\166\ The Agencies believe this should help address commenters'
concerns about the burdens associated with rebutting the
presumption. See ABA (Keating); AllianceBernstein; Capital Group;
Japanese Bankers Ass'n.; Liberty Global; JPMC; NAIB et al.; Capital
Group.
---------------------------------------------------------------------------

    The final rule provides three clarifying changes to the proposed
rebuttable presumption. First, in response to comments, the final rule
replaces the reference to an ``account'' that is presumed to be a
trading account with the purchase or sale of a ``financial
instrument.'' \167\ This change clarifies that the presumption only
applies to the purchase or sale of a financial instrument that is held
for fewer than 60 days, and not the entire account that is used to make
the purchase or sale. Second, the final rule clarifies that basis
trades, in which a banking entity buys one instrument and sells a
substantially similar instrument (or otherwise transfers the first
instrument's risk), are subject to the rebuttable presumption.\168\
Third, in order to maintain consistency with definitions used
throughout the final rule, the references to ``acquire'' or ``take'' a
financial position have been replaced with references to ``purchase''
or ``sell'' a financial instrument.\169\
---------------------------------------------------------------------------

    \167\ See, e.g., ABA (Keating); Clearing House Ass'n.; JPMC.
    \168\ The rebuttable presumption covered these trades in the
proposal, but the final rule's use of ``financial instrument''
rather than ``covered financial position'' necessitated clarifying
this point in the rule text. See final rule Sec.  .3(b)(2). See also
Public Citizen.
    \169\ The Agencies do not believe these revisions have a
substantive effect on the operation or scope of the final rule in
comparison to the statute or proposed rule.

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

c. Definition of ``Financial Instrument''
    Section 13 of the BHC Act generally prohibits proprietary trading,
which is defined in section 13(h)(4) to mean engaging as principal for
the trading account in any purchase or sale of any security, any
derivative, any contract of sale of a commodity for future delivery,
any option on any such security, derivative, or contract, or any other
security or financial instruments that the Agencies may, by rule,
determine.\170\ The proposed rule defined the term ``covered financial
position'' to reference the instruments listed in section 13(h)(4),
including: (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.\171\ To provide additional clarity, the proposed rule also
provided that, consistent with the statute, any position that is itself
a loan, a commodity, or foreign exchange or currency was not a covered
financial position.\172\
---------------------------------------------------------------------------

    \170\ See 12 U.S.C. 1851(h)(4).
    \171\ See proposed rule Sec.  .3(c)(3)(i).
    \172\ See proposed rule Sec.  .3(c)(3)(ii).
---------------------------------------------------------------------------

    The proposal also defined a number of other terms used in the
definition of covered financial position, including commodity,
derivative, loan, and security.\173\ These terms were generally defined
by reference to the federal securities laws or the Commodity Exchange
Act because these existing definitions are generally well-understood by
market participants and have been subject to extensive interpretation
in the context of securities, commodities, and derivatives trading.
---------------------------------------------------------------------------

    \173\ See proposed rule Sec.  .2(l), (q), (w); Sec.  .3(c)(1)
and (2).
---------------------------------------------------------------------------

    As noted above, the proposed rule included derivatives within the
definition of covered financial position. Derivative was defined to
include any swap (as that term is defined in the Commodity Exchange
Act) and 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.\174\
The proposed rule also included 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 purpose of section 13 of the BHC Act.
Specifically, the proposed definition also included: (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); \175\ (iii) any agreement, contract, or
transaction in foreign currency described in section 2(c)(2)(C)(i) of
the Commodity Exchange Act; \176\ (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; \177\ and (v) any
transactions authorized under section 19 of the Commodity Exchange
Act.\178\ In addition, the proposed rule excluded from the definition
of derivative (i) 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 or security-based swap, and (ii) 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)).
---------------------------------------------------------------------------

    \174\ See 7 U.S.C. 1a(47) (defining ``swap''); 15 U.S.C.
78c(a)(68) (defining ``security-based swap'').
    \175\ 7 U.S.C. 1a(24), (25).
    \176\ 7 U.S.C. 2(c)(2)(C)(i).
    \177\ 7 U.S.C. 2(c)(2)(D)(i).
    \178\ 7 U.S.C. 23.
---------------------------------------------------------------------------

    Commenters expressed a variety of views regarding the definition of
covered financial position, as well as other defined terms used in that
definition. For instance, some commenters argued that the definition
should be expanded to include transactions in spot commodities or
foreign currency, even though those instruments are not included by the
statute.\179\ Other commenters strongly supported the exclusion of spot
commodity and foreign currency transactions as consistent with the
statute, arguing that these instruments are part of the traditional
business of banking and do not represent the types of instruments that
Congress designed section 13 to address. These commenters argued that
including spot commodities and foreign exchange within the definition
of covered financial position in the final rule would put U.S. banking
entities at a competitive disadvantage and prevent them from conducting
routine banking operations.\180\ One commenter argued that the proposed
definition of covered financial position was effective and recommended
that the definition should not be expanded.\181\ Another commenter
argued that an instrument be considered to be a spot foreign exchange
transaction, and thus not a covered financial position, if it settles
within 5 days of purchase.\182\ Another commenter argued that covered
financial positions used in interaffiliate transactions should
expressly be excluded because they are used for internal risk
management purposes and not for proprietary trading.\183\
---------------------------------------------------------------------------

    \179\ See Sens. Merkley & Levin (Feb. 2012); Public Citizen;
Occupy.
    \180\ See Northern Trust; Morgan Stanley; JPMC; Credit Suisse
(Seidel); Am. Express; See also AFR et al. (Feb. 2012) (arguing that
the final rule should explicitly exclude ``spot'' commodities and
foreign exchange).
    \181\ See Alfred Brock.
    \182\ See Credit Suisse (Seidel).
    \183\ See GE (Feb. 2012).
---------------------------------------------------------------------------

    Some commenters requested that the final rule exclude additional
instruments from the definition of covered financial position. For
instance, some commenters requested that the Agencies exclude commodity
and foreign exchange futures, forwards, and swaps, arguing that these
instruments typically have a commercial and not financial purpose and
that making them subject to the prohibitions of section 13 would
negatively affect the spot market for these instruments.\184\ A few
commenters also argued that foreign exchange swaps and forwards are
used in many jurisdictions to provide U.S. dollar-funding for foreign
banking entities and that these instruments should be excluded since
they contribute to the stability and liquidity of the market for spot
foreign exchange.\185\ Other commenters contended that foreign exchange
swaps and forwards should be excluded because they are an integral part
of banking entities' ability to provide trust and custody services to
customers and are necessary to enable banking entities to deal in the
exchange of currencies for customers.\186\
---------------------------------------------------------------------------

    \184\ See JPMC; BoA; Citigroup (Feb. 2012).
    \185\ See Govt. of Japan/Bank of Japan; Japanese Bankers Ass'n.;
See also Norinchukin.
    \186\ See Northern Trust; Citigroup (Feb. 2012).
---------------------------------------------------------------------------

    One commenter argued that the inclusion of certain instruments
within the definition of derivative, such as purchases or sales of
nonfinancial commodities for deferred shipment or delivery that are
intended to be physically settled, was inappropriate.\187\ This
commenter alleged that these instruments are not derivatives but

should instead be viewed as contracts for purchase of specific
commodities to be delivered at a future date. This commenter also
argued that the Agencies do not have authority under section 13 to
include these instruments as ``other securities or financial
instruments'' subject to the prohibition on proprietary trading.\188\
---------------------------------------------------------------------------

    \187\ See SIFMA et al. (Prop. Trading) (Feb. 2012).
    \188\ See id.
---------------------------------------------------------------------------

    Some commenters also argued that, because the CFTC and SEC had not
yet finalized their definitions of swap and security-based swap, it was
inappropriate to use those definitions as part of the proposed
definition of derivative.\189\ One commenter argued that the definition
of derivative was effective, although this commenter argued that the
final rule should not cross-reference the definition of swap and
security-based swap under the federal commodities and securities
laws.\190\
---------------------------------------------------------------------------

    \189\ See SIFMA et al. (Prop.Trading) (Feb. 2012); ISDA (Feb.
2012).
    \190\ See Alfred Brock.
---------------------------------------------------------------------------

    After carefully considering the comments received on the proposal,
the final rule continues to apply the prohibition on proprietary
trading to the same types of instruments as listed in the statute and
the proposal, which the final rule defines as ``financial instrument.''
Under the final rule, a financial instrument is defined as: (i) A
security, including an option on a security; \191\ (ii) a derivative,
including an option on a derivative; or (iii) a contract of sale of a
commodity for future delivery, or option on a contract of sale of a
commodity for future delivery.\192\ The final rule excludes from the
definition of financial instrument: (i) A loan; \193\ (ii) a commodity
that is not an excluded commodity (other than foreign exchange or
currency), a derivative, a contract of sale of a commodity for future
delivery, or an option on a contract of sale of a commodity for future
delivery; or (iii) foreign exchange or currency.\194\ An excluded
commodity is defined to have the same meaning as in section 1a(19) of
the Commodity Exchange Act.
---------------------------------------------------------------------------

    \191\ The definition of security under the final rule is the
same as under the proposal. See final rule Sec.  ----.2(y).
    \192\ See final rule Sec.  .3(c)(1).
    \193\ The definition of loan, as well as comments received
regarding that definition, is discussed in detail below in Part
IV.B.1.c.8.a.
    \194\ See final rule Sec.  .3(c)(2).
---------------------------------------------------------------------------

    The Agencies continue to believe that these instruments and
transactions, which are consistent with those referenced in section
13(h)(4) of the BHC Act as part of the statutory definition of
proprietary trading, represent the type of financial instruments which
the proprietary trading prohibition of section 13 was designed to
cover. While some commenters requested that this definition be expanded
to include spot transactions \195\ or loans,\196\ the Agencies do not
believe that it is appropriate at this time to expand the scope of
instruments subject to the ban on proprietary trading.\197\ Similarly,
while some commenters requested that certain other instruments, such as
foreign exchange swaps and forwards, be excluded from the definition of
financial instrument,\198\ the Agencies believe that these instruments
appear to be, or operate in economic substance as, derivatives (which
are by statute included within the scope of instruments subject to the
prohibitions of section 13). If these instruments were not included
within the definition of financial instrument, banking entities could
use them to engage in proprietary trading that is inconsistent with the
purpose and design of section 13 of the BHC Act.
---------------------------------------------------------------------------

