account positions. In particular, Sec.  --.3(b)(2)(ii) of the proposed
rule provides that an account would be presumed to be a trading account
if it is used to acquire or take a covered financial position, other
than dealing positions or certain Market Risk Capital Rules covered
positions that are automatically considered part of the trading
account, that the banking entity holds for a period of sixty days or
less. However, the presumption does not apply if the banking entity can
demonstrate, based on all the facts and circumstances, that the covered
financial position, either individually or as a category, was not
acquired or taken principally for the purpose of short-term resale,
benefitting from short-term price movements, realizing short-term
arbitrage profits, or hedging another trading account position.\109\
Because it appears likely that most positions held for sixty days or
less would have been acquired with short-term trading intent, the
proposal presumes such positions are trading account positions unless
the banking entity can demonstrate otherwise. The purpose of the
proposed rebuttable presumption is to simplify the process of
evaluating whether individual positions are included in the definition
of trading account. The proposal does not apply this rebuttable
presumption to positions described in Sec.  --.3(b)(2)(i)(B) or (C) of
the proposed rule (i.e., certain Market Risk Capital Rules positions
and dealing positions), because these positions are automatically part
of the trading account, and cannot be rebutted.
---------------------------------------------------------------------------

    \109\ See proposed rule Sec.  --.3(b)(2)(ii).
---------------------------------------------------------------------------

    However, the Agencies recognize that, for a variety of reasons, a
banking entity may acquire a covered financial position for purposes
other than short-term trading but nonetheless dispose of that position
within the sixty-day period covered by the presumption. Accordingly,
Sec.  --.3(b)(2)(ii) is only a presumption, and may be rebutted by
reference to all the facts and circumstances surrounding the
acquisition of a particular position. For example, if a banking entity
acquired a covered financial position with the demonstrable intent of
holding it for investment or other non-trading purposes but, because of
developments not expected or anticipated at the time of acquisition
(e.g., increased customer demand, an unexpected increase in its
volatility or a need to liquidate the position to meet unexpected
liquidity demands), held it for less than sixty days, those facts and
circumstances would generally suggest that the position was not
acquired with short-term trading intent, notwithstanding the
presumption.\110\ The proposed rule also makes clear that this rebuttal
may be made not only with respect to a particular transaction, but also
with respect to a particular category of transactions, recognizing that
it may be possible to identify a category of similar

transactions that clearly do not involve short-term trading,
notwithstanding the typical holding period of the related positions.
---------------------------------------------------------------------------

    \110\ In such cases, the documented intention for acquiring or
taking the position should be consistent with the intention
articulated for financial reporting and other purposes.
---------------------------------------------------------------------------

    It is important to note that these presumptions are designed to
help determine whether a transaction is within the definition of
``proprietary trading,'' not whether a transaction is permissible under
section 13 of the BHC Act. A transaction may fall within the definition
of ``proprietary trading'' and yet be permissible if it meets one of
the exemptions provided in the proposed rule, such as the exemption for
market making-related activities.
vi. Request for Comment
    The Agencies request comment on the proposed rule's approach to
defining trading account. In particular, the Agencies request comment
on the following questions:
    Question 14. Is the proposed rule's definition of trading account
effective? Is it over- or under-inclusive in this context? What
alternative definition might be more effective in light of the language
and purpose of the statute? How would such definition better identify
the accounts that are intended to be covered by section 13 of the BHC
Act?
    Question 15. Is the proposed rule's approach for determining when a
position falls within the definition of ``trading account'' for
purposes of the proposed rule from when it must be reported in the
``trading account'' for purpose of filing the Call Report effective?
What additional guidance could the Agencies provide on this
distinction? Are there alternative approaches that would be more
effective in light of the language and purpose of the statute? Is this
approach workable for affiliates of bank holding companies that are not
subject to the Federal banking agencies' market Risk Capital Rules
(e.g., affiliated investment advisers)? If not, why not? Are affiliates
of bank holding companies familiar with the concepts from the Market
Risk Capital Rules that are being incorporated into the proposed rule?
If not, what steps would an affiliate of a bank holding company have to
take to become familiar with these concepts and what would be the costs
and/or benefits of such actions? Is application of the trading account
concept from the Federal banking agencies' Market Risk Capital Rules to
affiliates of bank holding companies necessary to promote consistency
and prevent regulatory arbitrage? Please explain.
    Question 16. Is the manner in which the Agencies intend to take
into account, and substantially adopt, the approach used in the Market
Risk Capital Rules and related concepts for determining whether a
position is acquired with short-term trading intent effective?
    Question 17. Should the proposed rule's definition of trading
account, or its use of the term ``short-term,'' be clarified? Are there
particular transactions or positions to which its application would be
unclear? Should the proposed rule define ``short-term'' for these
purposes? What alternative approaches to construing the term ``short-
term'' should the Agencies consider and/or adopt?
    Question 18. Are there particular transactions or positions to
which the application of the proposed definition of trading account is
unclear? Is additional regulatory language, guidance, or clarity
necessary?
    Question 19. Is the exchange of variation margin as a potential
indicator of short-term trading in derivative or commodity future
transactions appropriate for the definition of trading account? How
would this impact such transactions or the manner by which banking
entities conduct such transactions? For instance, would banking
entities seek to avoid the use of variation margin to avoid this rule?
What are the costs and benefits of referring to the exchange of
variation margin to determine if positions should be included in a
banking entity's trading account? Please explain.
    Question 20. Are there particular transactions or positions that
are included in the definition of trading account that should not be?
If so, what transactions or positions and why?
    Question 21. Are there particular transactions or positions that
are not included in the definition of trading account that should be?
If so, what transactions or positions and why?
    Question 22. Is the proposed rule of construction for positions
acquired or taken by dealers, swap dealers and security-based swap
dealers appropriate and consistent with the purpose and language of
section 13 of the BHC Act? Is its application to any particular type of
entity, such as an insured depository institution engaged in
derivatives dealing activities, sufficiently clear and effective? If
not, what alternative would be clearer and/or more effective?
    Question 23. Is the rebuttable presumption included in the proposed
rule appropriate and effective? Are there more effective ways in which
to provide clarity regarding the determination of whether or not a
position is included within the definition of trading account? If so,
what are they?
    Question 24. Are records currently created and retained that could
be used to demonstrate investment or other non-trading purposes in
connection with rebutting the presumption in the proposed rule? If yes,
please identify such records and explain when they are created and
whether they would be useful in connection with a single transaction or
a category of similar transactions. If no, we seek commenter input
regarding the manner in which banking entities might demonstrate
investment or other non-trading intent. Should the Agencies require
banking entities to make and keep records to demonstrate investment or
non-trading intent with respect to their covered financial positions?
    Question 25. How should the proposed trading account definition
address arbitrage positions? Should all arbitrage positions be included
in the definition of trading account, unless the timing of such profits
is long-term and established at the time the arbitrage position is
acquired or taken? Please explain in detail, including a discussion of
different arbitrage trading strategies and whether subjecting such
strategies to the proposed rule would be consistent with the language
and purpose of section 13 of the BHC Act.
    Question 26. Is the holding period referenced in the rebuttable
presumption appropriate? If not, what holding period would be more
appropriate, and why?
    Question 27. Should the proposed rule include a rebuttable
presumption regarding positions that are presumed not to be within the
definition of trading account? If so, why, and what would the
presumption be?
    Question 28. Should any additional accounts be included in the
proposed rule pursuant to the authority granted under section 13(h)(6)
of the BHC Act? If so, what accounts and why? For example, should
accounts used to acquire or take certain long-term positions be
included in the definition? If so, how would subjecting such accounts
to the proposed rule's prohibitions and restrictions be consistent with
the language and purpose of section 13 of the BHC Act?
    Question 29. Do any of the activities currently engaged in by
issuers of asset-backed securities that would be considered a banking
entity constitute proprietary trading as defined by Sec.  --.3(b) of
this rule proposal? Would any activities relating to investment of
funds in accounts held by issuers of asset-backed securities (e.g.,
reserve accounts, prefunding accounts, reinvestment accounts, etc.) or
the purchase and sale of securities as part

of the management of a collateralized debt obligation portfolio be
considered proprietary trading under the proposed rule? What would be
the potential impact of the prohibition on proprietary trading on the
use of such accounts in (i) existing securitization transactions and
(ii) future securitization transactions? Would any of the securities
typically acquired and retained using these accounts be considered an
ownership interest in a covered fund under the proposed rule? Does the
exclusion of trading in certain government obligations in Sec.  --.6(a)
of the proposed rule mitigate the impact of the proposed rule on such
issuers of asset-backed securities and their activities? Why or why
not?
c. Excluded Positions
i. Excluded Positions Under Certain Repurchase and Reverse Repurchase
Arrangements
    Section --.3(b)(2)(iii)(A) of the proposed rule's definition of
trading account provides that an account will not be a trading account
to the extent that such account is used to acquire or take one or more
covered financial positions that arise under a repurchase or reverse
repurchase agreement pursuant to which the banking entity has
simultaneously agreed, in writing at the start of the transaction, to
both purchase and sell a stated asset, at stated prices, and on stated
dates or on demand with the same counterparty.\111\ This clarifying
exclusion is proposed because positions held under a repurchase or
reverse repurchase agreement operate in economic substance as a secured
loan, and are not based on expected or anticipated movements in asset
prices. Accordingly, these types of asset purchases and sales do not
appear to be the type of transaction intended to be covered by the
statutory definition of trading account.
---------------------------------------------------------------------------

    \111\ See proposed rule Sec.  --.3(b)(2)(iii)(A).
---------------------------------------------------------------------------

ii. Excluded Positions Under Securities Lending Transactions
    Section --.3(b)(2)(iii)(B) of the proposed rule's definition of
trading account provides that an account will not be a trading account
to the extent that such account is used to acquire or take one or more
covered financial positions that arise under a transaction in which the
banking entity lends or borrows a security temporarily to or from
another party pursuant to a written securities lending agreement under
which the lender retains the economic interests of an owner of such
security, and has the right to terminate the transaction and to recall
the loaned security on terms agreed to by the parties.\112\ This
clarifying exclusion is proposed because a position held under a
securities lending arrangement can be used, for example, to operate in
economic substance and function, as a means to facilitate settlement of
securities transactions, and is not based on expected or anticipated
movements in asset prices. Accordingly, securities lending transactions
do not appear to be the type of transaction intended to be covered by
the statutory definition of trading account.
---------------------------------------------------------------------------

    \112\ See proposed rule Sec.  ----.3(b)(2)(iii)(B). The language
describing securities lending transactions in the proposed rule
generally mirrors that contained in Rule 3a5-3 under the Exchange
Act. See 17 CFR 240.3a5-3.
---------------------------------------------------------------------------

iii. Excluded Positions Acquired or Taken for Liquidity Management
Purposes
    Section ----.3(b)(2)(iii)(C) of the proposed definition of trading
account provides that an account will not be a trading account to the
extent that such account is used to acquire or take a position for the
purpose of bona fide liquidity management, so long as important
criteria are met.\113\
---------------------------------------------------------------------------

    \113\ See proposed rule Sec.  ----.3(b)(2)(iii)(C).
---------------------------------------------------------------------------

