADING AND RELATIONSHIPS WITH COVERED FUNDS
(REGULATION VV)

    6. The authority citation for part 248 is added to read as follows:

    Authority:  12 U.S.C. 1851, 12 U.S.C. 221 et seq., 12 U.S.C.
1818, 12 U.S.C. 1841 et seq., and 12 U.S.C. 3103 et seq.

    7. Part 248 is added as set forth at the end of the Common
Preamble.
    8. Part 248 is amended by:
    A. Removing ``[Agency]'' wherever it appears and adding in its
place ``the Board''; and
    B. Removing ``[The Agency]'' wherever it appears and adding in its
place ``The Board''.
    9. Section 248.1 is added to read as follows:

Sec.  248.1  Authority, purpose, scope, and relationship to other
authorities.

    (a) Authority. This part \1\ (Regulation VV) is issued by the Board
under section 13 of the Bank Holding Company Act of 1956, as amended
(12 U.S.C. 1851), as well as under the Federal Reserve Act, as amended
(12 U.S.C. 221 et seq.); section 8 of the Federal Deposit Insurance
Act, as amended (12 U.S.C. 1818); the Bank Holding Company Act of 1956,
as amended (12 U.S.C. 1841 et seq.); and the International Banking Act
of 1978, as amended (12 U.S.C. 3101 et seq.).
---------------------------------------------------------------------------

    \1\ Code of Federal Regulations, title 12, chapter II, part 248.
---------------------------------------------------------------------------

    (b) Purpose. Section 13 of the Bank Holding Company Act establishes
prohibitions and restrictions on proprietary trading and investments in
or relationships with covered funds by certain banking entities,
including state members banks, bank holding companies, savings and loan
holding companies, other companies that control an insured depository,
foreign banking organizations, and certain subsidiaries thereof. This
part implements section 13 of the Bank Holding Company Act by defining
terms used in the statute and related terms, establishing prohibitions
and restrictions on proprietary trading and investments in or
relationships with covered funds, and explaining the statute's
requirements.
    (c) Scope. This part implements section 13 of the Bank Holding
Company Act with respect to covered banking entities described in Sec.
248.2(j). This part takes effect on July 21, 2012.
    (d) Relationship to other authorities. Except as otherwise provided
in under section 13 of the Bank Holding Company Act, and
notwithstanding any other provision of law, the prohibitions and
restrictions under section 13 of Bank Holding Company Act shall apply
to the activities of a covered banking entity, even if such activities
are authorized for a covered banking entity under other applicable
provisions of law.
    10. In Sec.  248.2, paragraph (c) is revised, and paragraph (j) is
added to read as follows:

Sec.  248.2  Definitions.

* * * * *
    (c) Nothing in this part limits in any way the authority of the
Board, under the BHC Act (including section 8 of such Act) and other
provisions of law, to impose penalties for violation by any company or
individual.
* * * * *
    (j) Covered banking entity means any banking entity that is:
    (1) A state member bank (as defined in 12 CFR 208.2(g));
    (2) A bank holding company;
    (3) A savings and loan holding company (as defined in 12 U.S.C.
1467a);
    (4) A foreign banking organization (as defined in 12 CFR
211.21(o));
    (5) Any company that controls an insured depository institution;
and
    (6) Any subsidiary of a company described in paragraph (j)(1)
through (5) of this section, other than a subsidiary for which the OCC,
FDIC, CFTC, or SEC is the primary financial regulatory agency (as
defined in section 2(12) of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (12 U.S.C. 5301(12)).
    11-12. Add subpart E to read as follows:
Subpart E--Conformance Period and Extended Transition Period
Authorities
Sec.
248.30 Definitions.
248.31 Conformance periods for banking entities engaged in
prohibited proprietary trading or covered fund activities or
investments.
248.32 Conformance period for nonbank financial companies supervised
by the Board engaged in prohibited proprietary trading or covered
fund activities and investments.

Subpart E--Conformance Period and Extended Transition Period
Authorities

Sec.  248.30  Definitions.