    \195\ See Sens. Merkley & Levin (Feb. 2012); Public Citizen;
Occupy.
    \196\ See Occupy.
    \197\ Several commenters supported the exclusion of spot
commodity and foreign currency transactions as consistent with the
statute. See Northern Trust; Morgan Stanley; State Street (Feb.
2012); JPMC; Credit Suisse (Seidel); Am. Express; See also AFR et
al. (Feb. 2012) (arguing that the final rule should explicitly
exclude ``spot'' commodities and foreign exchange). One commenter
stated that the proposed definition should not be expanded. See
Alfred Brock. With respect to the exclusion for loans, the Agencies
note this is generally consistent with the rule of statutory
construction regarding the sale and securitization of loans. See 12
U.S.C. 1851(g)(2).
    \198\ See JPMC; BAC; Citigroup (Feb. 2012); Govt. of Japan/Bank
of Japan; Japanese Bankers Ass'n.; Northern Trust; See also
Norinchukin.
---------------------------------------------------------------------------

    As under the proposal, loans, commodities, and foreign exchange or
currency are not included within the scope of instruments subject to
section 13. The exclusion of these types of instruments is intended to
eliminate potential confusion by making clear that the purchase and
sale of loans, commodities, and foreign exchange or currency--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. 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 qualify for the exclusion.
    The final rule also adopts the definitions of security and
derivative as proposed.\199\ These definitions, which reference
existing definitions under the federal securities and commodities laws,
are generally well-understood by market participants and have been
subject to extensive interpretation in the context of securities and
commodities trading activities. While some commenters argued that it
would be inappropriate to use the definition of swap and security-based
swap because those terms had not yet been finalized pursuant to public
notice and comment,\200\ the CFTC and SEC have subsequently finalized
those definitions after receiving extensive public comment on the
rulemakings.\201\ The Agencies believe that this notice and comment
process provided adequate opportunity for market participants to
comment on and understand those terms, and as such they are
incorporated in the definition of derivative under this final rule.
---------------------------------------------------------------------------

    \199\ See final rule Sec. Sec.  ----.2(h), (y).
    \200\ See SIFMA et al. (Prop. Trading) (Feb. 2012); ISDA (Feb.
2012).
    \201\ See CFTC and SEC, Further Definition of ``Swap,''
``Security-Based Swap,'' and ``Security-Based Swap Agreement'';
Mixed swaps; Security Based Swap Agreement Recordkeeping, 78 FR
48,208 (Aug. 13, 2012).
---------------------------------------------------------------------------

    While some commenters requested that foreign exchange swaps and
forwards be excluded from the definition of derivative or financial
instrument, the Agencies have not done so for the reasons discussed
above. However, as explained below in Part IV.A.1.d., the Agencies note
that to the extent a banking entity purchases or sells a foreign
exchange forward or swap, or any other financial instrument, in a
manner that meets an exclusion from proprietary trading, that
transaction would not be considered to be proprietary trading and thus
would not be subject to the requirements of section 13 of the BHC Act
and the final rule. This includes, for instance, the purchase or sale
of a financial instrument by a banking entity acting solely as agent,
broker, or custodian, or the purchase or sale of a security as part of
a bona fide liquidity management plan.
d. Proprietary Trading Exclusions
    The proposed rule contained four exclusions from the definition of
trading account for categories of transactions that do not fall within
the scope of section 13 of the BHC Act because they do not involve
short-term trading activities subject to the statutory prohibition on
proprietary trading. These exclusions covered the purchase or sale of a
financial instrument under certain repurchase and reverse repurchase
agreements and securities lending arrangements, for bona fide

liquidity management purposes, and by a clearing agency or derivatives
clearing organization in connection with clearing activities.
    As discussed below, the final rule provides exclusions for the
purchase or sale of a financial instrument under certain repurchase and
reverse repurchase agreements and securities lending agreements; for
bona fide liquidity management purposes; by certain clearing agencies,
derivatives clearing organizations in connection with clearing
activities; by a member of a clearing agency, derivatives clearing
organization, or designated financial market utility engaged in
excluded clearing activities; to satisfy existing delivery obligations;
to satisfy an obligation of the banking entity in connection with a
judicial, administrative, self-regulatory organization, or arbitration
proceeding; solely as broker, agent, or custodian; through a deferred
compensation or similar plan; and to satisfy a debt previously
contracted. After considering comments on these issues, which are
discussed in more detail below, the Agencies believe that providing
clarifying exclusions for these non-proprietary activities will likely
promote more cost-effective financial intermediation and robust capital
formation. Overly narrow exclusions for these activities would
potentially increase the cost of core banking services, while overly
broad exclusions would increase the risk of allowing the types of
trades the statute was designed to prohibit. The Agencies considered
these issues in determining the appropriate scope of these exclusions.
Because the Agencies do not believe these excluded activities involve
proprietary trading, as defined by the statute and the final rule, the
Agencies do not believe it is necessary to use our exemptive authority
in section 13(d)(1)(J) of the BHC Act to deem these activities a form
of permitted proprietary trading.
1. Repurchase and Reverse Repurchase Arrangements and Securities
Lending
    The proposed rule's definition of trading account excluded an
account used to acquire or take one or more covered financial positions
that arise under (i) a repurchase or reverse repurchase agreement
pursuant to which the banking entity had 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,\202\ or (ii) 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.\203\ Positions held under
these agreements operate in economic substance as a secured loan and
are not based on expected or anticipated movements in asset prices.
Accordingly, these types of transactions do not appear to be of the
type the statutory definition of trading account was designed to
cover.\204\
---------------------------------------------------------------------------

    \202\ See proposed rule Sec.  ----.3(b)(2)(iii)(A).
    \203\ See proposed rule Sec.  ----.3(b)(2)(iii)(B). The language
that described securities lending transactions in the proposed rule
generally mirrored that contained in Rule 3a5-3 under the Exchange
Act. See 17 CFR 240.3a5-3.
    \204\ See Joint Proposal, 76 FR 68,862.
---------------------------------------------------------------------------

    Several commenters expressed support for these exclusions and
requested that the Agencies expand them.\205\ For example, one
commenter requested clarification that all types of repurchase
transactions qualify for the exclusion.\206\ Some commenters requested
expanding this exclusion to cover all positions financed by, or
transactions related to, repurchase and reverse repurchase
agreements.\207\ Other commenters requested that the exclusion apply to
all transactions that are analogous to extensions of credit and are not
based on expected or anticipated movements in asset prices, arguing
that the exclusion would be too limited in scope to achieve its
objective if it is based on the legal form of the underlying
contract.\208\ Additionally, some commenters suggested expanding the
exclusion to cover transactions that are for funding purposes,
including prime brokerage transactions, or for the purpose of asset-
liability management.\209\ Commenters also recommended expanding the
exclusion to include re-hypothecation of customer securities, which can
produce financing structures that, like a repurchase agreement, are
functionally loans.\210\
---------------------------------------------------------------------------

    \205\ See generally ABA (Keating); Alfred Brock; Citigroup (Feb.
2012); GE (Feb. 2012); Goldman (Prop. Trading); ICBA; Japanese
Bankers Ass'n.; JPMC; Norinchukin; RBC; RMA; SIFMA et al. (Prop.
Trading) (Feb. 2012); State Street (Feb. 2012); T. Rowe Price; UBS;
Wells Fargo (Prop. Trading). See infra Part IV.A.d.10. for the
discussion of commenters' requests for additional exclusions from
the trading account.
    \206\ See SIFMA et al. (Prop.Trading) (Feb. 2012).
    \207\ See FIA; SIFMA et al. (Prop. Trading) (Feb. 2012).
    \208\ See Goldman (Prop. Trading); JPMC; UBS.
    \209\ See Goldman (Prop. Trading); UBS. For example, one
commenter suggested that fully collateralized swap transactions
should be exempted from the definition of trading account because
they serve as funding transactions and are economically similar to
repurchase agreements. See SIFMA et al. (Prop. Trading) (Feb. 2012).
    \210\ See Goldman (Prop. Trading).
---------------------------------------------------------------------------

    In contrast, other commenters argued that there was no statutory or
policy justification for excluding repurchase and reverse repurchase
agreements from the trading account, and requested that this exclusion
be removed from the final rule.\211\ Some of these commenters argued
that repurchase agreements could be used for prohibited proprietary
trading \212\ and suggested that, if repurchase agreements are excluded
from the trading account, documentation detailing the use of liquidity
derived from repurchase agreements should be required.\213\ These
commenters suggested that unless the liquidity is used to secure a
position for a willing customer, repurchase agreements should be
regarded as a strong indicator of proprietary trading.\214\ As an
alternative, commenters suggested that the Agencies instead use their
exemptive authority pursuant to section 13(d)(1)(J) of the BHC Act to
permit repurchase and reverse repurchase transactions so that such
transactions must comply with the statutory limits on material
conflicts of interests and high-risks assets and trading strategies,
and compliance requirements under the final rule.\215\ These commenters
urged the Agencies to specify permissible collateral types, haircuts,
and contract terms for securities lending agreements and require that
the investment of proceeds from securities lending transactions be
limited to high-quality liquid assets in order to limit potential risks
of these activities.\216\
---------------------------------------------------------------------------

    \211\ See AFR et al. (Feb. 2012); Occupy; Public Citizen; Sens.
Merkley & Levin (Feb. 2012).
    \212\ See AFR et al. (Feb. 2012).
    \213\ See Public Citizen.
    \214\ See Public Citizen.
    \215\ See AFR et al. (Feb. 2012); Occupy.
    \216\ See AFR et al. (Feb. 2012); Occupy.
---------------------------------------------------------------------------