    This proposed clarifying exclusion is intended to make clear that,
where the purpose for which a banking acquires or takes a position is
to ensure that it has sufficient liquid assets to meet its short-term
cash demands, and the related position is held as part of the banking
entity's liquidity management process, that transaction falls outside
of the types of transactions described in the proposed rule's
definition of trading account. Maintaining liquidity management
positions is a critical aspect of the safe and sound operation of
certain banking entities, and does not involve the requisite short-term
trading intent that forms the basis of the statutory definition of
``trading account.'' In the context of bona fide liquidity management
activity that would qualify for the clarifying exclusion, a banking
entity's purpose for acquiring or taking these types of positions is
not to benefit from short-term profit or short-term price movements,
but rather to ensure that it has sufficient, readily-marketable assets
available to meet its expected short-term liquidity needs.
    However, the Agencies are concerned with the potential for abuse of
this clarifying exclusion--specifically, that a banking entity might
attempt to improperly mischaracterize positions acquired or taken for
prohibited proprietary trading purposes as positions acquired or taken
for liquidity management purposes. To address this, the proposed rule
requires that the transaction be conducted in accordance with a
documented liquidity management plan that meets five criteria. First,
the plan would be required to specifically contemplate and authorize
any particular instrument used for liquidity management purposes, its
profile with respect to market, credit and other risks, and the
liquidity circumstances in which the position may or must be used.
Second, the plan would have to require that any transaction
contemplated and authorized by the plan be principally for the purpose
of managing the liquidity of the banking entity, and not for the
purpose of short-term resale, benefitting from actual or expected
short-term price movements, realizing short-term arbitrage profits, or
hedging a position acquired or taken for such short-term purposes.
Third, the plan would have to require that any positions acquired or
taken for liquidity management purposes be highly liquid and limited to
financial instruments the market, credit and other risks of which are
not expected to give rise to appreciable profits or losses as a result
of short-term price movements.\114\ Fourth, the plan would be required
to limit any position acquired or taken for liquidity management
purposes, together with any other positions acquired or taken for such
purposes, to an amount that is consistent with the banking entity's
near-term funding needs, including deviations from normal operations,
as estimated and documented pursuant to methods specified in the plan.
Fifth, the plan would be required to be consistent with the relevant
Agency's supervisory requirements, guidance and expectations regarding
liquidity management. The Agencies would review these liquidity plans
and transactions effected in accordance with these plans through
supervisory and examination processes to ensure that the applicable
criteria are met and that any position acquired or taken in reliance on
the clarifying exclusion for liquidity management transactions is fully
consistent with such plans.
---------------------------------------------------------------------------

    \114\ Any instance in which positions characterized as taken for
liquidity purposes do give rise to appreciable profits or losses as
a result of short-term price movements will be subject to
significant Agency scrutiny and, absent compelling explanatory facts
and circumstances, would be viewed as prohibited proprietary trading
under the proposal.

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

iv. Excluded Positions of Derivatives Clearing Organizations and
Clearing Agencies
    Section --.3(b)(2)(iii)(D) of the proposed rule's definition of
trading account provides that an account will not be a trading account
to the extent that such account is used to acquire or take one or more
covered financial positions that are acquired or taken by a banking
entity that is a derivatives clearing organization registered under
section 5b of the Commodity Exchange Act (7 U.S.C. 7a-1) or a clearing
agency registered with the SEC under section 17A of the Exchange Act
(15 U.S.C. 78q-1) in connection with clearing derivatives or securities
transactions.\115\ This clarifying exclusion is proposed because, in
the case of a banking entity that acts as a registered, central
counterparty in the securities or derivatives markets, these types of
transactions do not appear to be the type of transaction intended to be
covered by the statutory definition of trading account, as the purpose
of such transactions is to provide a clearing service to third parties
and not to profit from short-term resale or short-term price movements.
---------------------------------------------------------------------------

    \115\ See proposed rule Sec.  ----.3(b)(2)(iii)(D).
---------------------------------------------------------------------------

v. Request for Comment
    The Agencies request comment regarding the proposed clarifying
exclusions and whether any other types of activity or transactions
should be excluded from the proposed definition of trading account for
clarity. In particular, the Agencies request comment on the following
questions:
    Question 30. Are the proposed clarifying exclusions for positions
under certain repurchase and reverse repurchase arrangements and
securities lending transactions over- or under-inclusive and could they
have unintended consequences? Is there an alternative approach to these
clarifying exclusions that would be more effective? Are the proposed
clarifying exclusions broad enough to include bona fide arrangements
that operate in economic substance as secured loans and are not based
on expected or anticipated movements in asset prices? Are there other
types of arrangements, such as open dated repurchase arrangements, that
should be excluded for clarity and, if so, how should the proposed rule
be revised? Alternatively, are the proposed clarifying exclusions
narrow enough to not inadvertently exclude from coverage any similar
arrangements or transactions that do not have these characteristics?
    Question 31. Are repurchase and reverse repurchase arrangements and
securities lending transactions sufficiently similar that they should
be treated in the same way for purposes of the proposed rule? Are there
aspects of repurchase and reverse repurchase arrangements or securities
lending transactions that should be highlighted in considering the
application of the proposed rule? Do repurchase and reverse repurchase
arrangements or securities lending transactions raise any additional or
heightened concerns regarding risk? Please identify and explain how
these concerns should be reflected in the proposed rule.
    Question 32. Are the proposed exclusions for repurchase and reverse
repurchase arrangements and securities lending transactions appropriate
or are there conditions that commenters believe would be appropriate as
a pre-requisite to relying on these exclusions? Please identify such
conditions and explain. Alternatively, we seek commenter input
regarding why repurchase and reverse repurchase arrangements and
securities lending transactions do not present the potential for abuse,
namely, that a banking entity might attempt to improperly
mischaracterize prohibited proprietary trading as activity that
qualifies for the proposed exclusions.
    Question 33. Is the proposed clarifying exclusion for liquidity
management transactions effective and appropriate? If not, what
alternative would be more effective and appropriate, and why? Is the
proposed exclusion under- or over-inclusive? Does the proposed
clarifying exclusion place sufficient limitations on liquidity
management transactions to prevent abuse of the clarifying exclusion?
If not, what additional limitations should be specified? Are any of the
limitations contained in the proposed rule inappropriate or
unnecessary? If so, how could such limitations be eliminated or altered
in way that does not permit abuse of the clarifying exclusion?
    Question 34: Is the proposed exclusion for liquidity management
positions necessary? If not excluded, would such activity otherwise
qualify for an exemption contained in the proposed rule (e.g., the
exemptions contains in Sec. Sec.  ----.5 and ----.6(a) of the proposed
rule)? What types of banking entities are likely to engage in the
liquidity management activities described in the proposed exclusion?
    Question 35: What types of instruments do particular types of
banking entities currently use in connection with liquidity management
activities (e.g., Treasuries)? Why are such instruments chosen for
liquidity management purposes? Would such instruments meet the proposed
requirement that the position be highly liquid and limited to financial
instruments the market, credit and other risk of which are not expected
to give rise to appreciable profits or losses as a result of short-term
price movements? Why or why not?
    Question 36: What methodologies do banking entities currently use
for estimating deviations from normal operations in connection with
liquidity management programs?
    Question 37: Which unit or units within a banking entity are
typically responsible for liquidity management? What is the typical
reporting line structure used to control and supervise that unit or
units? Are the responsibilities of personnel in the unit limited to
liquidity management or do they perform other functions in addition to
liquidity management? How is compensation determined for personnel in
the unit of the banking entity responsible for liquidity management?
    Question 38: Would current liquidity management programs meet the
five proposed criteria for liquidity management programs? If not which
criteria would not be met, and why? What effect would the proposed
liquidity management exclusions have on current liquidity management
programs and banking entities in general?
    Question 39: Are liquidity management programs used for purposes
other than ensuring the banking entity has sufficient assets available
to it that are readily marketable to meet expected short-term liquidity
needs? If so, for what purposes, and why?
    Question 40: What costs or other burdens would arise if the
proposal did not contain an exclusion for positions acquired or taken
for liquidity management purpose? Please explain and quantify these
costs or other burdens in detail.
    Question 41: Is the proposed liquidity management exclusion
sufficiently clear? If not, why is the exclusion unclear and how should
the Agencies clarify the terms of this exclusion?
    Question 42. Is the proposed clarifying exclusion for certain
positions taken by derivatives clearing organizations and clearing
agencies effective and appropriate? If not, what alternative would be
more effective and appropriate, and why?
    Question 43. Are any additional clarifying exclusions warranted? If
so, what clarifying exclusion, and why?

    Question 44. Should the proposed definition exclude any position
the market risk of which cannot be hedged by the banking entity in a
two-way market?\116\ If so, what would be the basis for concluding that
such positions are clearly not within the statutory definition of
trading account?
---------------------------------------------------------------------------

    \116\ The Agencies also note that such an exclusion would be
similar to the express exclusion of similar positions under the
Federal banking agencies' most recent proposed revisions to the
Market Risk Capital Rules. See 76 FR 1890, 1912 (Jan. 11, 2011)
(excluding from the definition of a covered position any position
the material risk elements of which the holder is unable to hedge in
a two-way market).
---------------------------------------------------------------------------

    Question 45. Should the proposed definition include a clarifying
exclusion for any position in illiquid assets? If so, what would be the
basis for concluding that such positions are clearly not within the
statutory definition of trading account? How should ``illiquid assets''
be defined for these purposes? Should the definition be consistent with
the definition given that term in the Board's Conformance Rule under
section 13 of the BHC Act (12 CFR 225.180 et seq.)? \117\
---------------------------------------------------------------------------

    \117\ See 76 FR 8265 (Feb. 14, 2011). The Board's conformance
rule defines ``illiquid asset'' as ``any real property, security
obligation, or other asset that (i) is not a liquid asset; (ii)
because of statutory or regulatory restrictions applicable to the
hedge fund, private equity fund or asset, cannot be offered, sold,
or otherwise transferred by the hedge fund or private equity fund to
a person that is unaffiliated with the relevant banking entity; or
(iii) because of contractual restrictions applicable to the hedge
fund, private equity fund or asset, cannot be offered, sold, or
otherwise transferred by the hedge fund or private equity fund for a
period of 3 years or more to a person that is unaffiliated with the
relevant banking entity.'' 12 CFR 225.180(g). A ``liquid asset'' is
defined in paragraph (h) of the conformance rule. See 12 CFR
225.180(h).
---------------------------------------------------------------------------

d. Covered Financial Position
i. Definition of ``Covered Financial Position''
    Section --.3(b)(3)(i) of the proposed rule defines a covered
financial position as any long, short, synthetic or other position\118\
in: (i) A security, including an option on a security; (ii) a
derivative, including an option on a derivative; or (iii) a contract of
sale of a commodity for future delivery, or an option on such a
contract. The types of financial instruments described in the proposed
definition are consistent with those referenced in section 13(h)(4) of
the BHC Act as part of the statutory definition of proprietary
trading.\119\
---------------------------------------------------------------------------

    \118\ The proposed definition's reference to any ``long, short,
synthetic or other position'' is intended to make clear that a
position in an identified category of financial instrument qualifies
as a covered financial position regardless of whether the position
is (i) an asset or liability or (ii) is acquired through acquisition
or sale of the financial instrument or synthetically through a
derivative or other transaction.
    \119\ Section 13(h)(4) of the BHC Act also permits the Agencies
to extend the scope of the proprietary trading restrictions to other
financial instruments. The Agencies have not proposed to do so at
this time.
---------------------------------------------------------------------------

    To provide additional clarity, Sec.  ----.3(b)(3)(ii) of the
proposed rule provides that, consistent with the statute, the term
covered financial position does not include any position that is itself
a loan, a commodity, or foreign exchange or currency.\120\ The
exclusion of these types of positions is intended to eliminate
potential confusion by making clear that the purchase and sale of
loans, commodities and foreign exchange--none of which are referred to
in section 13(h)(4) of the BHC Act--are outside the scope of
transactions to which the proprietary trading restrictions apply. The
reference in Sec.  ----.3(b)(3)(ii) to a position that is, rather than
a position that is in, a loan, a commodity, or foreign exchange or
currency is intended to capture only the purchase and sale of these
instruments themselves. This reflects the fact that, consistent with
section 13(h)(4) of the BHC Act and the proposed rule, although a
position that is a foreign exchange derivative or commodity derivative
is included in the definition of covered financial position and
therefore subject to the prohibition on proprietary trading, a position
that is a commodity or foreign currency is not.\121\ For example, the
spot purchase of a commodity would meet the terms of the exclusion, but
the acquisition of a futures position in the same commodity would not.
The Agencies request comment on the proposed rule's definition of
covered financial position. In particular, the Agencies request comment
on the following questions:
---------------------------------------------------------------------------