    For purposes of this subpart:
    (a) Illiquid fund means a covered fund that:
    (1) As of May 1, 2010:
    (i) Was principally invested in illiquid assets; or
    (ii) Was invested in, and contractually committed to principally
invest in, illiquid assets; and
    (2) Makes all investments pursuant to, and consistent with, an
investment strategy to principally invest in illiquid assets.
    (b) Illiquid assets means any real property, security, obligation,
or other asset that:
    (1) Is not a liquid asset;
    (2) Because of statutory or regulatory restrictions applicable to
the covered fund or asset, cannot be offered, sold, or otherwise
transferred by covered fund to a person that is unaffiliated with the
relevant banking entity; or
    (3) Because of contractual restrictions applicable to the covered
fund or asset, cannot be offered, sold, or otherwise transferred by the
covered fund for a period of 3 years or more to a person that is
unaffiliated with the relevant banking entity.
    (c) Liquid asset means:
    (1) Cash or cash equivalents;
    (2) An asset that is traded on a recognized, established exchange,
trading facility or other market on which there exist independent, bona
fide offers to buy and sell so that a price reasonably related to the
last sales price or current bona fide competitive bid and offer
quotations can be determined for the particular asset almost
instantaneously;
    (3) An asset for which there are bona fide, competitive bid and
offer quotations in a recognized inter-dealer quotation system or
similar system or for which multiple dealers furnish bona fide,
competitive bid and offer quotations to other brokers and dealers on
request;
    (4) An asset the price of which is quoted routinely in a widely
disseminated publication that is readily available to the general
public or through an electronic service that provides indicative data
from real-time financial networks;
    (5) An asset with an initial term of one year or less and the
payments on which at maturity may be settled, closed-out, or paid in
cash or one or more other liquid assets described in paragraphs (c)(1),
(2), (3), or (4) of this section; and

    (6) Any other asset that the Board determines, based on all the
facts and circumstances, is a liquid asset.
    (d) Principally invested and related definitions.--A covered fund:
    (1) Is principally invested in illiquid assets if at least 75
percent of the fund's consolidated total assets are--
    (i) Illiquid assets; or
    (ii) Risk-mitigating hedges entered into in connection with and
related to individual or aggregated positions in, or holdings of,
illiquid assets;
    (2) Is contractually committed to principally invest in illiquid
assets if the fund's organizational documents, other documents that
constitute a contractual obligation of the fund, or written
representations contained in the fund's offering materials distributed
to potential investors provide for the fund to be principally invested
in assets described in paragraph (d)(1) of this section at all times
other than during temporary periods, such as the period prior to the
initial receipt of capital contributions from investors or the period
during which the fund's investments are being liquidated and capital
and profits are being returned to investors; and
    (3) Has an investment strategy to principally invest in illiquid
assets if the fund:
    (i) Markets or holds itself out to investors as intending to
principally invest in assets described in paragraph (d)(1) of this
section; or
    (ii) Has a documented investment policy of principally investing in
assets described in paragraph (d)(1) of this section.

Sec.  248.31  Conformance periods for banking entities engaged in
prohibited proprietary trading or covered fund activities or
investments.