    After considering the comments received, the Agencies have
determined to exclude repurchase and reverse repurchase agreements and
securities lending agreements from the definition of proprietary
trading under the final rule. The final rule defines these terms
subject to the same conditions as were in the proposal. This
determination recognizes that repurchase and reverse repurchase
agreements and securities lending agreements excluded from the
definition operate in economic substance as secured loans and do not in
normal practice represent proprietary

trading.\217\ The Agencies will, however, monitor these transactions to
ensure this exclusion is not used to engage in prohibited proprietary
trading activities.
---------------------------------------------------------------------------

    \217\ Congress recognized that repurchase agreements and
securities lending agreements are loans or extensions of credit by
including them in the legal lending limit. See Dodd-Frank Act
section 610 (amending 12 U.S.C. 84b). The Agencies believe the
conditions of the final rule's exclusions for repurchase agreements
and securities lending agreements identify those activities that do
not in normal practice represent proprietary trading and, thus, the
Agencies decline to provide additional requirements for these
activities, as suggested by some commenters. See Public Citizen; AFR
et al. (Feb. 2012); Occupy.
---------------------------------------------------------------------------

    To avoid evasion of the rule, the Agencies note that, in contrast
to certain commenters' requests,\218\ only the transactions pursuant to
the repurchase agreement, reverse repurchase agreement, or securities
lending agreement are excluded. For example, the collateral or position
that is being financed by the repurchase or reverse repurchase
agreement is not excluded and may involve proprietary trading. The
Agencies further note that if a banking entity uses a repurchase or
reverse repurchase agreement to finance a purchase of a financial
instrument, other transactions involving that financial instrument may
not qualify for this exclusion.\219\ Similarly, short positions
resulting from securities lending agreements cannot rely upon this
exclusion and may involve proprietary trading.
---------------------------------------------------------------------------

    \218\ See Goldman (Prop. Trading); JPMC; UBS.
    \219\ See CFTC Proposal, 77 FR 8348.
---------------------------------------------------------------------------

    Additionally, the Agencies have determined not to exclude all
transactions, in whatever legal form that may be construed to be an
extension of credit, as suggested by commenters, because such a broad
exclusion would be too difficult to assess for compliance and would
provide significant opportunity for evasion of the prohibitions in
section 13 of the BHC Act.
2. Liquidity Management Activities
    The proposed definition of trading account excluded an account used
to acquire or take a position for the purpose of bona fide liquidity
management, subject to certain requirements.\220\ The preamble to the
proposed rule explained that bona fide liquidity management seeks to
ensure that the banking entity has sufficient, readily-marketable
assets available to meet its expected near-term liquidity needs, not to
realize short-term profit or benefit from short-term price
movements.\221\
---------------------------------------------------------------------------

    \220\ See proposed rule Sec.  ----.3(b)(2)(iii)(C).
    \221\ Id.
---------------------------------------------------------------------------

    To curb abuse, the proposed rule required that a banking entity
acquire or take a position for liquidity management in accordance with
a documented liquidity management plan that meets five criteria.\222\
Moreover, the Agencies stated in the preamble that liquidity management
positions that give rise to appreciable profits or losses as a result
of short-term price movements would be subject to significant Agency
scrutiny and, absent compelling explanatory facts and circumstances,
would be considered proprietary trading.\223\
---------------------------------------------------------------------------

    \222\ See proposed rule Sec.  ----.3(b)(2)(iii)(C)(1)-(5).
    \223\ See Joint Proposal, 76 FR 68,862.
---------------------------------------------------------------------------

    The Agencies received a number of comments regarding the exclusion.
Many commenters supported the exclusion of liquidity management
activities from the definition of trading account as appropriate and
necessary. At the same time, some commenters expressed the view that
the exclusion was too narrow and should be replaced with a broader
exclusion permitting trading activity for asset-liability management
(``ALM''). Commenters argued that two aspects of the proposed rule's
definition of ``trading account'' would cause ALM transactions to fall
within the prohibition on proprietary trading--the 60-day rebuttable
presumption and the reference to the market risk rule trading
account.\224\ For example, commenters expressed concern that hedging
transactions associated with a banking entity's residential mortgage
pipeline and mortgage servicing rights, and managing credit risk,
earnings at risk, capital, asset-liability mismatches, and foreign
exchange risks would be among positions that may be held for 60 days or
less.\225\ These commenters contended that the exclusion for liquidity
management and the activity exemptions for risk-mitigating hedging and
trading in U.S. government obligations would not be sufficient to
permit a wide variety of ALM activities.\226\ These commenters
contended that prohibiting trading for ALM purposes would be contrary
to the goals of enhancing sound risk management, the safety and
soundness of banking entities, and U.S. financial stability,\227\ and
would limit banking entities' ability to manage liquidity.\228\
---------------------------------------------------------------------------

    \224\ See ABA (Keating); BoA; CH/ABASA; JPMC. See supra Part
IV.A.1.b. (discussing the rebuttable presumption under Sec.  ----
3.(b)(2) of the final rule); See also supra Part IV.A.1.a.
(discussing the market risk rule trading account under Sec.  ----
3.(b)(1)(ii) of the final rule).
    \225\ See CH/ABASA; Wells Fargo (Prop. Trading).
    \226\ See CH/ABASA; JPMC; State Street (Feb. 2012); Wells Fargo
(Prop. Trading). See also BaFin/Deutsche Bundesbank.
    \227\ See BoA; JPMC; RBC.
    \228\ See ABA (Keating); Allen & Overy (on behalf of Canadian
Banks); JPMC; NAIB et al.; State Street (Feb. 2012); T. Rowe Price.
---------------------------------------------------------------------------

    Some commenters argued that the requirements of the exclusion would
not provide a banking entity with sufficient flexibility to respond to
liquidity needs arising from changing economic conditions.\229\ Some
commenters argued the requirement that any position taken for liquidity
management purposes be limited to the banking entity's near-term
funding needs failed to account for longer-term liquidity management
requirements.\230\ These commenters further argued that the
requirements of the liquidity management exclusion might not be
synchronized with the Basel III framework, particularly with respect to
the liquidity coverage ratio if ``near-term'' is considered less than
30 days.\231\
---------------------------------------------------------------------------

    \229\ See ABA (Keating); CH/ABASA; JPMC.
    \230\ See ABA (Keating); BoA; CH/ABASA; JPMC.
    \231\ See ABA (Keating); Allen & Overy (on behalf of Canadian
Banks); BoA; CH/ABASA
---------------------------------------------------------------------------

    Commenters also requested clarification on a number of other issues
regarding the exclusion. For example, one commenter requested
clarification that purchases and sales of U.S. registered mutual funds
sponsored by a banking entity would be permissible.\232\ Another
commenter requested clarification that the deposits resulting from
providing custodial services that are invested largely in high-quality
securities in conformance with the banking entity's ALM policy would
not be presumed to be ``short-term trading'' under the final rule.\233\
Commenters also urged that the final rule not prohibit interaffiliate
transactions essential to the ALM function.\234\
---------------------------------------------------------------------------

    \232\ See T. Rowe Price.
    \233\ See State Street (Feb. 2012).
    \234\ See State Street (Feb. 2012); JPMC. See also Part
IV.A.1.d.10. (discussing commenter requests to exclude inter-
affiliate transactions).
---------------------------------------------------------------------------

    In contrast, other commenters supported the liquidity management
exclusion criteria \235\ and suggested tightening these requirements.
For example, one commenter recommended that the rule require that
investments made under the liquidity management exclusion consist only
of high-quality liquid assets.\236\ Other commenters argued that the
exclusion for liquidity management should be eliminated.\237\ One
commenter argued that there was no need to provide a special exemption
for liquidity management or ALM activities given the exemptions for

trading in government obligations and risk-mitigating hedging
activities.\238\
---------------------------------------------------------------------------

    \235\ See AFR et al. (Feb. 2012); Occupy.
    \236\ See Occupy.
    \237\ See Sens. Merkley & Levin (Feb. 2012).
    \238\ See Sens. Merkley & Levin (Feb. 2012).
---------------------------------------------------------------------------

    After carefully reviewing the comments received, the Agencies have
adopted the proposed exclusion for liquidity management with several
important modifications. As limited below, liquidity management
activity serves the important prudential purpose, recognized in other
provisions of the Dodd-Frank Act and in rules and guidance of the
Agencies, of ensuring banking entities have sufficient liquidity to
manage their short-term liquidity needs.\239\
---------------------------------------------------------------------------

    \239\ See section 165(b)(1)(A)(ii) of the Dodd-Frank Act;
Enhanced Prudential Standards, 77 FR 644 at 645 (Jan. 5, 2012),
available at http://www.gpo.gov/fdsys/pkg/FR-2012-01-05/pdf/2011-33364.pdf; See also Enhanced Prudential Standards, 77 FR 76,678 at
76,682 (Dec. 28, 2012), available at http://www.gpo.gov/fdsys/pkg/FR-2012-12-28/pdf/2012-30734.pdf.
---------------------------------------------------------------------------

    To ensure that this exclusion is not misused for the purpose of
proprietary trading, the final rule imposes a number of requirements.
First, the liquidity management plan of the banking entity must be
limited to securities (in keeping with the liquidity management
requirements proposed by the Federal banking agencies) and specifically
contemplate and authorize the particular securities to be used for
liquidity management purposes; describe the amount, types, and risks of
securities that are consistent with the entity's liquidity management;
and the liquidity circumstances in which the particular securities may
or must be used.\240\ Second, any purchase or sale of securities
contemplated and authorized by the plan must 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 taken for such short-term purposes. Third, the plan
must require that any securities purchased or sold for liquidity
management purposes be highly liquid and limited to instruments the
market, credit and other risks of which the banking entity does not
reasonably expect to give rise to appreciable profits or losses as a
result of short-term price movements.\241\ Fourth, the plan must limit
any securities purchased or sold for liquidity management purposes to
an amount that is consistent with the banking entity's near-term
funding needs, including deviations from normal operations of the
banking entity or any affiliate thereof, as estimated and documented
pursuant to methods specified in the plan.\242\ Fifth, the banking
entity must incorporate into its compliance program internal controls,
analysis and independent testing designed to ensure that activities
undertaken for liquidity management purposes are conducted in
accordance with the requirements of the final rule and the entity's
liquidity management plan. Finally, the plan must be consistent with
the supervisory requirements, guidance and expectations regarding
liquidity management of the Agency responsible for regulating the
banking entity.
---------------------------------------------------------------------------