    \120\ See proposed rule Sec.  ----.3(b)(ii).
    \121\ The types of commodity- and foreign exchange-related
derivatives that are included within the definition of
``derivative'' under the proposed rule are discussed in detail below
in Part III.B.2.d.ii of this Supplementary Information.
---------------------------------------------------------------------------

    Question 46. Is the proposed rule's definition of covered financial
position effective? Is the definition over- or under-inclusive? What
alternative approaches might be more effective in light of the language
and purpose of section 13 of the BHC Act, and why?
    Question 47. Are there definitions in other rules or regulations
that might inform the proposed definition of covered financial
position? If so, what rule or regulation? How should that approach be
incorporated into the proposed definition? Why would that approach be
more appropriate?
    Question 48. Are there particular transactions or positions to
which the application of the proposed definition of covered financial
position is unclear? Is additional regulatory language, guidance, or
clarity necessary?
    Question 49. The proposal would apply to long, short, synthetic, or
other positions in one of the listed categories of financial
instruments. Does this language adequately describe the type of
positions that are intended to fall within the proposed definition of
covered financial position? If not, why not? Are there different or
additional concepts that should be specified in this context? Please
explain.
    Question 50. Should the Agencies expand the scope of covered
financial positions to include other transactions, such as spot
commodities or foreign exchange or currency, or certain subsets of
transaction (e.g., spot commodities or foreign exchange or currency
traded on a high-frequency basis)? If so, which instruments and why?
    Question 51. What factors should the Agencies consider in deciding
whether to extend the scope of the proprietary trading restriction to
other financial instruments under the authority granted in section
13(h)(4) of the BHC Act? Please explain.
    Question 52. Is the proposed exclusion of any position that is a
loan, a commodity, or foreign exchange or currency effective? If not,
what alternative approaches might be more effective in light of the
language and purpose of section 13 of the BHC Act? Should additional
positions be excluded? If so, why and under what authority?
ii. Other Terms Used in the Definition of Covered Financial Position
    The proposal also defines a number of terms used in the proposed
definition of covered financial position. The term ``security'' is
defined by reference to that same term under the Exchange Act.\122\ The
terms ``commodity'' and ``contract of sale of a commodity for future
delivery'' are defined by reference to those same terms under the
Commodity Exchange Act.\123\ The Agencies have proposed to reference
these existing definitions from the securities and commodities laws
because these existing definitions are generally well-understood by
market participants and have been subject to extensive interpretation
in the context of securities and commodities trading activities.
---------------------------------------------------------------------------

    \122\ See proposed rule Sec.  ----.2(w).
    \123\ See proposed rule Sec. Sec.  ----.3(c)(1), (2).
---------------------------------------------------------------------------

    The proposed rule also defines the term ``derivative.'' \124\ In
particular, the

definition of ``derivative'' under the proposed rule includes any
``swap'' (as that term is defined in the Commodity Exchange Act) and
any ``security-based swap'' (as that term is defined in the Exchange
Act), in each case as further defined by the CFTC and SEC by joint
regulation, interpretation, guidance, or other action, in consultation
with the Board pursuant to section 712(d) of the Dodd-Frank Act. The
Agencies have proposed to incorporate these definitions of ``swap'' and
``security-based swap'' under the Federal securities and commodities
laws because those definitions: (i) Govern the primary Federal
regulatory scheme applicable to exchange-traded and over-the-counter
derivatives; (ii) will be frequently evaluated and applied by banking
entities in the course of their trading activities; and (iii) capture
agreements and contracts that are or function as derivatives.\125\ The
proposed rule also includes within the definition of derivative certain
other transactions that, although not included within the definition of
``swap'' or ``security-based swap,'' also appear to be, or operate in
economic substance as, derivatives, and which if not included could
permit banking entities to engage in proprietary trading that is
inconsistent with the spirit of section 13 of the BHC Act.
Specifically, the proposed definition of derivative also includes: (i)
Any purchase or sale of a nonfinancial commodity for deferred shipment
or delivery that is intended to be physically settled; (ii) any foreign
exchange forward or foreign exchange swap (as those terms are defined
in the Commodity Exchange Act); \126\ (iii) any agreement, contract, or
transaction in foreign currency described in section 2(c)(2)(C)(i) of
the Commodity Exchange Act (7 U.S.C. 2(c)(2)(C)(i)); \127\ (iv) any
agreement, contract, or transactions in a commodity other than foreign
currency described in section 2(c)(2)(D)(i) of the Commodity Exchange
Act (7 U.S.C. 2(c)(2)(D)(i)); and (v) any transaction authorized under
section 19 of the Commodity Exchange Act (7 U.S.C. 23(a) or (b)). The
Agencies are requesting comment on whether including these five types
of transactions within the proposed definition of derivative is
appropriate.
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    \124\ See proposed rule Sec.  ----.2(l).
    \125\ The Agencies note that they have not included a variety of
security-related derivatives within the proposed definition of
derivative, as such transactions are ``securities'' for purposes of
both the Exchange Act and the proposed rule and, as a result,
already included in the broader definition of ``covered financial
position'' to which the prohibition on proprietary trading applies.
    \126\ The Agencies note that foreign exchange swaps and foreign
exchange forwards are considered swaps for purposes of the Commodity
Exchange Act definition of that term unless the Secretary of the
Treasury determines, pursuant to section 1a(47)(E) of that Act (7
U.S.C. 1a(47)(E)), that foreign exchange swaps and forwards should
not be regulated as swaps under the Commodity Exchange Act and are
not structured to evade certain provisions of the Dodd-Frank Act. On
May 5, 2011, the Treasury Secretary proposed to exercise that
authority to exclude foreign exchange forwards and foreign exchange
swaps from the definition of ``swap.'' See Determination of Foreign
Exchange Swaps and Foreign Exchange Forwards Under the Commodity
Exchange Act, 76 FR 25774 (May 5, 2011). If the Secretary of the
Treasury issues a final determination, as proposed, a ``foreign
exchange swap'' and ``foreign exchange forward'' would be excluded
from the definition of ``swap'' under the Commodity Exchange Act
and, therefore, would fall outside of the proposed rule's definition
of ``derivative.'' Accordingly, the Agencies have proposed to
expressly include such transactions in the proposed definition of
derivative, but have requested comment on a variety of questions
related to whether foreign exchange swaps and forwards should be
included or excluded from the definition of derivative. The Agencies
note that, aside from foreign exchange swaps and forwards, the
Commodity Exchange Act's definition of ``swap'' (and therefore the
proposed definition of ``derivative'') also includes other types of
foreign exchange derivatives, including non-deliverable foreign
exchange forwards (NDFs), foreign exchange options, and currency
options, which fall outside of the Secretary of the Treasury's
authority to issue a determination to exclude certain transactions
from the ``swap'' definition.
    \127\ Section 2(c)(2)(C)(i) was added to the Commodity Exchange
Act in 2008 to address retail foreign exchange transactions that
were documented as automatically renewing spot contracts (so-called
rolling spot transactions) and therefore not futures contracts
subject to the Commodity Exchange Act, but which were functionally
and economically similar to futures. See Retail Foreign Exchange
Transactions, 76 FR 41375, 47376-77 (July 15, 2011). However,
section 2(c)(2)(C)(i) of the Commodity Exchange Act does not apply
to transactions entered into by U.S. financial institutions,
including insured depository institutions, brokers, dealers, and
certain retail foreign exchange dealers. See 7 U.S.C.
2(c)(2)(C)(i)(I)(aa). To apply this definitional prong to such
banking entities, the definition of derivative includes a
transaction ``described in'' section 2(c)(2)(C)(i) of the Commodity
Exchange Act. In other words, the use of this phrase is intended to
capture any transaction described in section 2(c)(2)(C)(i) without
regard to the identity of the counterparty.
---------------------------------------------------------------------------

    To provide additional clarity, the proposed definition of
derivative also clarifies two types of transactions that are outside
the scope of the definition. First, the proposed definition of
derivative would not include any consumer, commercial, or other
agreement, contract, or transaction that the CFTC and SEC have further
defined by joint regulation, interpretation, guidance, or other action
as not within the definition of swap, as that term is defined in the
Commodity Exchange Act, or security-based swap, as that term is defined
in the Exchange Act. The SEC and CFTC have, in proposing rules further
defining the terms ``swap'' and ``security-based swap,'' proposed to
not include a variety of agreements, contracts, and transactions within
those definitions by joint regulation or interpretation, and the
Agencies have proposed to expressly reflect such exclusions in the
proposed rule's definition in order to avoid the potential application
of its restrictions to transactions that are not commonly thought to be
derivatives.\128\ Second, the proposed definition of derivative also
does not include any identified banking product, as defined in section
402(b) of the Legal Certainty for Bank Products Act of 2000 (7 U.S.C.
27(b)), that is subject to section 403(a) of that Act (7 U.S.C.
27a(a)). This provision is proposed to clearly exclude identified
banking products that are expressly excluded (i) from the definition of
``security-based swap'' and (ii) from Commodity Exchange Act and CFTC
jurisdiction pursuant to section 403(a) of the Legal Certainty for Bank
Products Act of 2000.\129\
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    \128\ See 76 FR 29818 (May 23, 2011). For example, the SEC and
CFTC have proposed to not include (i) certain insurance products
within the definitions of ``swap'' and ``security-based swap'' by
regulation and (ii) certain consumer agreements (e.g., agreements to
acquire or lease real property or purchase products at a capped
price) and commercial agreements (e.g., employment contracts or the
purchase of real property, intellectual property, equipment or
inventory) by joint interpretation. See id. at 29832-34. The
Agencies have proposed to define ``derivative'' in the proposed rule
by reference to the definition of ''swap'' and ``security-based
swap'' under the Federal securities and commodities laws in
contemplation of the SEC and CFTC's proposed regulatory and
interpretative exclusions; to the extent that such exclusions are
not included in any final action taken by the SEC and CFTC, the
Agencies will consider whether to state such exclusions expressly
within the proposed rule's definition of derivative.
    \129\ Examples of excluded identified banking products are
deposit accounts, savings accounts, certificates of deposit, or
other deposit instruments issued by a bank.
---------------------------------------------------------------------------

    The proposed rule defines a ``loan'' as any loan, lease, extension
of credit, or secured or unsecured receivable.\130\ The Agencies note
that the proposed definition of loan is expansive, and includes a broad
array of loans and similar credit transactions, but does not include
any asset-backed security that is issued in connection with a loan
securitization or otherwise backed by loans.
---------------------------------------------------------------------------

    \130\ See proposed rule Sec.  ----.2(q).
---------------------------------------------------------------------------