    (a) Conformance Period. (1) In general.--Except as provided in
paragraph (a)(2) or (3) of this section, a banking entity shall bring
its activities and investments into compliance with the requirements of
section 13 of the BHC Act (12 U.S.C. 1851) and this part no later than
2 years after July 21, 2012.
    (2) New banking entities.--A company that was not a banking entity,
or a subsidiary or affiliate of a banking entity, as of July 21, 2010,
and becomes a banking entity, or a subsidiary or affiliate of a banking
entity, after that date shall bring its activities and investments into
compliance with the requirements of section 13 of the BHC Act (12
U.S.C. 1851) and this part before the later of:
    (i) The conformance date determined in accordance with paragraph
(a)(1) of this section; or
    (ii) 2 years after the date on which the company becomes a banking
entity or a subsidiary or affiliate of a banking entity.
    (3) Extended conformance period. The Board may extend the two-year
period under paragraph (a) (1) or (2) of this section by not more than
three separate one-year periods, if, in the judgment of the Board, each
such one-year extension is consistent with the purposes of section 13
of the BHC Act (12 U.S.C. 1851) and this part and would not be
detrimental to the public interest.
    (b) Illiquid funds. (1) Extended transition period. The Board may
further extend the period provided by paragraph (a) of this section
during which a banking entity may acquire or retain an ownership
interest in, or otherwise provide additional capital to, a covered fund
if:
    (i) The fund is an illiquid fund; and
    (ii) The acquisition or retention of such interest, or provision of
additional capital, is necessary to fulfill a contractual obligation of
the banking entity that was in effect on May 1, 2010.
    (2) Duration limited. The Board may grant a banking entity only one
extension under paragraph (b)(1) of this section and such extension:
    (i) May not exceed 5 years beyond any conformance period granted
under paragraph (a)(3) of this section; and
    (ii) Shall terminate automatically on the date during any such
extension on which the banking entity is no longer under a contractual
obligation described in paragraph (b)(1)(ii) of this section.
    (3) Contractual obligation. For purposes of this paragraph (b):
    (i) A banking entity has a contractual obligation to take or retain
an ownership interest in an illiquid fund if the banking entity is
prohibited from redeeming all of its ownership interests in the fund,
and from selling or otherwise transferring all such ownership interests
to a person that is not an affiliate of the banking entity--
    (A) Under the terms of the banking entity's ownership interest in
the fund or the banking entity's other contractual arrangements with
the fund or unaffiliated investors in the fund; or
    (B) If the banking entity is the sponsor of the fund, under the
terms of a written representation made by the banking entity in the
fund's offering materials distributed to potential investors;
    (ii) A banking entity has a contractual obligation to provide
additional capital to an illiquid fund if the banking entity is
required to provide additional capital to such fund--
    (A) Under the terms of its ownership interest in the fund or the
banking entity's other contractual arrangements with the fund or
unaffiliated investors in the fund; or
    (B) If the banking entity is the sponsor of the fund, under the
terms of a written representation made by the banking entity in the
fund's offering materials distributed to potential investors; and
    (iii) A banking entity shall be considered to have a contractual
obligation for purposes of paragraph (b)(3)(i) or (ii) of this section
only if:
    (A) The obligation may not be terminated by the banking entity or
any of its subsidiaries or affiliates under the terms of its agreement
with the fund; and
    (B) In the case of an obligation that may be terminated with the
consent of other persons, the banking entity and its subsidiaries and
affiliates have used their reasonable best efforts to obtain such
consent and such consent has been denied.
    (c) Approval Required to Hold Interests in Excess of Time Limit.
The conformance period in paragraph (a) of this section may be extended
in accordance with paragraph (a)(3) or (b) only with the approval of
the Board. A banking entity that seeks the Board's approval for an
extension of the conformance period under paragraph (a)(3) or for an
extended transition period under paragraph (b)(1) must:
    (1) Submit a request in writing to the Board at least 180 days
prior to the expiration of the applicable time period;
    (2) Provide the reasons why the banking entity believes the
extension should be granted, including information that addresses the
factors in paragraph (d)(1) of this section; and
    (3) Provide a detailed explanation of the banking entity's plan for
divesting or conforming the activity or investment(s).
    (d) Factors governing Board determinations.
    (1) Extension requests generally.--In reviewing any application by
a specific company for an extension under paragraph (a)(3) or (b)(1) of
this section, the Board may consider all the facts and circumstances
related to the activity, investment, or fund, including, to the extent
relevant:
    (i) Whether the activity or investment:
    (A) Involves or results in material conflicts of interest between
the banking entity and its clients, customers or counterparties;
    (B) Would result, directly or indirectly, in a material exposure by
the banking entity to high-risk assets or high-risk trading strategies;
    (C) Would pose a threat to the safety and soundness of the banking
entity; or