    \240\ To ensure sufficient flexibility to respond to liquidity
needs arising from changing economic times, a banking entity should
envision and address a range of liquidity circumstances in its
liquidity management plan, and provide a mechanism for periodically
reviewing and revising the liquidity management plan.
    \241\ The requirement to use highly liquid instruments is
consistent with the focus of the clarifying exclusion on a banking
entity's near-term liquidity needs. Thus, the final rules do not
include commenters' suggested revisions to this requirement. See
Clearing House Ass'n.; See also Occupy; Sens. Merkley & Levin (Feb.
2012). The Agencies decline to identify particular types of
securities that will be considered highly liquid for purposes of the
exclusion, as requested by some commenters, in recognition that such
a determination will depend on the facts and circumstances. See T.
Rowe Price; State Street (Feb. 2012).
    \242\ The Agencies plan to construe ``near-term funding needs''
in a manner that is consistent with the laws, regulations, and
issuances related to liquidity risk management. See, e.g., Liquidity
Coverage Ratio: Liquidity Risk Measurement, Standards, and
Monitoring, 78 FR 71,818 (Nov. 29, 2013); Basel Committee on Bank
Supervision, Basel III: The Liquidity Coverage Ratio and Liquidity
Risk Management Tools (January 2013) available at http://www.bis.org/publ/bcbs238.htm. The Agencies believe this should help
address commenters' concerns about the proposed requirement. See,
e.g., ABA (Keating); Allen & Overy (on behalf of Canadian Banks);
CH/ABASA; BoA; JPMC.
---------------------------------------------------------------------------

    The final rule retains the provision that the financial instruments
purchased and sold as part of a liquidity management plan be highly
liquid and not reasonably expected to give rise to appreciable profits
or losses as a result of short-term price movements. This requirement
is consistent with the Agencies' expectation for liquidity management
plans in the supervisory context. It is not intended to prevent firms
from recognizing profits (or losses) on instruments purchased and sold
for liquidity management purposes. Instead, this requirement is
intended to underscore that the purpose of these transactions must be
liquidity management. Thus, the timing of purchases and sales, the
types and duration of positions taken and the incentives provided to
managers of these purchases and sales must all indicate that managing
liquidity, and not taking short-term profits (or limiting short-term
losses), is the purpose of these activities.
    The exclusion as adopted does not apply to activities undertaken
with the stated purpose or effect of hedging aggregate risks incurred
by the banking entity or its affiliates related to asset-liability
mismatches or other general market risks to which the entity or
affiliates may be exposed. Further, the exclusion does not apply to any
trading activities that expose banking entities to substantial risk
from fluctuations in market values, unrelated to the management of
near-term funding needs, regardless of the stated purpose of the
activities.\243\
---------------------------------------------------------------------------

    \243\ See, e.g., Staff of S. Comm. on Homeland Sec. &
Governmental Affairs Permanent Subcomm. on Investigations, 113th
Cong., Report: JPMorgan Chase Whale Trades: A Case History of
Derivatives Risks and Abuses (Apr. 11, 2013), available at http://www.hsgac.senate.gov/download/report-jpmorgan-chase-whale-trades-a-case-history-of-derivatives-risks-and-abuses-march-15-2013.
---------------------------------------------------------------------------

    Overall, the Agencies do not believe that the final rule will stand
as an obstacle to or otherwise impair the ability of banking entities
to manage the risks of their businesses and operate in a safe and sound
manner. Banking entities engaging in bona fide liquidity management
activities generally do not purchase or sell financial instruments for
the purpose of short-term resale or to benefit from actual or expected
short-term price movements. The Agencies have determined, in contrast
to certain commenters' requests, not to expand this liquidity
management provision to broadly allow asset-liability management,
earnings management, or scenario hedging.\244\ To the extent these
activities are for the purpose of profiting from short-term price
movements or to hedge risks not related to short-term funding needs,
they represent proprietary trading subject to section 13 of the BHC Act
and the final rule; the activity would then be permissible only if it
meets all of the requirements for an exemption, such as the risk-
mitigating hedging exemption, the exemption for trading in U.S.
government securities, or another exemption.
---------------------------------------------------------------------------

    \244\ See, e.g., ABA (Keating); BoA; CH/ABASA; JPMC.
---------------------------------------------------------------------------

3. Transactions of Derivatives Clearing Organizations and Clearing
Agencies
    A banking entity that is a central counterparty for clearing and
settlement activities engages in the purchase and sale of financial
instruments as an integral part of clearing and settling those
instruments. The proposed definition of trading account excluded an
account used to acquire or take one or more covered financial positions
by

a derivatives clearing organization registered under the Commodity
Exchange Act or a clearing agency registered under the Securities
Exchange Act of 1934 in connection with clearing derivatives or
securities transactions.\245\ The preamble to the proposed rule noted
that the purpose of these transactions is to provide a clearing service
to third parties, not to profit from short-term resale or short-term
price movements.\246\
---------------------------------------------------------------------------

    \245\ See proposed rule Sec.  ----.3(b)(2)(iii)(D).
    \246\ See Joint Proposal, 76 FR 68,863.
---------------------------------------------------------------------------

    Several commenters supported the proposed exclusion for derivatives
clearing organizations and urged the Agencies to expand the exclusion
to cover a banking entity's clearing-related activities, such as
clearing a trade for a customer, trading with a clearinghouse, or
accepting positions of a defaulting member, on grounds that these
activities are not proprietary trades and reduce systemic risk.\247\
One commenter recommended expanding the exclusion to non-U.S. central
counterparties \248\ In contrast, one commenter argued that the
exclusion for derivatives clearing organizations and clearing agencies
had no statutory basis and should instead be a permitted activity under
section 13(d)(1)(J).\249\
---------------------------------------------------------------------------

    \247\ See Allen & Overy (Clearing); Goldman (Prop. Trading);
SIFMA et al. (Prop. Trading) (Feb. 2012); State Street (Feb. 2012).
    \248\ See IIB/EBF.
    \249\ See Sens. Merkley & Levin (Feb. 2012).
---------------------------------------------------------------------------

    After considering the comments received, the final rule retains the
exclusion for purchases and sales of financial instruments by a banking
entity that is a clearing agency or derivatives clearing organization
in connection with its clearing activities.\250\ In response to
comments,\251\ the Agencies have also incorporated two changes to the
rule. First, the final rule applies the exclusion to the purchase and
sale of financial instruments by a banking entity that is a clearing
agency or derivatives clearing organization in connection with clearing
financial instrument transactions. Second, in response to
comments,\252\ the exclusion in the final rule is not limited to
clearing agencies or derivatives clearing organizations that are
subject to SEC or CFTC registration requirements and, instead, certain
foreign clearing agencies and foreign derivatives clearing
organizations will be permitted to rely on the exclusion if they are
banking entities.
---------------------------------------------------------------------------

    \250\ ``Clearing agency'' is defined in the final rule with
reference to the definition of this term in the Exchange Act. See
final rule Sec.  ----.3(e)(2). ``Derivatives clearing organization''
is defined in the final rule as (i) a derivatives clearing
organization registered under section 5b of the Commodity Exchange
Act; (ii) a derivatives clearing organization that, pursuant to CFTC
regulation, is exempt from the registration requirements under
section 5b of the Commodity Exchange Act; or (iii) a foreign
derivatives clearing organization that, pursuant to CFTC regulation,
is permitted to clear for a foreign board of trade that is
registered with the CFTC.
    \251\ See IIB/EBF; BNY Mellon et al.; SIFMA et al.
(Prop.Trading) (Feb. 2012); Allen & Overy (Clearing); Goldman (Prop.
Trading).
    \252\ See IIB/EBF; Allen & Overy (Clearing).
---------------------------------------------------------------------------

    The Agencies believe that clearing and settlement activity is not
designed to create short-term trading profits. Moreover, excluding
clearing and settlement activities prevents the final rule from
inadvertently hindering the Dodd-Frank Act's goal of promoting central
clearing of financial transactions. The Agencies have narrowly tailored
this exclusion by allowing only central counterparties to use it and
only with respect to their clearing and settlement activity.
4. Excluded Clearing-Related Activities of Clearinghouse Members
    In addition to the exclusion for trading activities of a
derivatives clearing organization or clearing agency, some commenters
requested an additional exclusion from the definition of ``trading
account'' for clearing-related activities of members of these
entities.\253\ These commenters noted that the proposed definition of
``trading account'' provides an exclusion for positions taken by
registered derivatives clearing organizations and registered clearing
agencies \254\ and requested a corresponding exclusion for certain
clearing-related activities of banking entities that are members of a
clearing agency or members of a derivatives clearing organization
(collectively, ``clearing members'').\255\
---------------------------------------------------------------------------

    \253\ See SIFMA et al. (Prop. Trading) (Feb. 2012); Allen &
Overy (Clearing); Goldman (Prop. Trading); State Street (Feb. 2012).
    \254\ See proposed rule Sec.  ----.3(b)(2)(iii)(D).
    \255\ See SIFMA et al. (Prop. Trading) (Feb. 2012); Allen &
Overy (Clearing); Goldman (Prop. Trading); State Street (Feb. 2012).
---------------------------------------------------------------------------

    Several commenters argued that certain aspects of the clearing
process may require a clearing member to engage in principal
transactions. For example, some commenters argued that a
clearinghouse's default management process may require clearing members
to take positions in financial instruments upon default of another
clearing member.\256\ According to commenters, default management
processes can involve: (i) Collection of initial and variation margin
from customers under an ``agency model'' of clearing; (ii) porting,
where a defaulting clearing member's customer positions and margin are
transferred to another non-defaulting clearing member; \257\ (iii)
hedging, where the clearing house looks to clearing members and third
parties to enter into risk-reducing transactions and to flatten the
market risk associated with the defaulting clearing member's house
positions and non-ported customer positions; (iv) unwinding, where the
defaulting member's open positions may be allocated to other clearing
members, affiliates, or third parties pursuant to a mandatory auction
process or forced allocation; \258\ and (v) imposing certain
obligations on clearing members upon exhaustion of a guaranty
fund.\259\
---------------------------------------------------------------------------