    The Agencies request comment on the proposed rule's definition of
terms used in the definition of covered financial position. In
particular, the Agencies request comment on the following questions:
    Question 53. Are the proposed rule's definitions of commodity and
contract of sale of a commodity for future delivery appropriate? If
not, what

alternative definitions would be more appropriate?
    Question 54. Is the proposed definition of derivative effective? If
not, what alternative definition would be more effective? Should the
proposed rule expressly incorporate the definition of ``swap'' and
security-based swap'' under the Federal commodities and securities
laws? If not, what alternative approach should be taken? Are there
transactions included in those incorporated definitions that should not
be included in the proposed rule's definition? If so, what transactions
and why? Are there transactions excluded from those incorporated
definitions that should be included within the proposed rule's
definition? If so, what transactions and why?
    Question 55. Is the proposed inclusion of foreign exchange forwards
and swaps in the definition of derivative effective? If not, why not?
On what basis would the Agencies conclude that such transactions are
not derivatives? Are these transactions economically or functionally
more similar to secured loans or repurchase arrangements than to
commodity forwards and swaps? Would there be any unintended
consequences to banking entities if such transactions are included in
the proposal's definition of derivative? What effect is including
foreign exchange swaps and forwards in the definition of derivative
likely to have on banking entities, participants in the foreign
exchange markets, and the liquidity and efficiency of foreign exchange
markets generally? If included within the definition of derivative,
should transactions in foreign exchange swaps and forwards be permitted
under section 13(d)(1)(J) of the BHC Act? If so, why and on what basis?
Please quantify your responses, to the extent feasible.
    Question 56. Is the proposed inclusion of any purchase or sale of a
nonfinancial commodity for deferred shipment or delivery that is
intended to be physically settled in the definition of derivative
effective? If not, why not? Would there be any unintended consequences
to banking entities if such transactions are included in the proposal's
definition of derivative?
    Question 57. Is the proposed inclusion of foreign currency
transactions described in section 2(c)(2)(C)(i) of the Commodity
Exchange Act in the definition of derivative effective? If not, why
not? Would there be any unintended consequences to banking entities if
such transactions are included in the proposal's definition of
derivative?
    Question 58. Is the proposed inclusion of commodity transactions
described in section 2(c)(2)(D)(i) of the Commodity Exchange Act in the
definition of derivative effective? If not, why not? Would there be any
unintended consequences to banking entities if such transactions are
included in the proposal's definition of derivative?
    Question 59. Is the proposed inclusion of any transaction
authorized under section 19 of the Commodity Exchange Act (7 U.S.C.
23(a) or (b)) in the definition of derivative effective? If not, why
not? Would there be any unintended consequences to banking entities if
such transactions are included in the proposal's definition of
derivative?
    Question 60. Is the manner in which the proposed definition of
derivative excludes any transaction that the CFTC or SEC exclude by
joint regulation, interpretation, guidance, or other action from the
definition of ``swap'' or ``security-based swap'' effective? If not,
what alternative approach would be more appropriate? Should such
exclusions be restated in the proposed rule's definition? If so, why?
    Question 61. Is the proposed rule's definition of loan appropriate?
If not, what alternative definition would be more appropriate? Should
the definition of ``loan'' exclude a security? Should other types of
traditional banking products be included in the definition of ``loan''?
If so, why?
iii. Definition of Other Terms Related to Proprietary Trading
    Section --.3(d) of the proposed rule defines a variety of other
terms used throughout subpart B of the proposed rule. These definitions
are discussed in further detail below in the relevant summary of the
separate sections of the proposed rule in which they are used.
    The Agencies request comment on the proposed rule's definition of
other terms used in subpart B of the proposed rule. In particular, the
Agencies request comment on the following questions:
    Question 62. Are the proposed rule's definitions of other terms in
Sec.  --.3(d) appropriate? If not, what alternative definitions would
be more appropriate?
    Question 63. Is the definition of additional terms for purposes of
subpart B of the proposed rule necessary? If so, what terms should be
defined? How should those terms be defined?
2. Section --.4: Permitted Underwriting and Market Making-Related
Activities
    Section --.4 of the proposed rule implements section 13(d)(1)(B) of
the BHC Act, which permits banking entities to engage in certain
underwriting and market making-related activities, notwithstanding the
prohibition on proprietary trading.\131\ Section --.4(a) addresses
permitted underwriting activities, and Sec.  --.4(b) addresses
permitted market making-related activities.
---------------------------------------------------------------------------

    \131\ See 12 U.S.C. 1851(d)(1)(B).
---------------------------------------------------------------------------

a. Permitted Underwriting Activities
    Section --.4(a) of the proposed rule permits a banking entity to
purchase or sell a covered financial position in connection with the
banking entity's underwriting activities to the extent that such
activities are designed not to exceed the reasonably expected near-term
demands of clients, customers, or counterparties (the ``underwriting
exemption''). In order to rely on this exemption, a banking entity's
underwriting activities must meet all seven of the criteria listed in
Sec.  --.4(a)(2). These seven criteria are intended to ensure that any
banking entity relying on the underwriting exemption is engaged in bona
fide underwriting activities, and conducts those activities in a way
that is not susceptible to abuse through the taking of speculative,
proprietary positions as a part of, or mischaracterized as,
underwriting activity.
    First, the banking entity must have established the internal
compliance program required by subpart D of the proposed rule, as
further described below in Part III.D of this SUPPLEMENTARY
INFORMATION. This requirement is intended to ensure that any banking
entity relying on the underwriting exemption has reasonably designed
written policies and procedures, internal controls, and independent
testing in place to support its compliance with the terms of the
exemption.
    Second, the covered financial position that is being purchased or
sold must be a security. This requirement reflects the common usage and
understanding of the term ``underwriting.'' \132\
---------------------------------------------------------------------------

    \132\ The Agencies note, however, that a derivative or commodity
future transaction may be otherwise permitted under another
exemption (e.g., the exemptions for market making-related or risk-
mitigating hedging activities).
---------------------------------------------------------------------------

    Third, the transaction must be effected solely in connection with a
distribution of securities for which the banking entity is acting as an
underwriter. This prong is intended to give effect to the essential
element of the underwriting exemption--i.e., that the transaction be in
connection with underwriting activity. For these purposes, the proposed
rule defines both (i) a distribution of securities and (ii) an
underwriter. The definitions of these terms are generally identical to
the

definitions provided for the same terms in the SEC's Regulation M,\133\
which governs the activities of underwriters, issuers, selling security
holders, and others in connection with offerings of securities under
the Exchange Act.\134\ The Agencies have proposed to use similar
definitions because the meanings of these terms under Regulation M are
generally well-understood by market participants and define the scope
of underwriting activities in which banking entities typically engage,
including underwriting of SEC-registered offerings, underwriting of
unregistered distributions, and acting as a placement agent in private
placements.
---------------------------------------------------------------------------

    \133\ 17 CFR 242.100 et seq.
    \134\ See proposed rule Sec. Sec.  --.4(a)(3), (4); 17 CFR
242.100(b).
---------------------------------------------------------------------------

    With respect to the definition of distribution, the Agencies note
that Regulation M defines a distribution of securities as ``an offering
of securities, whether or not subject to registration under the
Securities Act that are distinguished from ordinary trading
transactions by the magnitude of the offering and the presence of
special selling efforts.'' \135\ The manner in which this Regulation M
definition distinguishes a distribution of securities from other
transactions appears to be relevant in the context of the underwriting
exemption and useful to address potential evasion of the general
prohibition on proprietary trading, while permitting bona fide
underwriting activities. Accordingly, in order to qualify as a
distribution for purposes of the proposal, as with Regulation M, the
offering must meet the two elements--``magnitude'' and ``special
selling efforts and selling methods.'' The Agencies have not defined
the terms ``magnitude'' and ``special selling efforts and selling
methods'' in the proposed rule, but would expect to rely on the same
factors considered under Regulation M in assessing these elements. For
example, the number of shares to be sold, the percentage of the
outstanding shares, public float, and trading volume that those shares
represent are all relevant to an assessment of magnitude.\136\ In
addition, delivering a sales document, such as a prospectus, and
conducting road shows are generally indicative of special selling
efforts and selling methods.\137\ Another indicator of special selling
efforts and selling methods is compensation that is greater than that
for secondary trades but consistent with underwriting compensation for
an offering. Similar to the approach taken under Regulation M, the
Agencies note that ``magnitude'' does not imply that a distribution
must be large; instead, this factor is a means to distinguish a
distribution from ordinary trading, and therefore does not preclude
small offerings or private placements from qualifying for the
underwriting exemption.
---------------------------------------------------------------------------

    \135\ 17 CFR 242.100.
    \136\ See Review of Antimanipulation Regulation of Securities
Offering, Exchange Act Release No. 33924 (Apr. 19, 1994), 59 FR
21681, 21684 (Apr. 26, 1994) (``Regulation M Concept Release'').
    \137\ See Regulation M Concept Release, 59 FR at 21684-85.
---------------------------------------------------------------------------

    The definition of ``underwriter'' in the proposed rule is generally
similar to that under the SEC's Regulation M, except that the proposed
rule's definition would also include, within that definition, a person
who has an agreement with another underwriter to engage in a
distribution of securities for or on behalf of an issuer or selling
security holder.\138\ Consistent with current practices and the Council
study, the Agencies propose to take into consideration the extent to
which the banking entity is engaged in the following activities when
determining whether a banking entity is acting as an underwriter as
part of a distribution of securities:
---------------------------------------------------------------------------

    \138\ See proposed rule Sec.  --.4(a)(4)(ii).
---------------------------------------------------------------------------

     Assisting an issuer in capital raising;
     Performing due diligence;
     Advising the issuer on market conditions and assisting in
the preparation of a registration statement or other offering
documents;
     Purchasing securities from an issuer, a selling security
holder, or an underwriter for resale to the public;
     Participating in or organizing a syndicate of investment
banks;
     Marketing securities; and
     Transacting to provide a post-issuance secondary market
and to facilitate price discovery.
    The Agencies note that the precise activities performed by an
underwriter may vary depending on the liquidity of the securities being
underwritten and the type of distribution being conducted. For example,
each factor need not be present in a private placement.
    There may be circumstances in which an underwriter would hold
securities that it could not sell in the distribution for investment
purposes. If the acquisition of such unsold securities were in
connection with the underwriting pursuant to the permitted underwriting
activities exemption, the underwriter would also be able to dispose of
such securities at a later time.\139\
---------------------------------------------------------------------------

    \139\ The Agencies note, however, that such sale would have to
be made in compliance with other applicable provisions of the
Federal securities laws and regulations.
---------------------------------------------------------------------------

    Fourth, to the extent that the transaction involves a security for
which a person must generally be a registered securities dealer,
municipal securities dealer or government securities dealer in order to
underwrite the security, the banking entity must have the appropriate
dealer registration (or in the case of a financial institution that is
a government securities dealer, has filed notice of that status as
required by section 15C(a)(1)(B) of the Exchange Act) or otherwise be
exempt from registration or excluded from regulation as a dealer.\140\
Similarly, if the banking entity is engaged in the business of a dealer
outside the United States in a manner for which no U.S. registration is
required, the banking entity must be subject to substantive regulation
of its dealing business in the jurisdiction in which the business is
located. This requirement is intended to ensure that (i) any
underwriting activity conducted in reliance on the exemption is subject
to appropriate regulation and (ii) banking entities are not
simultaneously characterizing the transaction as underwriting for
purposes of the exemption while characterizing it in a different manner
for purposes of applicable securities laws.
---------------------------------------------------------------------------

    \140\ See proposed rule Sec.  --.4(a)(2)(iv). For example, if a
banking entity is a bank engaged in underwriting asset-backed
securities for which it would be required to register as a
securities dealer but for the exclusion contained in section
3(a)(5)(C)(iii) of the Exchange Act, the proposed rule would not
require that banking entity be a registered securities dealer in
order to rely on the underwriting exemption for that transaction.
The proposed rule does not apply the dealer registration/notice
requirement to the underwriting of exempted securities, security-
based swaps, commercial paper, bankers acceptances or commercial
bills because the underwriting of such instruments does not require
registration as a securities dealer under the Exchange Act.
---------------------------------------------------------------------------

    Fifth, the underwriting activities of the banking entity with
respect to the covered financial position must be designed not to
exceed the reasonably expected near-term demands of clients, customers
and counterparties.\141\ This requirement restates the statutory
limitation on the underwriting exemption.
---------------------------------------------------------------------------

    \141\ See proposed rule Sec.  --.4(a)(2)(v).
---------------------------------------------------------------------------

    Sixth, the underwriting activities of the banking entity must be
designed to generate revenues primarily from fees, commissions,
underwriting spreads or other income, and not from appreciation in the
value of covered financial positions it holds related to such
activities or the hedging of such covered financial position.\142\ This
requirement

is intended to ensure that activities conducted in reliance on the
underwriting exemption demonstrate patterns of revenue generation and
profitability consistent with, and related to, the services an
underwriter provides to its customers in bringing securities to market,
rather than changes in the market value of the securities underwritten.
---------------------------------------------------------------------------