    (D) Would pose a threat to the financial stability of the United
States;
    (ii) Market conditions;
    (iii) The nature of the activity or investment;
    (iv) The date that the banking entity's contractual obligation to
make or retain an investment in the fund was incurred and when it
expires;
    (v) The contractual terms governing the banking entity's interest
in the fund;
    (vi) The degree of control held by the banking entity over
investment decisions of the fund;
    (vii) The types of assets held by the fund, including whether any
assets that were illiquid when first acquired by the fund have become
liquid assets, such as, for example, because any statutory, regulatory,
or contractual restrictions on the offer, sale, or transfer of such
assets have expired;
    (viii) The date on which the fund is expected to wind up its
activities and liquidate, or its investments may be redeemed or sold;
    (ix) The total exposure of the banking entity to the activity or
investment and the risks that disposing of, or maintaining, the
investment or activity may pose to the banking entity or the financial
stability of the United States;
    (x) The cost to the banking entity of divesting or disposing of the
activity or investment within the applicable period;
    (xi) Whether the divestiture or conformance of the activity or
investment would involve or result in a material conflict of interest
between the banking entity and unaffiliated clients, customers or
counterparties to which it owes a duty;
    (xii) The banking entity's prior efforts to divest or conform the
activity or investment(s), including, with respect to an illiquid fund,
the extent to which the banking entity has made efforts to terminate or
obtain a waiver of its contractual obligation to take or retain an
equity, partnership, or other ownership interest in, or provide
additional capital to, the illiquid fund; and
    (xiii) Any other factor that the Board believes appropriate.
    (2) Timing of Board review. The Board will seek to act on any
request for an extension under paragraph (a)(3) or (b)(1) of this
section no later than 90 calendar days after the receipt of a complete
record with respect to such request.
    (3) Consultation. In the case of a banking entity that is primarily
supervised by another Federal banking agency, the SEC, or the CFTC, the
Board will consult with such agency prior to the approval of a request
by the banking entity for an extension under paragraph (a)(3) or (b)(1)
of this section.
    (e) Authority to impose restrictions on activities or investments
during any extension period.
    (1) In general. The Board may impose such conditions on any
extension approved under paragraph (a)(3) or (b)(1) of this section as
the Board determines are necessary or appropriate to protect the safety
and soundness of the banking entity or the financial stability of the
United States, address material conflicts of interest or other unsound
banking practices, or otherwise further the purposes of section 13 of
the BHC Act (12 U.S.C. 1851) and this part.
    (2) Consultation. In the case of a banking entity that is primarily
supervised by another Federal banking agency, the SEC, or the CFTC, the
Board will consult with such agency prior to imposing conditions on the
approval of a request by the banking entity for an extension under
paragraph (a)(3) or (b)(1) of this section.

Sec.  248.32  Conformance period for nonbank financial companies
supervised by the Board engaged in prohibited proprietary trading or
covered fund activities and investments.

    (a) Divestiture requirement. A nonbank financial company supervised
by the Board shall come into compliance with all applicable
requirements of section 13 of the Bank Holding Company Act (12 U.S.C.
1851) and this subpart, including any capital requirements or
quantitative limitations adopted thereunder and applicable to the
company, not later than 2 years after the date the company becomes a
nonbank financial company supervised by the Board.
    (b) Extensions. The Board may, by rule or order, extend the two-
year period under paragraph (a) of this section by not more than three
separate one-year periods, if, in the judgment of the Board, each such
one-year extension is consistent with the purposes of section 13 of the
BHC Act (12 U.S.C. 1851) and this part and would not be detrimental to
the public interest.
    (c) Approval required to hold interests in excess of time limit. A
nonbank financial company supervised by the Board that seeks the
Board's approval for an extension of the conformance period under
paragraph (b) of this section must:
    (1) Submit a request in writing to the Board at least 180 days
prior to the expiration of the applicable time period;
    (2) Provide the reasons why the nonbank financial company
supervised by the Board believes the extension should be granted; and
    (3) Provide a detailed explanation of the company's plan for
conforming the activity or investment(s) to any applicable requirements
established under section 13(a)(2) or (f)(4) of the Bank Holding
Company Act (12 U.S.C. 1851(a)(2) and (f)(4)).
    (d) Factors governing Board determinations.
    (1) In general. In reviewing any application for an extension under
paragraph (b) of this section, the Board may consider all the facts and
circumstances related to the nonbank financial company and the request