    \256\ See SIFMA et al. (Prop. Trading) (Feb. 2012); Allen &
Overy (Clearing); State Street (Feb. 2012). See also ISDA (Feb.
2012).
    \257\ See SIFMA et al. (Prop. Trading) (Feb. 2012); Allen &
Overy (Clearing).
    \258\ See Allen & Overy (Clearing).
    \259\ See SIFMA et al. (Prop. Trading) (Feb. 2012).
---------------------------------------------------------------------------

    Commenters argued that, absent an exclusion from the definition of
``trading account,'' some of these clearing-related activities could be
considered prohibited proprietary trading under the proposal. Two
commenters specifically contended that the dealer prong of the
definition of ``trading account'' may cause certain of these activities
to be considered proprietary trading.\260\ Some commenters suggested
alternative avenues for permitting such clearing-related activity under
the rules.\261\ Commenters argued that such clearing-related activities
of banking entities should not be subject to the rule because they are
risk-reducing, beneficial for the financial system, required by law
under certain circumstances (e.g., central clearing requirements for
swaps and security-based swaps under Title VII of the Dodd-Frank Act),
and not used by banking entities to engage in proprietary trading.\262\
---------------------------------------------------------------------------

    \260\ See SIFMA et al. (Prop. Trading) (Feb. 2012) (arguing that
the SEC has suggested that entities that collect margins from
customers for cleared swaps may be required to be registered as
broker-dealers); State Street (Feb. 2012).
    \261\ See Goldman (Prop. Trading); SIFMA et al. (Prop.Trading)
(Feb. 2012); ISDA (Feb. 2012).
    \262\ See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman
(Prop. Trading); State Street (Feb. 2012); Allen & Overy (Clearing).
---------------------------------------------------------------------------

    Commenters further argued that certain activities undertaken as
part of a clearing house's daily risk management process may be
impacted by the rule, including unwinding self-referencing transactions
through a mandatory auction (e.g., where a firm acquired credit default
swap (``CDS'') protection on itself as a result of a merger with
another firm) \263\ and trade crossing, a mechanism employed by

certain clearing houses to ensure the accuracy of the price discovery
process in the course of, among other things, calculating settlement
prices and margin requirements.\264\
---------------------------------------------------------------------------

    \263\ See Allen & Overy (Clearing).
    \264\ See Allen & Overy (Clearing); SIFMA et al. (Prop.Trading)
(Feb. 2012). These commenters stated that, in order to ensure that a
clearing member is providing accurate end-of-day prices for its open
positions, a clearing house may require the member to provide firm
bids for such positions, which may be tested through a ``forced
trade'' with another member. See id.; See also ISDA (Feb. 2012).
---------------------------------------------------------------------------

    The Agencies do not believe that certain core clearing-related
activities conducted by a clearing member, often as required by
regulation or the rules and procedures of a clearing agency,
derivatives clearing organization, or designated financial market
utility, represent proprietary trading as contemplated by the statute.
For example, the clearing and settlement activities discussed above are
not conducted for the purpose of profiting from short-term price
movements. The Agencies believe that these clearing-related activities
provide important benefits to the financial system.\265\ In particular,
central clearing reduces counterparty credit risk,\266\ which can lead
to a host of other benefits, including lower hedging costs, increased
market participation, greater liquidity, more efficient risk sharing
that promotes capital formation, and reduced operational risk.\267\
---------------------------------------------------------------------------

    \265\ For example, Title VII of the Dodd-Frank Act mandates the
central clearing of swaps and security-based swaps, and requires
that banking entities that are swap dealers, security-based swap
dealers, major swap participants or major security-based swap
participants collect variation margin from many counterparties on a
daily basis for their swap or security-based swap activity. See 7
U.S.C. 2(h); 15 U.S.C. 78c-3; 7 U.S.C. 6s(e); 15 U.S.C. 78o-10(e);
Margin Requirements for Uncleared Swaps for Swap Dealers and Major
Swap Participants, 76 FR 23,732 (Apr. 28, 2011). Additionally, the
SEC's Rule 17Ad-22(d)(11) requires that each registered clearing
agency establish, implement, maintain and enforce policies and
procedures that set forth the clearing agency's default management
procedures. See 17 CFR 240.17Ad-22(d)(11). See also Exchange Act
Release No. 68,080 (Oct. 12, 2012), 77 FR 66,220, 66,283 (Nov. 2,
2012).
    \266\ Centralized clearing affects counterparty risk in three
basic ways. First, it redistributes counterparty risk among members
through mutualization of losses, reducing the likelihood of
sequential counterparty failure and contagion. Second, margin
requirements and monitoring reduce moral hazard, reducing
counterparty risk. Finally, clearing may reallocate counterparty
risk outside of the clearing agency because netting may implicitly
subordinate outside creditors' claims relative to other clearing
member claims.
    \267\ See Proposed Rule, Cross-Border Security-Based Swap
Activities, Exchange Act Release No. 69490 (May 1, 2013), 78 FR
30,968, 31,162-31,163 (May 23, 2013).
---------------------------------------------------------------------------

    Accordingly, in response to comments, the final rule provides that
proprietary trading does not include specified excluded clearing
activities by a banking entity that is a member of a clearing agency, a
member of a derivatives clearing organization, or a member of a
designated financial market utility.\268\ ``Excluded clearing
activities'' is defined in the rule to identify particular core
clearing-related activities, many of which were raised by
commenters.\269\ Specifically, the final rule will exclude the
following activities by clearing members: (i) Any purchase or sale
necessary to correct error trades made by or on behalf of customers
with respect to customer transactions that are cleared, provided the
purchase or sale is conducted in accordance with certain regulations,
rules, or procedures; (ii) any purchase or sale related to the
management of a default or threatened imminent default of a customer,
subject to certain conditions, another clearing member, or the clearing
agency, derivatives clearing organization, or designated financial
market utility itself; \270\ and (iii) any purchase or sale required by
the rules or procedures of a clearing agency, derivatives clearing
organization, or designated financial market utility that mitigates
risk to such agency, organization, or utility that would result from
the clearing by a clearing member of security-based swaps that
references the member or an affiliate of the member.\271\
---------------------------------------------------------------------------

    \268\ See final rule Sec.  ----.3(d)(5).
    \269\ See final rule Sec.  ----.3(e)(7).
    \270\ A number of commenters discussed the default management
process and requested an exclusion for such activities. See SIFMA et
al. (Prop. Trading) (Feb. 2012); Allen & Overy (Clearing); State
Street (Feb. 2012). See also ISDA (Feb. 2012).
    \271\ See Allen & Overy (Clearing) (discussing rules that
require unwinding self-referencing transactions through a mandatory
auction (e.g., where a firm acquired CDS protection on itself as a
result of a merger with another firm)).
---------------------------------------------------------------------------

    The Agencies are identifying specific activities in the rule to
limit the potential for evasion that may arise from a more generalized
approach. However, the relevant supervisory Agencies will be prepared
to provide further guidance or relief, if appropriate, to ensure that
the terms of the exclusion do not limit the ability of clearing
agencies, derivatives clearing organizations, or designated financial
market utilities to effectively manage their risks in accordance with
their rules and procedures. In response to commenters requesting that
the exclusion be available when a clearing member is required by rules
of a clearing agency, derivatives clearing organization, or designated
financial market utility to purchase or sell a financial instrument as
part of establishing accurate prices to be used by the clearing agency,
derivatives clearing organization, or designated financial market
utility in its end of day settlement process,\272\ the Agencies note
that whether this is an excluded clearing activity depends on the facts
and circumstances. Similarly, the availability of other exemptions to
the rule, such as the market-making exemption, depend on the facts and
circumstances. This exclusion applies only to excluded clearing
activities of clearing members. It does not permit a banking entity to
engage in proprietary trading and claim protection for that activity
because trades are cleared or settled through a central counterparty.
---------------------------------------------------------------------------

    \272\ See Allen & Overy (Clearing); SIFMA et al. (Prop. Trading)
(Feb. 2012); See also ISDA (Feb. 2012).
---------------------------------------------------------------------------

5. Satisfying an Existing Delivery Obligation
    A few commenters requested additional or expanded exclusions from
the definition of ``trading account'' for covering short sales or
failures to deliver.\273\ These commenters alleged that a banking
entity engages in this activity for purposes other than to benefit from
short term price movements and that it is not proprietary trading as
defined in the statute. In response to these comments, the final rule
provides that a purchase or sale by a banking entity that satisfies an
existing delivery obligation of the banking entity or its customers,
including to prevent or close out a failure to deliver, in connection
with delivery, clearing, or settlement activity is not proprietary
trading.
---------------------------------------------------------------------------

    \273\ See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman
(Prop. Trading).
---------------------------------------------------------------------------

    Among other things, this exclusion will allow a banking entity that
is an SEC-registered broker-dealer to take action to address failures
to deliver arising from its own trading activity or the trading
activity of its customers.\274\ In certain circumstances, SEC-
registered broker-dealers are required to take such action under SEC
rules.\275\ In addition, buy-in procedures of a clearing agency,
securities exchange, or national securities association may require a

banking entity to deliver securities if a party with a fail to receive
position takes certain action.\276\ When a banking entity purchases
securities to meet an existing delivery obligation, it is engaging in
activity that facilitates timely settlement of securities transactions
and helps provide a purchaser of the securities with the benefits of
ownership (e.g., voting and lending rights). In addition, a banking
entity has limited discretion to determine when and how to take action
to meet an existing delivery obligation.\277\ Providing a limited
exclusion for this activity will avoid the potential for SEC-registered
broker-dealers being subject to conflicting or inconsistent regulatory
requirements with respect to activity required to meet the broker-
dealer's existing delivery obligations.
---------------------------------------------------------------------------