    \142\ For these purposes, underwriting spreads would include any
``gross spread'' (i.e., the difference between the price an
underwriter sells securities to the public and the price it
purchases them from the issuer) designed to compensate the
underwriter for its services.
---------------------------------------------------------------------------

    Seventh, the compensation arrangements of persons performing
underwriting activities at the banking entity must be designed not to
encourage proprietary risk-taking. Activities for which a banking
entity has established a compensation incentive structure that rewards
speculation in, and appreciation of, the market value of securities
underwritten, rather than success in bringing securities to market for
a client, are inconsistent with permitted underwriting activities under
the proposed rule. Although a banking entity relying on the
underwriting exemption may appropriately take into account revenues
resulting from movements in the price of securities that the banking
entity underwrites to the extent that such revenues reflect the
effectiveness with which personnel have managed underwriting risk, the
banking entity should provide compensation incentives that primarily
reward client revenues and effective client service, not proprietary
risk-taking.
    The Agencies request comment on the proposed rule's implementation
of the underwriting exemption. In particular, the Agencies request
comment on the following questions:
    Question 64. Is the proposed rule's implementation of the
underwriting exemption effective? If not, what alternative approach
would be more effective? For example, should the exemption include
other transactions that do not involve a distribution of securities for
which the banking entity is acting as underwriter?
    Question 65. Are the seven requirements included in the
underwriting exemption effective? Is the application of each
requirement to potential transactions sufficiently clear? Should any of
the requirements be changed or eliminated? Should other requirements be
added in order to better provide an exemption that is not susceptible
to abuse through the taking of speculative, proprietary positions in
the context of, or mischaracterized as, underwriting? Alternatively,
are any of the proposed requirements inappropriately restrictive in
that they would be inconsistent with the statutory exemption for
certain underwriting activities? If so, how?
    Question 66. Do underwriters currently have processes in place that
would prevent or reduce the likelihood of taking speculative,
proprietary positions in the context of, or mischaracterized as,
underwriting? If so, what are those processes?
    Question 67. Would any of the proposed requirements cause
unintended consequences? Would the proposed requirements alter current
underwriting practices in any way? Would any of the proposed
requirements trigger an unwillingness to engage in underwriting? What
impact, if any, would the proposed exemption have on capital raising?
Please explain.
    Question 68. What increased costs, if any, would underwriters incur
to satisfy the seven proposed requirements of the underwriting
exemption? Would underwriters pass the increased costs onto issuers,
selling security holders, or their customers in connection with
qualifying for the proposed exemption?
    Question 69. In addition to the specific activities highlighted
above for purposes of evaluating whether a banking entity is acting as
an underwriter as part of distribution of securities (e.g., assisting
an issuer in capital raising, performing due diligence, etc), are there
other or alternative activities that should be considered? Please
explain.
    Question 70. Should the requirement that a covered financial
position be a security be expanded to include other financial
instruments? If so, why? How are such other instruments underwritten
within the meaning of section 13(d)(1)(B) of the BHC Act?
    Question 71. Is the proposed definition of a ``distribution'' of
securities appropriate, or over- or under-inclusive in this context? Is
there any category of underwriting activity that would not be captured
by the proposed definition? If so, what are the mechanics of that
underwriting activity? Should it be permitted under the proposed rule,
and, if so, why? Would an alternative definition better identify
offerings intended to be covered by the proposed definition? If so,
what alternative definition, and why?
    Question 72. Is the proposed definition of ``underwriter''
appropriate, or over- or under-inclusive in this context? Would an
alternative definition, such as the statutory definition of
``underwriter'' under the Securities Act, better identify persons
intended to be covered by the proposed definition? If so, why?
    Question 73. How accurately can a banking entity engaging in
underwriting predict the near-term demands of clients, customers, and
counterparties with respect to an offering? How can principal risk that
is retained in connection with underwriting activities to support near-
term client demand be distinguished from positions taken for
speculative purposes?
    Question 74. Is the requirement that the underwriting activities of
a banking entity relying on the underwriting exemption be designed to
generate revenues primarily from fees, commissions, underwriting
spreads or similar income effective? If not, how should the requirement
be changed? Does the requirement appropriately capture the type and
nature of revenues typically generated by underwriting activities? Is
any further clarification or additional guidance necessary?
    Question 75. Is the requirement that the compensation arrangements
of persons performing underwriting activities at a banking entity be
designed not to reward proprietary risk-taking effective? If not, how
should the requirement be changed? Are there other types of
compensation incentives that should be clearly referenced as
consistent, or inconsistent, with permitted underwriting activity? Are
there specific and identifiable characteristics of compensation
arrangements that clearly incentivize prohibited proprietary trading?
    Question 76. Are there other types of underwriting activities that
should also be included within the scope of the underwriting exemption?
If so, what additional activities and why? How would an exemption for
such additional activities be consistent with the language and purpose
of section 13 of the BHC Act? What criteria, requirements, or
restrictions would be appropriate to include with respect to such
additional activities to prevent misuse or evasion of the prohibition
on proprietary trading?
    Question 77. Does the proposed underwriting exemption appropriately
accommodate private placements? If not, what changes are necessary to
do so?
    Question 78. The creation, offer and sale of certain structured
securities such as trust preferred securities or tender option bonds,
among others, may involve the purchase of another security and
repackaging of that security through an intermediate entity. Should the
sale of the security by a banking entity to an intermediate entity as
part of the creation of the structured security be

permitted under one of the exemptions to the prohibition on proprietary
trading currently included in the proposed rule (e.g., underwriting or
market making)? Why or why not? For purposes of determining whether an
exemption is available under these circumstances, should gain on sale
resulting from the sale of the purchased security to the intermediate
entity as part of the creation of the structured security be considered
a relevant factor? Why or why not? What other factors should be
considered in connection with the creation of the structured securities
and why? Would the analysis be different if the banking entity acquired
and retained the security to be sold to the intermediate entity as part
of the creation of the structured securities as part of its
underwriting of the underlying security? Why or why not?
    Question 79. We seek comment on the application of the proposed
exemption to a banking entity retaining a portion of an underwriting.
Please discuss whether or not firms frequently retain securities in
connection with a distribution in which the firm is acting as
underwriter. Please identify the types of offerings in which this may
be done (e.g., fixed income offerings, securitized products, etc.).
Please identify and discuss any circumstances which can contribute to
the decision regarding whether or not to retain a portion of an
offering. Please describe the treatment of retained securities (e.g.,
the time period of retention, the type of account in which securities
are retained, the potential disposition of the securities). Please
discuss whether or not the retention is documented and, if so, how.
Should the Agencies require disclosure of securities retained in
connection with underwritings? Should the Agencies require specific
documentation to demonstrate that the retained portion is connected to
an underwriting pursuant to the proposed rule? If so, what kind of
documentation should be required? Please discuss how you believe
retention should be addressed under the proposal.
b. Permitted Market Making-Related Activities
    Section --.4(b) of the proposed rule permits a banking entity to
purchase or sell a covered financial position in connection with the
banking entity's market making-related activities (the ``market-making
exemption'').
i. Approach to Implementing the Exemption for Market Making-Related
Activities.
    As the Council study noted, implementing the statutory exception
for permitted market making-related activities requires a regulatory
regime that differentiates permitted market making-related activity,
and in particular the taking of principal positions in the course of
making a market in particular financial instruments, from prohibited
proprietary trading. Although the purpose and function of these two
activities are markedly different--market making-related activities
provide intermediation and liquidity services to customers, while
proprietary trading involves the generation of profit through
speculative risk-taking--clearly distinguishing these activities may be
difficult in practice. Market making-related activities, like
prohibited proprietary trading, sometimes require the taking of
positions as principal, and the amount of principal risk that must be
assumed by a market maker varies considerably by asset class and
differing market conditions.\143\ It may be difficult to distinguish
principal positions that appropriately support market making-related
activities from positions taken for short-term, speculative purposes.
In particular, it may be difficult to determine whether principal risk
has been retained because (i) the retention of such risk is necessary
to provide intermediation and liquidity services for a relevant
financial instrument or (ii) the position is part of a speculative
trading strategy designed to realize profits from price movements in
retained principal risk.\144\
---------------------------------------------------------------------------

    \143\ With respect to certain kinds of market making-related
activities, such as market making in securities, these principal
positions are often referred to as ``inventory'' or ``inventory
positions.'' However, since certain types of market making-related
activities, such as market making in derivatives, involve the
retention of principal positions arising out of multiple derivatives
transactions in particular risks (e.g., retained principal interest
rate risk), rather than retention of actual financial instruments,
the broader term ``principal positions'' is used in this discussion.
    \144\ The Council study contains a detailed discussion of the
challenges involved in delineating prohibited proprietary trading
from permitted market making-related activities. See Council study
at 15-18.
---------------------------------------------------------------------------

    In order to address these complexities, the Agencies have proposed
a multi-faceted approach that draws on several key elements. First,
similar to the underwriting exemption, the proposed rule includes a
number of criteria that a banking entity's activities must meet in
order to rely on the exemption for market making-related activities.
These criteria are intended to ensure that the banking entity is
engaged in bona fide market making. As described in greater detail in
Part III.D of the Supplementary Information, among these criteria is
the requirement that the banking entity have in place a programmatic
compliance regime to guide its compliance with section 13 of the BHC
Act and the proposed rule. This compliance regime includes requirements
that a banking entity have effective policies, procedures, and internal
controls that are designed to ensure that prohibited proprietary
trading positions are not taken under the guise of permitted market
making-related activity. Second, as described in greater detail in Part
III.B.5 of this Supplementary Information, Appendix B of the proposed
rule contains a detailed commentary regarding how the Agencies propose
to identify permitted market making-related activities. This commentary
includes six principles the Agencies propose to use as a guide to help
distinguish market-making related activities from prohibited
proprietary trading. Third, also as described in greater detail in Part
III.B.5 of this Supplementary Information, Sec.  --.7 and Appendix A of
the proposed rule require a banking entity with significant covered
trading activities to report certain quantitative measurements for each
of its trading units.\145\ These quantitative measurements are intended
to assist both banking entities and the Agencies in assessing whether
the quantitative profile of a trading unit (e.g., the types of revenues
it generates and the risks it retains) is consistent with permitted
market making-related activities under the proposed rule.
---------------------------------------------------------------------------