    \274\ In order to qualify for this exclusion, a banking entity's
principal trading activity that results in its own failure to
deliver must have been conducted in compliance with these rules.
    \275\ See, e.g., 17 CFR 242.204 (requiring, among other things,
that a participant of a registered clearing agency or, upon
reasonable allocation, a broker-dealer for which the participant
clears trades or from which the participant receives trades for
settlement, take action to close out a fail to deliver position in
any equity security by borrowing or purchasing securities of like
kind and quantity); 17 CFR 240.15c3-3(m) (providing that, if a
broker-dealer executes a sell order of a customer and does not
obtain possession of the securities from the customer within 10
business days after settlement, the broker-dealer must immediately
close the transaction with the customer by purchasing securities of
like kind and quantity).
    \276\ See, e.g., NSCC Rule 11, NASDAQ Rule 11810, FINRA Rule
11810.
    \277\ See, e.g., 17 CFR 242.204 (requiring action to close out a
fail to deliver position in an equity security within certain
specified timeframes); 17 CFR 240.15c3-3(m) (requiring a broker-
dealer to ``immediately'' close a transaction under certain
circumstances).
---------------------------------------------------------------------------

6. Satisfying an Obligation in Connection With a Judicial,
Administrative, Self-Regulatory Organization, or Arbitration Proceeding
    The Agencies recognize that, under certain circumstances, a banking
entity may be required to purchase or sell a financial instrument at
the direction of a judicial or regulatory body. For example, an
administrative agency or self-regulatory organization (``SRO'') may
require a banking entity to purchase or sell a financial instrument in
the course of disciplinary proceedings against that banking
entity.\278\ A banking entity may also be obligated to purchase or sell
a financial instrument in connection with a judicial or arbitration
proceeding.\279\ Such transactions do not represent trading for short-
term profit or gain and do not constitute proprietary trading under the
statute.
---------------------------------------------------------------------------

    \278\ For example, an administrative agency or SRO may require a
broker-dealer to offer to buy securities back from customers where
the agency or SRO finds the broker-dealer fraudulently sold
securities to those customers. See, e.g., In re Raymond James &
Assocs., Exchange Act Release No. 64767, 101 S.E.C. Docket 1749
(June 29, 2011); FINRA Dep't of Enforcement v. Pinnacle Partners
Fin. Corp., Disciplinary Proceeding No.<PHONE_NUMBER>501 (Apr. 25,
2012); FINRA Dep't of Enforcement v. Fifth Third Sec., Inc., No.
2005002244101 (Press Rel. Apr. 14, 2009).
    \279\ For instance, section 29 of the Exchange Act may require a
broker-dealer to rescind a contract with a customer that was made in
violation of the Exchange Act. Such rescission relief may involve
the broker-dealer's repurchase of a financial instrument from a
customer. See 15 U.S.C. 78cc; Reg'l Props., Inc. v. Fin. & Real
Estate Consulting Co., 678 F.2d 552 (5th Cir. 1982); Freeman v.
Marine Midland Bank N.Y., 419 F.Supp. 440 (E.D.N.Y. 1976).
---------------------------------------------------------------------------

    Accordingly, the Agencies have determined to adopt a provision
clarifying that a purchase or sale of one or more financial instruments
that satisfies an obligation of the banking entity in connection with a
judicial, administrative, self-regulatory organization, or arbitration
proceeding is not proprietary trading for purposes of these rules. This
clarification will avoid the potential for conflicting or inconsistent
legal requirements for banking entities.
7. Acting Solely as Agent, Broker, or Custodian
    The proposal clarified that proprietary trading did not include
acting solely as agent, broker, or custodian for an unaffiliated third
party.\280\ Commenters generally supported this aspect of the proposal.
One commenter suggested that acting as agent, broker, or custodian for
affiliates should be explicitly excluded from the definition of
proprietary trading in the same manner as acting as agent, broker, or
custodian for unaffiliated third parties.\281\
---------------------------------------------------------------------------

    \280\ See proposed rule Sec.  ----.3(b)(1).
    \281\ See Japanese Bankers Ass'n.
---------------------------------------------------------------------------

    Like the proposal, the final rule expressly provides that the
purchase or sale of one or more financial instruments by a banking
entity acting solely as agent, broker, or custodian is not proprietary
trading because acting in these types of capacities does not involve
trading as principal, which is one of the requisite aspects of the
statutory definition of proprietary trading.\282\ The final rule has
been modified to include acting solely as agent, broker, or custodian
on behalf of an affiliate. However, the affiliate must comply with
section 13 of the BHC Act and the final implementing rule; and may not
itself engage in prohibited proprietary trading. To the extent a
banking entity acts in both a principal and agency capacity for a
purchase or sale, it may only use this exclusion for the portion of the
purchase or sale for which it is acting as agent. The banking entity
must use a separate exemption or exclusion, if applicable, to the
extent it is acting in a principal capacity.
---------------------------------------------------------------------------

    \282\ See 12 U.S.C. 1851(h)(4). A common or collective
investment fund that is an investment company under section 3(c)(3)
or 3(c)(11) will not be deemed to be acting as principal within the
meaning of Sec.  ----.3(a) because the fund is performing a
traditional trust activity and purchases and sells financial
instruments solely on behalf of customers as trustee or in a similar
fiduciary capacity, as evidenced by its regulation under 12 CFR part
9 (Fiduciary Activities of National Banks) or similar state laws.
---------------------------------------------------------------------------

8. Purchases or Sales Through a Deferred Compensation or Similar Plan
    While the proposed rule provided that the prohibition on covered
fund activities and investments did not apply to certain instances
where the banking entity acted through or on behalf of a pension or
similar deferred compensation plan, no such similar treatment was given
for proprietary trading. One commenter argued that the proposal
restricted a banking entity's ability to engage in principal-based
trading as an asset manager that serves the needs of the institutional
investors, such as through ERISA pension and 401(k) plans.\283\
---------------------------------------------------------------------------

    \283\ See Ass'n. of Institutional Investors (Nov. 2012).
---------------------------------------------------------------------------

    To address these concerns, the final rule provides that proprietary
trading does not include the purchase or sale of one or more financial
instruments through a deferred compensation, stock-bonus, profit-
sharing, or pension plan of the banking entity that is established and
administered in accordance with the laws of the United States or a
foreign sovereign, if the purchase or sale is made directly or
indirectly by the banking entity as trustee for the benefit of the
employees of the banking entity or members of their immediate family.
Banking entities often establish and act as trustee to pension or
similar deferred compensation plans for their employees and, as part of
managing these plans, may engage in trading activity. The Agencies
believe that purchases or sales by a banking entity when acting through
pension and similar deferred compensation plans generally occur on
behalf of beneficiaries of the plan and consequently do not constitute
the type of principal trading that is covered by the statute.
    The Agencies note that if a banking entity engages in trading
activity for an unaffiliated pension or similar deferred compensation
plan, the trading activity of the banking entity would not be
proprietary trading under the final rule to the extent the banking
entity was acting solely as agent, broker, or custodian.
9. Collecting a Debt Previously Contracted
    Several commenters argued that the final rule should exclude
collecting and disposing of collateral in satisfaction of debts
previously contracted from the definition of proprietary trading.\284\
Commenters argued that acquiring and

disposing of collateral in satisfaction of debt previously contracted
does not involve trading with the intent of profiting from short-term
price movements and, thus, should not be proprietary trading for
purposes of this rule. Rather, this activity is a prudent and desirable
part of lending and debt collection activities.
---------------------------------------------------------------------------

    \284\ See LSTA (Feb. 2012); JPMC; Goldman (Prop. Trading); SIFMA
et al. (Prop.Trading) (Feb. 2012).
---------------------------------------------------------------------------

    The Agencies believe that the purchase and sale of a financial
instrument in satisfaction of a debt previously contracted does not
constitute proprietary trading. The Agencies believe an exclusion for
purchases and sales in satisfaction of debts previously contracted is
necessary for banking entities to continue to lend to customers,
because it allows banking entities to continue lending activity with
the knowledge that they will not be penalized for recouping losses
should a customer default. Accordingly, the final rule provides that
proprietary trading does not include the purchase or sale of one or
more financial instruments in the ordinary course of collecting a debt
previously contracted in good faith, provided that the banking entity
divests the financial instrument as soon as practicable within the time
period permitted or required by the appropriate financial supervisory
agency.\285\
---------------------------------------------------------------------------

    \285\ See final rule Sec.  ----.3(d)(9).
---------------------------------------------------------------------------

    As a result of this exclusion, banking entities, including SEC-
registered broker-dealers, will be able to continue providing margin
loans to their customers and may take possession of margined collateral
following a customer's default or failure to meet a margin call under
applicable regulatory requirements.\286\ Similarly, a banking entity
that is a CFTC-registered swap dealer or SEC-registered security-based
swap dealer may take, hold, and exchange any margin collateral as
counterparty to a cleared or uncleared swap or security-based swap
transaction, in accordance with the rules of the Agencies.\287\ This
exclusion will allow banking entities to comply with existing
regulatory requirements regarding the divestiture of collateral taken
in satisfaction of a debt.
---------------------------------------------------------------------------

    \286\ For example, if any margin call is not met in full within
the time required by Regulation T, then Regulation T requires a
broker-dealer to liquidate securities sufficient to meet the margin
call or to eliminate any margin deficiency existing on the day such
liquidation is required, whichever is less. See 12 CFR 220.4(d).
    \287\ See SEC Proposed Rule, Capital, Margin, Segregation,
Reporting and Recordkeeping Requirements for Security-Based Swap
Dealers, Exchange Act Release No. 68071, 77 FR 70,214 (Nov. 23,
2012); CFTC Proposed Rule, Margin Requirements for Uncleared Swaps
for Swap Dealers and Major Swap Participants, 76 FR 23,732 (Apr. 28,
2011); Banking Agencies' Proposed Rule, Margin and Capital
Requirements for Covered Swap Entities, 76 FR 27,564 (May 11, 2011).
---------------------------------------------------------------------------

10. Other Requested Exclusions
    Commenters requested a number of additional exclusions from the
trading account and, in turn, the prohibition on proprietary trading.
In order to avoid potential evasion of the final rule, the Agencies
decline to adopt any exclusions from the trading account other than the
exclusions described above.\288\ The Agencies believe that various
modifications to the final rule, including in particular to the
exemption for market-making related activities, address many of
commenters' concerns regarding unintended consequences of the
prohibition on proprietary trading.
---------------------------------------------------------------------------

    \288\ See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012)
(transactions that are not based on expected or anticipated
movements in asset prices, such as fully collateralized swap
transactions that serve funding purposes); Norinchukin and Wells
Fargo (Prop. Trading) (derivatives that qualify for hedge
accounting); GE (Feb. 2012) (transactions related to commercial
contracts); Citigroup (Feb. 2012) (FX swaps and FX forwards); SIFMA
et al. (Prop. Trading) (Feb. 2012) (interaffiliate transactions); T.
Rowe Price (purchase and sale of shares in sponsored mutual funds);
RMA (cash collateral pools); Alfred Brock (arbitrage trading); ICBA
(securities traded pursuant to 12 U.S.C. 1831a(f)). The Agencies are
concerned that these exclusions could be used to conduct
impermissible proprietary trading, and the Agencies believe some of
these exclusions are more appropriately addressed by other
provisions of the rule. For example, derivatives qualifying for
hedge accounting may be permitted under the hedging exemption.
---------------------------------------------------------------------------

2. Section ----.4(a): Underwriting Exemption
a. Introduction
    After carefully considering comments on the proposed underwriting
exemption, the Agencies are adopting the proposed underwriting
exemption substantially as proposed, but with certain refinements and
clarifications to the proposed approach to better reflect the range of
securities offerings that an underwriter may help facilitate on behalf
of an issuer or selling security holder and the types of activities an
underwriter may undertake in connection with a distribution of
securities to facilitate the distribution process and provide important
benefits to issuers, selling security holders, or purchasers in the
distribution. The Agencies are adopting such an approach because the
statute specifically permits banking entities to continue providing
these beneficial services to clients, customers, and counterparties. At
the same time, to reduce the potential for evasion of the general
prohibition on proprietary trading, the Agencies are requiring, among
other things, that the trading desk make reasonable efforts to sell or
otherwise reduce its underwriting position (accounting for the
liquidity, maturity, and depth of the market for the relevant type of
security) and be subject to a robust risk limit structure that is
designed to prevent a trading desk from having an underwriting position
that exceeds the reasonably expected near term demands of clients,
customers, or counterparties.
b. Overview
1. Proposed Underwriting Exemption
    Section 13(d)(1)(B) of the BHC Act provides an exemption from the
prohibition on proprietary trading for the purchase, sale, acquisition,
or disposition of securities and certain other instruments in
connection with underwriting activities, to the extent that such
activities are designed not to exceed the reasonably expected near term
demands of clients, customers, or counterparties.\289\
---------------------------------------------------------------------------

    \289\ 12 U.S.C. 1851(d)(1)(B).
---------------------------------------------------------------------------

    Section ----.4(a) of the proposed rule would have implemented this
exemption by requiring that a banking entity's underwriting activities
comply with seven requirements. As discussed in more detail below, the
proposed underwriting exemption required that: (i) A banking entity
establish a compliance program under Sec.  ----.20; (ii) the covered
financial position be a security; (iii) the purchase or sale be
effected solely in connection with a distribution of securities for
which the banking entity is acting as underwriter; (iv) the banking
entity meet certain dealer registration requirements, where applicable;
(v) the underwriting activities be designed not to exceed the
reasonably expected near term demands of clients, customers, or
counterparties; (vi) the underwriting activities be designed to
generate revenues primarily from fees, commissions, underwriting
spreads, or other income not attributable to appreciation in the value
of covered financial positions or to hedging of covered financial
positions; and (vii) the compensation arrangements of persons
performing underwriting activities be designed not to reward
proprietary risk-taking.\290\ The proposal explained that these seven
criteria were proposed so that any banking entity relying on the
underwriting exemption would be engaged in bona fide underwriting
activities and would conduct those activities in a way that would not
be susceptible to abuse through the taking of speculative, proprietary
positions as

part of, or mischaracterized as, underwriting activity.\291\
---------------------------------------------------------------------------

    \290\ See proposed rule Sec.  ----.4(a).
    \291\ See Joint Proposal, 76 FR 68,866; CFTC Proposal, 77 FR
8352.
---------------------------------------------------------------------------

2. Comments on Proposed Underwriting Exemption
    As a general matter, a few commenters expressed overall support for
the proposed underwriting exemption.\292\ Some commenters indicated
that the proposed exemption is too narrow and may negatively impact
capital markets.\293\ As discussed in more detail below, many
commenters expressed views on the effectiveness of specific
requirements of the proposed exemption. Further, some commenters
requested clarification or expansion of the proposed exemption for
certain activities that may be conducted in the course of underwriting.
---------------------------------------------------------------------------

    \292\ See Barclays (stating that the proposed exemption
generally effectuates the aims of the statute while largely avoiding
undue interference, although the commenter also requested certain
technical changes to the rule text); Alfred Brock.
    \293\ See, e.g., Lord Abbett; BoA; Fidelity; Chamber (Feb.
2012).
---------------------------------------------------------------------------

    Several commenters suggested alternative approaches to implementing
the statutory exemption for underwriting activities.\294\ More
specifically, commenters recommended that the Agencies: (i) Provide a
safe harbor for low risk, standard underwritings; \295\ (ii) better
incorporate the statutory limitations on high-risk activity or
conflicts of interest; \296\ (iii) prohibit banking entities from
underwriting illiquid securities; \297\ (iv) prohibit banking entities
from participating in private placements; \298\ (v) place greater
emphasis on adequate internal compliance and risk management
procedures; \299\ or (vi) make the exemption as broad as possible.\300\
---------------------------------------------------------------------------

    \294\ See Sens. Merkley & Levin (Feb. 2012); BoA; Fidelity;
Occupy; AFR et al. (Feb. 2012).
    \295\ See Sens. Merkley & Levin (Feb. 2012) (suggesting a safe
harbor for underwriting efforts that meet certain low-risk criteria,
including that: The underwriting be in plain vanilla stock or bond
offerings, including commercial paper, for established business and
governments; and the distribution be completed within relevant time
periods, as determined by asset classes, with relevant factors being
the size of the issuer and the market served); Johnson & Prof.
Stiglitz (expressing support for a narrow safe harbor for
underwriting of basic stocks and bonds that raise capital for real
economy firms).
    \296\ See Sens. Merkley & Levin (Feb. 2012) (suggesting that,
for example, the exemption plainly prevent high-risk, conflict
ridden underwritings of securitizations and structured products and
cross-reference Section 621 of the Dodd-Frank Act, which prohibits
certain material conflicts of interest in connection with asset-
backed securities).
    \297\ See AFR et al. (Feb. 2012) (recommending that the Agencies
prohibit banking entities from acting as underwriter for assets
classified as Level 3 under FAS 157, which would prohibit
underwriting of illiquid and opaque securities without a genuine
external market, and representing that such a restriction would be
consistent with the statutory limitation on exposures to high-risk
assets).
    \298\ See Occupy.
    \299\ See BoA (recommending that the Agencies establish a strong
presumption that all of a banking entity's activities related to
underwriting are permitted under the rules as long as the banking
entity has adequate compliance and risk management procedures).
    \300\ See Fidelity (suggested that the rules be revised to
``provide the broadest exemptions possible under the statute'' for
underwriting and certain other permitted activities).
---------------------------------------------------------------------------

3. Final Underwriting Exemption
    After considering the comments received, the Agencies are adopting
the underwriting exemption substantially as proposed, but with
important modifications to clarify provisions or to address commenters'
concerns. As discussed above, some commenters were generally supportive
of the proposed approach to implementing the underwriting exemption,
but noted certain areas of concern or uncertainty. The underwriting
exemption the Agencies are adopting addresses these issues by further
clarifying the scope of activities that qualify for the exemption. In
particular, the Agencies are refining the proposed exemption to better
capture the broad range of capital-raising activities facilitated by
banking entities acting as underwriters on behalf of issuers and
selling security holders.
    The final underwriting exemption includes the following components:
     A framework that recognizes the differences in
underwriting activities across markets and asset classes by
establishing criteria that will be applied flexibly based on the
liquidity, maturity, and depth of the market for the particular type of
security.
     A general focus on the ``underwriting position'' held by a
banking entity or its affiliate, and managed by a particular trading
desk, in connection with the distribution of securities for which such
banking entity or affiliate is acting as an underwriter.\301\
---------------------------------------------------------------------------

    \301\ See infra Part IV.A.2.c.1.c.
---------------------------------------------------------------------------

     A definition of the term ``trading desk'' that focuses on
the functionality of the desk rather than its legal status, and
requirements that apply at the trading desk level of organization
within a banking entity or across two or more affiliates.\302\
---------------------------------------------------------------------------

    \302\ See infra Part IV.A.2.c.1.c. The term ``trading desk'' is
defined in final rule Sec.  ----.3(e)(13) as ``the smallest discrete
unit of organization of a banking entity that purchases or sells
financial instruments for the trading account of the banking entity
or an affiliate thereof.''
---------------------------------------------------------------------------

     Five standards for determining whether a banking entity is
engaged in permitted underwriting activities. Many of these criteria
have similarities to those included in the proposed rule, but with
important modifications in response to comments. These standards
require that:
    [cir] The banking entity act as an ``underwriter'' for a
``distribution'' of securities and the trading desk's underwriting
position be related to such distribution. The final rule includes
refined definitions of ``distribution'' and ``underwriter'' to better
capture the broad scope of securities offerings used by issuers and
selling security holders and the range of roles that a banking entity
may play as intermediary in such offerings.\303\
---------------------------------------------------------------------------

    \303\ See final rule Sec. Sec.  ----.4(a)(2)(i), ----.4(a)(3),
----.4(a)(4); See also infra Part IV.A.2.c.1.c.
---------------------------------------------------------------------------

    [cir] The amount and types of securities in the trading desk's
underwriting position be designed not to exceed the reasonably expected
near term demands of clients, customers, or counterparties, and
reasonable efforts be made to sell or otherwise reduce the underwriting
position within a reasonable period, taking into account the liquidity,
maturity, and depth of the market for the relevant type of
security.\304\
---------------------------------------------------------------------------

    \304\ See final rule Sec.  ----.4(a)(2)(ii); See also infra Part
IV.A.2.c.2.c.
---------------------------------------------------------------------------