    \145\ The definition of ``trading unit'' for this purpose is
discussed in detail in Part III.B.5 of this Supplementary
Information.
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    The proposal's multi-faceted approach is intended, through the
incorporation of multiple regulatory and supervisory tools, to strike
an appropriate balance in implementing the market-making exemption in a
way that articulates the scope of permitted activities and meaningfully
addresses the potential for misuse of the exemption, while not unduly
constraining the important liquidity and intermediation services that
market makers provide to their customers and to the capital markets at
large.
    The Agencies request comment on the proposed rule's approach to
implementing the exemption for permitted market making-related
activities. In particular, the Agencies request comment on the
following questions:
    Question 80. Is the proposed rule's approach to implementing the
exemption for permitted market making-related activities (i)
appropriate and (ii) likely to be effective? If not, what

alternative approach would be more appropriate or effective?
    Question 81. Does the proposed multi-faceted approach appropriately
take into account and address the challenges associated with
differentiating prohibited proprietary trading from permitted market
making-related activities? Should the approach include other elements?
If so, what elements and why? Should any of the proposed elements be
revised or eliminated? If so, why and how?
    Question 82. Does the proposed multi-faceted approach provide
banking entities and market participants with sufficient clarity
regarding what constitutes permitted market making-related activities?
If not, how could greater clarity be provided?
    Question 83. What impact will the proposed multi-faceted approach
have on the market making-related services that a banking entity
provides to its customers? How will the proposed approach impact market
participants who use the services of market makers? How will the
approach impact the capital markets at large, and in particular the
liquidity, efficiency and price transparency of capital markets? If any
of these impacts are positive, how can they be amplified? If any of
these impacts are negative, how can they be mitigated? Would the
proposed rule's prohibition on proprietary trading and exemption for
market making-related activity reduce incentives or opportunities for
banking entities to trade against customers, as opposed to trading on
behalf of customers? If so, please discuss the benefits arising from
such reduced incentives or opportunities.
    Question 84. What burden will the proposed multi-faceted approach
have on banking entities, their customers, and other market
participants? How can any burden be minimized or eliminated in a manner
consistent with the language and purpose of the statute?
    Question 85. Are there particular asset classes that raise special
concerns in the context of market making-related activity that should
be considered in connection with the proposed market-making exemption?
If so, what asset class(es) and concern(s), and how should the concerns
be addressed in the proposed exemption?
    Question 86. Are there other market making-related activities that
the rule text should more clearly permit? Why or why not?
ii. Required Criteria for Permitted Market Making-Related Activities
    As part of the proposal's multi-faceted approach to implementing
the exemption for permitted market making-related activities, Sec.
--.4(b)(2) of the proposed rule specifies seven criteria that a banking
entity's market making-related activities must meet in order to rely on
the exemption, each of which are described in detail below. These
criteria are designed to ensure that any banking entity relying on the
exemption is engaged in bona fide market making-related activities and
conducts those activities in a way that is not susceptible to abuse
through the taking of speculative, proprietary positions as a part of,
or mischaracterized as, market making-related activity.
First Criterion--Establishment of Internal Compliance Program
    Section --.4(b)(2)(i) of the proposed rule requires a banking
entity to establish a comprehensive compliance program to monitor and
control its market making-related activities. Subpart D of the proposed
rule further describes the appropriate elements of an effective
compliance program. This criterion is intended to ensure that any
banking entity relying on the market-making exemption has reasonably
designed written policies and procedures, internal controls, and
independent testing in place to support its compliance with the terms
of the exemption.
Second Criterion--Bona Fide Market Making
    Section --.4(b)(2)(ii) of the proposed rule articulates the core
element of the statutory exemption, which is that the activity must be
market making-related. In order to give effect to this requirement,
Sec.  ----.4(b)(2)(ii) of the proposed rule requires the trading desk
or other organizational unit that purchases or sells a particular
covered financial position to hold itself out as being willing to buy
and sell, or otherwise enter into long and short positions in, the
covered financial position for its own account on a regular or
continuous basis. Notably, this criterion requires that a banking
entity relying on the exemption with respect to a particular
transaction must actually make a market in the covered financial
position involved; simply because a banking entity makes a market in
one type of covered financial position does not permit it to rely on
the market-making exemption for another type of covered financial
position.\146\ Similarly, the particular trading desk or other
organizational unit of the banking entity that is relying on the
exemption for a particular type of covered financial position must also
be the trading desk or other organizational unit that is actually
making the market in that covered financial position; market making in
a particular covered financial position by one trading desk of a
banking entity does not permit another trading desk of the banking
entity to rely on the market-making exemption for that type of covered
financial position.
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    \146\ The Agencies note that a market maker may often make a
market in one type of covered financial positions and hedge its
activities using different covered financial positions in which it
does not make a market. Such hedging transactions would meet the
terms of the market-making exemption if the hedging transaction met
the requirements of Sec.  --.4(b)(3) of the proposed rule.
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    The language used in Sec.  --.4(b)(2)(ii) of the proposed rule to
describe bona fide market making-related activity is similar to the
definition of ``market maker'' under section 3(a)(38) of the Exchange
Act.\147\ The Agencies have proposed to use similar language because
the Exchange Act definition is generally well-understood by market
participants and is consistent with the scope of bona fide market
making-related activities in which banking entities typically engage.
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    \147\ Section 3(a)(38) of the Exchange Act defines ``market
maker'' as ``any specialist permitted to act as a dealer, any dealer
acting in the capacity of block positioner, and any dealer who, with
respect to a security, holds himself out (by entering quotations in
an inter-dealer quotation communications system or otherwise) as
being willing to buy and sell such security for his own account on a
regular or continuous basis.'' 15 U.S.C. 78c(a)(38).
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    In assessing whether a particular trading desk or other
organizational unit holds itself out as being willing to buy and sell,
or otherwise enter into long and short positions in, a covered
financial position for its own account on a regular or continuous basis
in liquid markets, the Agencies expect to take an approach similar to
that used by the SEC in the context of assessing whether a person is
engaging in bona fide market making. The precise nature of a market
maker's activities often varies depending on the liquidity, trade size,
market infrastructure, trading volumes and frequency, and geographic
location of the market for any particular covered financial position.
In the context of relatively liquid positions, such as equity
securities or other exchange-traded instruments, a trading desk or
other organizational unit's market making-related activity should
generally include:
     Making continuous, two sided quotes and holding oneself
out as willing to buy and sell on a continuous basis;
     A pattern of trading that includes both purchases and
sales in roughly comparable amounts to provide liquidity;

     Making continuous quotations that are at or near the
market on both sides; and
     Providing widely accessible and broadly disseminated
quotes.\148\
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    \148\ The Agencies note that these indicia are generally
consistent with the indicia of bona fide market making in equity
markets articulated by the SEC for purposes of describing the
exception to the locate requirement of the SEC's Regulation SHO for
market makers engaged in bona fide market-making activities. See
Exchange Act Release No. 58775 (October 14, 2008), 73 FR 61690,
61698-61699 (Oct. 17, 2008); see also 17 CFR 242.203(b)(2)(iii).
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    In less liquid markets, such as over-the-counter markets for debt
and equity securities or derivatives, the appropriate indicia of market
making-related activities will vary, but should generally include:
     Holding oneself out as willing and available to provide
liquidity by providing quotes on a regular (but not necessarily
continuous) basis; \149\
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    \149\ The frequency of such regular quotations will itself vary;
less illiquid markets may involve quotations on a daily or more
frequent basis, while highly illiquid markets may trade only by
appointment.
---------------------------------------------------------------------------

     With respect to securities, regularly purchasing covered
financial positions from, or selling the positions to, clients,
customers, or counterparties in the secondary market; and
     Transaction volumes and risk proportionate to historical
customer liquidity and investments needs.\150\
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    \150\ The Agencies also note that the CFTC and SEC have
identified, in a proposed rule further defining the terms ``swap
dealer'' and ``security-based swap dealer'' under the Commodity
Exchange Act and Exchange Act, a variety of distinguishing
characteristics of swap dealers and security-based swap dealers in
the context of derivatives, including that: (i) Dealers tend to
accommodate demand for swaps and security-based swaps from other
parties; (ii) dealers are generally available to enter into swaps or
security-based swaps to facilitate other parties' interest in
entering into those instruments; (iii) dealers tend not to request
that other parties propose the terms of swaps or security-based
swaps, but instead tend to enter into those instruments on their own
standard terms or on terms they arrange in response to other
parties' interest; and (iv) dealers tend to be able to arrange
customized terms for swaps or security-based swaps upon request, or
to create new types of swaps or security-based swaps at the dealer's
own initiative. See 75 FR 80174, 80176 (Dec. 21, 2010).
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    The Agencies would apply these indicia when evaluating when a
banking entity is eligible for the market making-related activities
exemption, but also recognize that these indicia cannot be applied at
all times and under all circumstances because some may be inapplicable
to the specific asset class or market in which the market making
activity is conducted.
    The bona fide market making-related activity described in Sec.
--.4(b)(2)(ii) of the proposed rule would include block positioning if
undertaken by a trading desk or other organizational unit of a banking
entity for the purpose of intermediating customer trading.\151\ In
addition, bona fide market making-related activity may include taking
positions in securities in anticipation of customer demand, so long as
any anticipatory buying or selling activity is reasonable and related
to clear, demonstrable trading interest of clients, customers, or
counterparties.
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    \151\ The definition of ``market maker'' in the Exchange Act
includes a dealer acting in the capacity of a block positioner.
Although the term ``block positioner'' is not defined in the
proposed rule, the Agencies note that the SEC has adopted a
definition of ``qualified block positioner'' in the SEC's Rule 3b-
8(c) (17 CFR 240.3b-8(c)), which may serve as guidance in
determining whether a block positioner engaged in block positioning
is engaged in bona fide market making-related activities for
purposes of Sec.  --.4(b)(2)(ii) of the proposed rule. Under the
SEC's Rule 3b-8(c), among other things, a qualified block positioner
must meet all of the following conditions: (i) Engages in the
activity of purchasing long or selling short, from time to time,
from or to a customer (other than a partner or a joint venture or
other entity in which a partner, the dealer, or a person associated
with such dealer participates) a block of stock with a current
market value of $200,000 or more in a single transaction, or in
several transactions at approximately the same time, from a single
source to facilitate a sale or purchase by such customer; (ii) has
determined in the exercise of reasonable diligence that the block
could not be sold to or purchased from others on equivalent or
better terms; and (iii) sells the shares comprising the block as
rapidly as possible commensurate with the circumstances. The
Agencies note that the rule establishes a minimum dollar value
threshold for a block. The size of a block will vary among different
asset classes.
---------------------------------------------------------------------------

Third Criterion--Reasonably Expected Near-Term Demands of Clients,
Customers, and Counterparties
    Under Sec.  --.4(b)(2)(iii) of the proposed rule, the market
making-related activities of the trading desk or other organization
unit that conducts a transaction in reliance on the market-making
exemption must be designed not to exceed the reasonably expected near-
term demands of clients, customers, and counterparties. This criterion
implements the language in section 13(d)(1)(B) of the BHC Act and is
intended to prevent a trading desk relying on the market-making
exemption from taking a speculative proprietary position unrelated to
customer needs as part of its purported market making-related
activities. As described in further detail in Parts III.B.5 and III.D
of the Supplementary Information, the proposed rule also includes a
programmatic compliance requirement and requires reporting of
quantitative measurements for certain banking entities, both of which
are designed, in part, to meaningfully circumscribe the principal
positions taken as part of market making-related activities to those
which are necessary to meet the reasonably expected near-term demands
of clients, customers, and counterparties. The Agencies expect that the
programmatic compliance requirement and required reporting of
quantitative measurements will play an important role in assessing a
banking entity's compliance with Sec.  --.4(b)(2)(iii)'s requirement.
In addition, as described in Part II.B.5 of the Supplementary
Information, Appendix B of the proposed rule provides additional,
detailed commentary regarding how the Agencies expect a firm relying on
the market-making exemption to manage principal positions and how the
Agencies propose to assess whether such positions are consistent with
market making-related activities under the proposed rule.
    In order for a banking entity's expectations regarding near-term
customer demand to be considered reasonable, such expectations should
be based on more than a simple expectation of future price appreciation
and the generic increase in marketplace demand that such price
appreciation reflects. Rather, a banking entity's expectation should
generally be based on the unique customer base of the banking entity's
specific market-making business lines and the near-term demands of
those customers based on particular factors beyond a general
expectation of price appreciation. To the extent that a trading desk or
other organizational unit of a banking entity is engaged wholly or
principally in trading that is not in response to, or driven by,
customer demands, the Agencies would not expect those activities to
qualify under Sec.  --.4(b) of the proposed rule, regardless of whether
those activities promote price transparency or liquidity. For example,
a trading desk or other organizational unit of a banking entity that is
engaged wholly or principally in arbitrage trading with non-customers
would not meet the terms of the proposed rule's market making
exemption. In the case of a market maker engaging in market making in a
security that is executed on an organized trading facility or exchange,
that market maker's activities are generally consistent with reasonably
expected near-term customer demand when such activities involve
passively providing liquidity by submitting resting orders that
interact with the orders of others in a non-directional or market-
neutral trading strategy and the market maker is registered, if the
exchange or organized trading facility

registers market makers.\152\ However, activities by such a person that
primarily takes liquidity on an organized trading facility or exchange,
rather than provides liquidity, would not qualify for the market-making
exemption under the proposed rule, even if those activities were
conducted by a registered market maker.
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    \152\ The Agencies emphasize that 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). however, being a registered market maker
is required under these circumstances if the applicable exchange or
organized trading facility registers market makers. 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.
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Fourth Criterion--Registration Under Securities or Commodities Laws
    Under Sec.  --.4(b)(2)(iv) of the proposed rule, a banking entity
relying on the market-making exemption with respect to trading in
securities or certain derivatives must be appropriately registered as a
dealer, or exempt from registration or excluded from regulation as a
dealer, under applicable securities or commodities laws. With respect
to a market-making transaction in one or more covered financial
positions that are securities, other than exempted securities,
security-based swaps, commercial paper, bankers acceptances or
commercial bills, for which a person must be a registered securities
dealer, municipal securities dealer or government securities dealer in
order to deal in the security, the banking entity must have the
appropriate dealer registration (or in the case of a financial
institution that is a government securities dealer, has filed notice of
that status as required by section 15C(a)(1)(B) of the Exchange Act) or
otherwise be exempt from registration or excluded from regulation as a
dealer.\153\ Similarly, with respect to a market-making transaction
involving a swap or security-based swap for which a person must
generally be a registered swap dealer or security-based swap dealer,
respectively, the banking entity must be appropriately registered or
otherwise be exempt from registration or excluded from regulation as a
swap dealer or security-based swap dealer.\154\ If the banking entity
is engaged in the business of a securities dealer, swap dealer or
security-based swap dealer outside the United States in a manner for
which no U.S. registration is required, the banking entity must be
subject to substantive regulation of its dealing business in the
jurisdiction in which the business is located. This requirement is
intended to ensure that (i) any market making-related activity
conducted in reliance on the exemption is subject to appropriate
regulation and (ii) a banking entity does not simultaneously
characterize the transaction as market making-related for purposes of
the exemption while characterizing it in a different manner for
purposes of applicable securities or commodities laws.
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    \153\ See proposed rule Sec. Sec.  --.4(b)(2)(iv)(A), (D), (E).
For example, if a banking entity is a bank engaged in market-making
in qualified Canadian government obligations for which it would be
required to register as a securities dealer but for the exclusion
contained in section 3(a)(5)(C)(i)(I) of the Exchange Act, the
proposed rule would not require that banking entity to be a
registered securities dealer in order to rely on the market-making
exemption for that market-making transaction. Such a bank would,
however, be required to file notice that it is a government
securities dealer and comply with rules applicable to financial
institutions that are government securities dealers. See 15 U.S.C.
78c(a)(42)(E); 15 U.S.C. 78o-5(a)(1)(B); 17 CFR 400.5(b); 17 CFR
449.1. Similar to the underwriting exemption, the proposed rule does
not apply the dealer registration requirement to market making in
securities that are exempted securities, commercial paper, bankers
acceptances or commercial bills because dealing in such securities
does not require registration as securities dealer under the
Exchange Act; however, registering as a municipal securities dealer
or government securities dealer is required, if applicable.
    \154\ See proposed rule Sec. Sec.  --.4(b)(2)(iv)(B), (C). A
banking entity may be required to be a registered securities dealer
if it engages in market-making transactions involving security-based
swaps with persons that are not eligible contract participants. See
15 U.S.C. 78c(a)(5) (the definition of ``dealer'' in section 3(a)(5)
of the Exchange Act, 15 U.S.C. 78c(a)(5), generally includes ``any
person engaged in the business of buying and selling securities (not
including security-based swaps, other than security-based swaps with
or for persons that are not eligible contract participants), for
such person's own account.'').
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Fifth Criterion--Revenues From Fees, Commissions, Bid/Ask Spreads or
Other Similar Income
    Under Sec.  --.4(b)(2)(v) of the proposed rule, the market making-
related activities of the banking entity must be designed to generate
revenues primarily from fees, commissions, bid/ask spreads or other
income not attributable to appreciation in the value of covered
financial positions it holds in trading accounts or the hedging of such
positions. This criterion is intended to ensure that activities
conducted in reliance on the market-making exemption demonstrate
patterns of revenue generation and profitability consistent with, and
related to, the intermediation and liquidity services a market maker
provides to its customers, rather than changes in the market value of
the positions or risks held in inventory. Similar to the requirement
that a firm relying on the market-making exemption design its
activities not to exceed reasonably expected near-term client,
customer, or counterparty demands, the Agencies expect that the
programmatic compliance requirement and required reporting of
quantitative measurements will play an important role in assessing a
banking entity's compliance with Sec.  --.4(b)(2)(v)'s requirement. In
addition, as described in Part III.B.5 of this Supplementary
Information, Appendix B of the proposed rule provides additional,
detailed commentary regarding how the Agencies propose to assess
whether the types of revenues generated by a banking entity relying on
the market-making exemption are consistent with market making-related
activities.
Sixth Criterion--Compensation Incentives
    Under Sec.  --.4(b)(2)(vii) of the proposed rule, the compensation
arrangements of persons performing market making-related activities at
the banking entity must be designed not to encourage or reward
proprietary risk-taking. Activities for which a banking entity has
established a compensation incentive structure that rewards speculation
in, and appreciation of, the market value of a covered financial
position held in inventory, rather than success in providing effective
and timely intermediation and liquidity services to customers, are
inconsistent with permitted market making-related activities. Although
a banking entity relying on the market-making exemption may
appropriately take into account revenues resulting from movements in
the price of principal positions to the extent that such revenues
reflect the effectiveness with which personnel have managed principal
risk retained, a banking entity relying on the market-making exemption
should provide compensation incentives that primarily reward customer
revenues and effective customer service, not proprietary risk-taking.
In addition, as described in Part III.B.5 of this Supplementary
Information, Appendix B of the proposed rule provides further
commentary regarding how the Agencies propose to assess whether the
compensation incentives provided to trading personnel performing
trading activities in reliance on the market-making exemption are
consistent with market making-related activities.

Seventh Criterion--Consistency With Appendix B Commentary
    Under Sec.  --.4(b)(2)(vi) of the proposed rule, the market making-
related activities of the trading desk or other organizational unit
that conducts the purchase or sale are required to be consistent with
the commentary provided in Appendix B, which provides guidance that the
Agencies propose to apply to help distinguish permitted market making-
related activities from prohibited proprietary trading. Appendix B's
proposed commentary, which is described in detail below in Part III.B.5
of this Supplementary Information, discusses various factors by which
the Agencies propose to distinguish prohibited proprietary trading from
permitted market making-related activities (e.g., how and to what
extent a market maker hedges the risk of its market-making
transactions, including (i) further detail related directly to other
criteria in Sec.  --.4(b)(2) (e.g., the types of revenues generated by
market makers), and (ii) expectations regarding other factors not
expressly included in Sec.  --.4(b)(2)).

B. Market Making-Related Hedging

    Section --.4(b)(3) of the proposed rule provides that certain
hedging transactions related to market-making positions and holdings
will also be deemed to be made in connection with a banking entity's
market making-related activities for purposes of the market-making
exemption. In particular, Sec.  --.4(b)(3) provides that the purchase
or sale of a covered financial position for hedging purposes will
qualify for the market-making exemption if it meets two requirements.
First, the purchase or sale must be conducted in order to reduce the
specific risks to the banking entity in connection with and related to
individual or aggregated positions, contracts, or other holdings
acquired pursuant to the market-making exemption. Where the purpose of
a transaction is to hedge a market making-related position, it would
appear to be market making-related activity of the type described in
section 13(d)(1)(B) of the BHC Act. Second, the hedging transaction
must also meet the criteria specified in the general exemption for
risk-mitigating hedging activity for purposes of the proprietary
trading prohibition, which is contained in Sec. Sec.  --.5(b) and (c)
of the proposed rule and described in detail in Part III.B.3 of this
Supplementary Information. Those criteria are intended to clearly
define the scope of appropriate risk-mitigating hedging activities, to
foreclose reliance on the exemption for prohibited proprietary trading
that is conducted in the context of, or mischaracterized as, hedging
activity, and to require documentation regarding the hedging purpose of
certain transactions that are established at a level of organization
that is different than the level of organization establishing or
responsible for the underlying risk or risks that are being hedged,
which in the context of the market making-related activity would
generally be the trading desk.
iii. Request for Comment
    The Agencies request comment on the proposed criteria that must be
met in order to rely on the market-making exemption. In particular, the
Agencies request comment on the following questions (as well as related
questions in Part III.B.5 of this Supplementary Information):
    Question 87. Are the seven criteria included in the market-making
exemption effective? Is the application of each criterion to potential
transactions sufficiently clear? Should any of the criteria be changed
or eliminated? Should other criteria be added?
    Question 88. Is incorporation of concepts from the definition of
``market maker'' under the Exchange Act useful for purposes of section
13 of the BHC Act and consistent with its purposes? If not, what
alternative definition would be more useful or more consistent?
    Question 89. Is the proposed exemption overly broad or narrow? For
example, would it encompass activity that should be considered
prohibited proprietary trading under the proposed rule? Alternatively,
would it prohibit forms of market making or market making-related
activities that are permitted under other rules or regulations?
    Question 90. We seek commenter input on the types of banking
entities and forms of activities that would not qualify for the
proposed market-making exemption but that commenters consider to
otherwise be market making. Please discuss the impact of not permitting
such activities under the proposed exemption (e.g., the impact on
liquidity).
    Question 91. Is the requirement that a trading desk or other
organizational unit relying on the market-making exemption hold itself
out as being willing to buy and sell, or otherwise enter into long and
short positions in, the relevant covered financial position for its own
account on a regular or continuous basis effective? If not, what
alternative would be more effective? Does the proposed requirement
appropriately differentiate between market making-related activities in
different markets and asset classes? If not, how could such differences
be better reflected? Should the requirement be modified to include
certain arbitrage trading activities engaged in by market makers that
promote liquidity or price transparency, but do not serve customer,
client or counterparty demands, within the scope of market making-
related activity? If so why? How could such liquidity- or price
transparency-promoting activities be meaningfully identified and
distinguished from prohibited proprietary trading practices that also
may incidentally promote liquidity or price transparency? Do particular
markets or instruments, such as the market for exchange-traded funds,
raise particular issues that are not adequately or appropriately
addressed in the proposal? If so, how could the proposal better address
those instruments, markets or market features?
    Question 92. Do the proposed indicia of market making in liquid
markets accurately reflect the factors that should generally be used to
analyze whether a banking entity is engaged in market making-related
activities for purposes of section 13 of the BHC Act and the proposed
rule? If not, why not? Should any of the proposed factors be eliminated
or modified? Should any additional factors be included? Is reliance on
the SEC's indicia of bona fide market making for purposes of Regulation
SHO under the Exchange Act and the equity securities market appropriate
in the context of section 13 of the BHC Act and the proposed rule with
respect to liquid markets? If not, why not?
    Question 93. Do the proposed indicia of market making in illiquid
markets accurately reflect the factors that should generally be used to
analyze whether a banking entity is engaged in market making-related
activities for purposes of section 13 of the BHC Act and the proposed
rule? If not, why not? Should any of the proposed factors be eliminated
or modified? Should any additional factors be included?
    Question 94. How accurately can a banking entity predict the near-
term demands of clients, customers, and counterparties? Are there
measures that can distinguish the amount of principal risk that should
be retained to support such near-term client, customer, or counterparty
demand from positions taken for speculative purposes? How is client,
customer, or counterparty demand anticipated in connection with market
making-related activities, and how does such approach vary by asset
class?

    Question 95. Is the requirement that a banking entity relying on
the market-making exemption be registered as a dealer (or in the case
of a financial institution that is a government securities dealer, has
filed notice of that status as required by section 15C(a)(1)(B) of the
Exchange Act), or exempt from registration or excluded from regulation
as a dealer under relevant securities or commodities laws effective? If
not, how should the requirement be changed? Does the requirement
appropriately take into account the particular registration
requirements applicable to dealing in different types of financial
instruments? If not, how could it better do so? Does the requirement
appropriately take into account the various registration exemptions and
exclusions available to certain entities, such as banks, under the
securities and commodities laws? If not, how could it better do so?
    Question 96. Is the requirement that a trading desk or other
organizational unit of a banking entity relying on the market-making
exemption be designed to generate revenues primarily from fees,
commissions, bid/ask spreads or similar income effective? If not, how
should the requirement be changed? Does the requirement appropriately
capture the type and nature of revenues typically generated by market
making-related activities? Is any further clarification or additional
guidance necessary? Can revenues primarily from fees, commissions, bid/
ask spreads or similar income be meaningfully separated from other
types of revenues?
    Question 97. Is the requirement that the compensation arrangements
of persons performing market making-related activities at a banking
entity not be designed to encourage proprietary risk-taking effective?
If not, how should the requirement be changed? Are there other types of
compensation incentives that should be clearly referenced as
consistent, or inconsistent, with permitted market making-related
activity? Are their specific and identifiable characteristics of
compensation arrangements that clearly incentivize prohibited
proprietary trading?
    Question 98. Is the inclusion of market making-related hedging
transactions within the market-making exemption effective and
appropriate? Are the proposed requirements that certain hedging
transactions must meet in order to be considered to have been made in
connection with market making-related activity effective and
sufficiently clear? If not, what alternative requirements would be more
effective and/or clearer? Should any of the proposed requirements be
eliminated? If so, which ones, and why?
    Question 99. Should the terms ``client,'' ``customer,'' or
``counterparty'' be defined for purposes of the market-making
exemption? If so, how should these terms be defined? For example, would
an appropriate definition of ``customer'' be: (i) A continuing
relationship in which the banking entity provides one or more financial
products or services prior to the time of the transaction; (ii) a
direct and substantive relationship between the banking entity and a
prospective customer prior to the transaction; (iii) a relationship
initiated by the banking entity to a prospective customer to induce
transactions; or (iv) a relationship initiated by the prospective
customer with a view to engaging in transactions?
    Question 100. Are there other types of market making-related
activities that should also be included within the scope of the market-
making exemption? If so, what additional activities and why? How would
an exemption for such additional activities be consistent with the
language and intent of section 13 of the BHC Act? What criteria,
requirements, or restrictions would be appropriate to include with
respect to such additional activities? How would such criteria,
requirements, or restrictions prevent circumvention or evasion of the
prohibition on proprietary trading?
    Question 101. Do banking entities currently have processes in place
that would prevent or reduce the likelihood of taking speculative,
proprietary positions in the context of, or mischaracterized as, market
making-related activities? If so, what processes?
3. Section --.5: Permitted Risk-Mitigating Hedging Activities
    Section --.5 of the proposed rule permits a banking entity to
purchase or sell a covered financial position if the transaction is
made in connection with, and related to, individual or aggregated
positions, contracts, or other holdings of a banking entity and is
designed to reduce the specific risks to the banking entity in
connection with and related to such positions, contracts, or other
holdings (the ``hedging exemption''). This section of the proposed rule
implements, in relevant part, section 13(d)(1)(C) of the BHC Act, which
provides an exemption from the prohibition on proprietary trading for
certain risk-mitigating hedging activities.
a. Approach to Implementing the Hedging Exemption
    Like market making-related activities, risk-mitigating hedging
activities present certain implementation challenges because of the
potential that prohibited proprietary trading could be conducted in the
context of, or mischaracterized as, a hedging transaction. This is
because it may often be difficult to identify in retrospect whether a
banking entity engaged in a particular transaction to manage or
eliminate risks arising from related positions, on the one hand, or to
profit from price movements related to the hedge position itself, on
the other. The intent with which a purported hedge position is acquired
may often be difficult to discern in practice.
    In light of these complexities, the Agencies have again proposed a
multi-faceted approach to implementation. As with the underwriting and
market-making exemptions, the Agencies have proposed a set of criteria
that must be met in order for a banking entity to rely on the hedging
exemption. The proposed criteria are intended to define the scope of
permitted risk-mitigating hedging activities and to foreclose reliance
on the exemption for prohibited proprietary trading that is conducted
in the context of, or mischaracterized as, permitted hedging activity.
This includes implementation of the programmatic compliance regime
required under subpart D of the proposed rule and, in particular,
requires that a banking entity with significant trading activities
implement robust, detailed hedging policies and procedures and related
internal controls that are designed to prevent prohibited proprietary
trading in the context of permitted hedging activity.\155\ In
particular, a banking entity's compliance regime must include written
hedging policies at the trading unit level and clearly articulated
trader mandates for each trader to ensure that the decision of when and
how to put on a hedge is consistent with such policies and mandates,
and not fully left to a trader's discretion.\156\ In addition, to
address potential supervisory concerns raised by certain types of
hedging transactions, Sec.  --.5 of the proposed rule also requires a
banking entity to document certain hedging transactions at the time the
hedge is established. This multi-faceted approach is intended to
articulate the Agencies' expectations regarding the scope of permitted
risk-

mitigating hedging activities in a manner that limits potential abuse
of the hedging exemption while not unduly constraining the important
risk management function that is served by a banking entity's hedging
activities.
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    \155\ These aspects of the compliance program requirement are
described in further detail in Part III.D of this Supplementary
Information.
    \156\ See, e.g., proposed rule Appendix C.II.a.
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b. Required Criteria for Permitted Risk-Mitigating Hedging Activitiesm
    Section --.5(b) of the proposed rule describes the seven criteria
that a banking entity must meet in order to rely on the hedging
exemption. First, Sec.  --.5(b)(1) of the proposed rule requires the
banking entity to have established an internal compliance program,
consistent with the requirements of subpart D, that is designed to
ensure the banking entity's compliance with the requirements of this
paragraph, including reasonably-designed written policies and
procedures, internal controls, and independent testing. This criterion
is intended to ensure that any banking entity relying on the exemption
has appropriate internal control processes in place to support its
compliance with the terms of the exemption.
    Second, Sec.  --.5(b)(2)(i) of the proposed rule requires that a
transaction for which a banking entity is relying on the hedging
exemption have been made in accordance with written policies,
procedures and internal controls established by the banking entity
pursuant to subpart D. This criterion would preclude reliance on the
hedging exemption if the transaction was inconsistent with a banking
entity's own hedging policies and procedures, as such inconsistency
would appear to be indicative of prohibited proprietary trading.
    Third, Sec.  --.5(b)(2)(ii) of the proposed rule requires that the
transaction hedge or otherwise mitigate one or more specific risks,
including market risk, counterparty or other credit risk, currency or
foreign exchange risk, interest rate risk, basis risk, or similar
risks, arising in connection with and related to individual or
aggregated positions, contracts, or other holdings of a banking entity.
This criterion implements the essential element of the hedging
exemption--i.e., that the transaction be risk-mitigating. Notably, and
consistent with the statutory reference to mitigating risks of
individual or aggregated positions, this criterion would include the
hedging of risks on a portfolio basis. For example, it would include
the hedging of one or more specific risks arising from a portfolio of
diverse holdings, such as the hedging of the aggregate risk of one or
more trading desks. However, in each case, the Agencies would expect
that the transaction or series of transactions being used to hedge is,
in the aggregate, demonstrably risk-reducing with respect to the
positions, contracts, or other holdings that are being hedged. A
banking entity relying on the exemption should be prepared to identify
the specific position or portfolio of positions that is being hedged
and demonstrate that the hedging transaction is risk-reducing in the
aggregate, as measured by appropriate risk management tools.
    In addition, this criterion would include a series of hedging
transactions designed to hedge movements in the price of a portfolio of
positions. For example, a banking entity may need to engage in dynamic
hedging, which involves rebalancing its current hedge position(s) based
on a change in the portfolio resulting from permissible activities or
from a change in the price, or other characteristic, of the individual
or aggregated positions, contracts, or other holdings. The Agencies
recognize that, in such dynamic hedging, material changes in risk may
require a corresponding modification to the banking entity's current
hedge positions.\157\
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    \157\ This corresponding modification to the hedge should also
be reasonably correlated to the material changes in risk that are
intended to be hedged or otherwise mitigated, as required by
proposed rule Sec.  --.5(b)(2)(iii).
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    The Agencies also expect that a banking entity relying on the
exemption would be able to demonstrate that the banking entity is
already exposed to the specific risks being hedged; generally, the
purported hedging of risks to which the banking entity is not actually
exposed would not meet the terms of the exemption. However, the hedging
exemption would be available in certain cases where the hedge is
established slightly before the banking entity becomes exposed to the
underlying risk if such anticipatory hedging activity: (i) Is
consistent with appropriate risk management practices; (ii) otherwise
meets the terms of the hedging exemption; and (iii) does not involve
the potential for speculative profit. For example, if a banking entity
was contractually obligated, or otherwise highly likely, to become
exposed to a particular risk and there was a sound risk management
rationale for hedging that risk slightly in advance of actual exposure,
the hedging transaction would generally be consistent with the
requirement described in Sec.  --.5(b)(2)(ii) of the proposed rule.
    Fourth, Sec.  --.5(b)(2)(iii) of the proposed rule requires that
the transaction be reasonably correlated, based upon the facts and
circumstances of the underlying and hedging positions and the risks and
liquidity of those positions, to the risk or risks the transaction is
intended to hedge or otherwise mitigate. A transaction that is only
tangentially related to the risks that it purportedly mitigates would
appear to be indicative of prohibited proprietary trading. Importantly,
the Agencies have not proposed that a transaction relying on the
hedging exemption be fully correlated; instead, only reasonable
correlation is required.\158\ The degree of correlation that may be
reasonable will vary depending on the underlying risks and the
availability of alternative hedging options--risks that can be easily
and cost-effectively hedged with extremely high or near-perfect
correlation would typically be expected to be so hedged, whereas other
risks may be difficult or impossible to hedge with anything greater
than partial correlation. Moreover, it is important to consider the
fact that trading positions are often subject to a number of different
risks, and some risks may be hedged easily and at low cost but may only
account for a small proportion of the total risk in the position.\159\
More generally, potential correlation levels between asset classes can
differ significantly, and analysis of the reasonableness of correlation
would depend on the facts and circumstances of the initial position(s),
risk(s) created, liquidity of the instrument, and the legitimacy of the
hedge. Regardless of the precise degree of correlation, if the
predicted performance of a hedge position during the period that the
hedge position and the related position are held would result in a
banking entity earning appreciably more profits on the hedge position
than it stood to lose on the related position, the hedge would appear
likely to be a proprietary trade designed to result in profit rather
than an exempt hedge position.
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    \158\ Although certain accounting standards, such as FASB ASC
Topic 815 hedge accounting, address circumstances in which a
transaction may be considered a hedge of another transaction, the
proposed rule does not refer to or rely on these accounting
standards, because such standards (i) are designed for financial
statement purposes, not to identify proprietary trading and (ii)
change often and are likely to change in the future without
consideration of the potential impact on section 13 of the BHC Act.
    \159\ Interest rate risk in an equity derivative transaction is
one example--the hedging of interest rate risk in an equity
derivative position may only result in a small reduction in overall
risk and interest rates may only exhibit a small correlation with
the value of the equity derivative, but the lack of perfect or
significant correlation would not impair reliance on the hedging
exemption.
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    Fifth, Sec.  --.5(b)(2)(iv) of the proposed rule requires that the
hedging transaction not give rise, at the

inception of the hedge, to significant exposures that are not
themselves hedged in a contemporaneous transaction. A transaction that