    [cir] The banking entity establish, implement, maintain, and
enforce an internal compliance program that is reasonably designed to
ensure the banking entity's compliance with the requirements of the
underwriting exemption, including reasonably designed written policies
and procedures, internal controls, analysis, and independent testing
identifying and addressing:
    [ssquf] The products, instruments, or exposures each trading desk
may purchase, sell, or manage as part of its underwriting activities;
    [ssquf] Limits for each trading desk, based on the nature and
amount of the trading desk's underwriting activities, including the
reasonably expected near term demands of clients, customers, or
counterparties, on the amount, types, and risk of the trading desk's
underwriting position, level of exposures to relevant risk factors
arising from the trading desk's underwriting position, and period of
time a security may be held;
    [ssquf] Internal controls and ongoing monitoring and analysis of
each trading desk's compliance with its limits; and
    [ssquf] Authorization procedures, including escalation procedures
that require review and approval of any trade that would exceed a
trading desk's limit(s), demonstrable analysis of the basis for any
temporary or permanent

increase to a trading desk's limit(s), and independent review of such
demonstrable analysis and approval.\305\
---------------------------------------------------------------------------

    \305\ See final rule Sec.  ----.4(a)(2)(iii); See also infra
Part IV.A.2.c.3.c.
---------------------------------------------------------------------------

    [cir] The compensation arrangements of persons performing the
banking entity's underwriting activities are designed not to reward or
incentivize prohibited proprietary trading.\306\
---------------------------------------------------------------------------

    \306\ See final rule Sec.  ----.4(a)(2)(iv); See also infra Part
IV.A.2.c.4.c.
---------------------------------------------------------------------------

    [cir] The banking entity is licensed or registered to engage in the
activity described in the underwriting exemption in accordance with
applicable law.\307\
---------------------------------------------------------------------------

    \307\ See final rule Sec.  ----.4(a)(2)(v); See also infra Part
IV.A.2.c.5.c.
---------------------------------------------------------------------------

    After considering commenters' suggested alternative approaches to
implementing the statute's underwriting exemption, the Agencies have
determined to retain the general structure of the proposed underwriting
exemption. For instance, two commenters suggested providing a safe
harbor for ``plain vanilla'' or ``basic'' underwritings of stocks and
bonds.\308\ The Agencies do not believe that a safe harbor is necessary
to provide certainty that a banking entity may act as an underwriter in
these particular types of offerings. This is because ``plain vanilla''
or ``basic'' underwriting activity should be able to meet the
requirements of the final rule. For example, the final definition of
``distribution'' includes any offering of securities made pursuant to
an effective registration statement under the Securities Act.\309\
---------------------------------------------------------------------------

    \308\ See Sens. Merkley & Levin (Feb. 2012); Johnson & Prof.
Stiglitz. One of these commenters also suggested that the Agencies
better incorporate the statutory limitations on material conflicts
of interest and high-risk activities in the underwriting exemption
by including additional provisions in the exemption to refer to
these limitations. See Sens. Merkley & Levin (Feb. 2012). The
Agencies note that these limitations are adopted in Sec.  ----.7 of
the final rules, and this provision will apply to underwriting
activities, as well as all other exempted activities.
    \309\ See final rule Sec.  ----.4(a)(3).
---------------------------------------------------------------------------

    Further, in response to one commenter's request that the final rule
prohibit a banking entity from acting as an underwriter in illiquid
assets that are determined to not have observable price inputs under
accounting standards,\310\ the Agencies continue to believe that it
would be inappropriate to incorporate accounting standards in the rule
because accounting standards could change in the future without
consideration of the potential impact on the final rule.\311\ Moreover,
the Agencies do not believe it is necessary to differentiate between
liquid and less liquid securities for purposes of determining whether a
banking entity may underwrite a distribution of securities because, in
either case, a banking entity must have a reasonable expectation of
purchaser demand for the securities and must make reasonable efforts to
sell or otherwise reduce its underwriting position within a reasonable
period under the final rule.\312\
---------------------------------------------------------------------------

    \310\ See AFR et al. (Feb. 2012).
    \311\ See Joint Proposal, 76 FR 68,859 n.101 (explaining why the
Agencies declined to incorporate certain accounting standards in the
proposed rule); CFTC Proposal, 77 FR 8344 n.107.
    \312\ See infra Part IV.A.2.c.2.c.
---------------------------------------------------------------------------

    Another commenter suggested that the Agencies establish a strong
presumption that all of a banking entity's activities related to
underwriting are permitted under the rule as long as the banking entity
has adequate compliance and risk management procedures.\313\ While
strong compliance and risk management procedures are important for
banking entities' permitted activities, the Agencies believe that an
approach focused solely on the establishment of a compliance program
would likely increase the potential for evasion of the general
prohibition on proprietary trading. Similarly, the Agencies are not
adopting an exemption that is unlimited, as requested by one commenter,
because the Agencies believe controls are necessary to prevent
potential evasion of the statute through, among other things, retaining
an unsold allotment when there is sufficient customer interest for the
securities and to limit the risks associated with these
activities.\314\
---------------------------------------------------------------------------

    \313\ See BoA.
    \314\ See Fidelity.
---------------------------------------------------------------------------

    Underwriters play an important role in facilitating issuers' access
to funding, and thus underwriters are important to the capital
formation process and economic growth.\315\ Obtaining new financing can
be expensive for an issuer because of the natural information advantage
that less well-known issuers have over investors about the quality of
their future investment opportunities. An underwriter can help reduce
these costs by mitigating the information asymmetry between an issuer
and its potential investors. The underwriter does this based in part on
its familiarity with the issuer and other similar issuers as well as by
collecting information about the issuer. This allows investors to look
to the reputation and experience of the underwriter as well as its
ability to provide information about the issuer and the underwriting.
For these and other reasons, most U.S. issuers rely on the services of
an underwriter when raising funds through public offerings. As
recognized in the statute, the exemption is intended to permit banking
entities to continue to perform the underwriting function, which
contributes to capital formation and its positive economic effects.
---------------------------------------------------------------------------

    \315\ See, e.g., BoA (``The underwriting activities of U.S.
banking entities are essential to capital formation and, therefore,
economic growth and job creation.''); Goldman (Prop. Trading); Sens.
Merkley & Levin (Feb. 2012).
---------------------------------------------------------------------------

c. Detailed Explanation of the Underwriting Exemption
1. Acting as an Underwriter for a Distribution of Securities
a. Proposed Requirements That the Purchase or Sale be Effected Solely
in Connection With a Distribution of Securities for Which the Banking
Entity Acts as an Underwriter and That the Covered Financial Position
be a Security
    Section ----.4(a)(2)(iii) of the proposed rule required that the
purchase or sale be effected solely in connection with a distribution
of securities for which a banking entity is acting as underwriter.\316\
As discussed below, the Agencies proposed to define the terms
``distribution'' and ``underwriter'' in the proposed rule. The proposed
rule also required that the covered financial position being purchased
or sold by the banking entity be a security.\317\
---------------------------------------------------------------------------

    \316\ See proposed rule Sec.  ----.4(a)(2)(iii).
    \317\ See proposed rule Sec.  ----.4(a)(2)(ii).
---------------------------------------------------------------------------

i. Proposed Definition of ``Distribution''
    The proposed definition of ``distribution'' mirrored the definition
of this term used in the SEC's Regulation M under the Exchange
Act.\318\ More specifically, the proposed rule defined ``distribution''
as ``an offering of securities, whether or not subject to registration
under the Securities Act, that is distinguished from ordinary trading
transactions by the magnitude of the offering and the presence of
special selling efforts and selling methods.''\319\ The Agencies did
not propose to define the terms ``magnitude'' and ``special selling
efforts and selling methods,'' but stated that the Agencies would
expect to rely on the same factors considered in Regulation M for
assessing these elements.\320\ The Agencies noted that

``magnitude'' does not imply that a distribution must be large and,
therefore, this factor would not preclude small offerings or private
placements from qualifying for the proposed underwriting
exemption.\321\
---------------------------------------------------------------------------

    \318\ See Joint Proposal, 76 FR 68,866-68,867; CFTC Proposal, 77
FR 8352; 17 CFR 242.101; proposed rule Sec.  ----.4(a)(3).
    \319\ See proposed rule Sec.  ----.4(a)(3).
    \320\ See Joint Proposal, 76 FR 68,867 (``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. In addition,
delivering a sales document, such as a prospectus, and conducting
road shows are generally indicative of special selling efforts and
selling methods. 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.''); CFTC Proposal, 77 FR 8352; Review of
Antimanipulation Regulation of Securities Offering, Exchange Act
Release No. 33924 (Apr. 19, 1994), 59 FR 21,681, 21,684-21,685 (Apr.
26, 1994).
    \321\ See Joint Proposal, 76 FR 68,867; CFTC Proposal, 77 FR
8352.*COM057**COM057*
---------------------------------------------------------------------------

ii. Proposed Definition of ``Underwriter''
    Like the proposed definition of ``distribution,'' the Agencies
proposed to define ``underwriter'' in a manner similar to the
definition of this term in the SEC's Regulation M.\322\ The definition
of ``underwriter'' in the proposed rule was: (i) Any person who has
agreed with an issuer or selling security holder to: (a) Purchase
securities for distribution; (b) engage in a distribution of securities
for or on behalf of such issuer or selling security holder; or (c)
manage a distribution of securities for or on behalf of such issuer or
selling security holder; and (ii) a person who has an agreement with
another person described in the preceding provisions to engage in a
distribution of such securities for or on behalf of the issuer or
selling security holder.\323\

    \322\ See Joint Proposal, 76 FR 68,866-68,867; CFTC Proposal, 77
FR 8352; 17 CFR 242.101; proposed rule Sec.  ----.4(a)(4).
    \323\ See proposed rule Sec.  ----.4(a)(4). As noted in the
proposal, the proposed rule's definition differed from the
definition in Regulation M because the proposed rule's definition
would also include 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. See Joint Proposal,
76 FR 68,867; CFTC Proposal, 77 FR 8352.
---------------------------------------------------------------------------

    In connection with this proposed requirement, the Agencies noted
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. To determine whether a banking
entity is acting as an underwriter as part of a distribution of
securities, the Agencies proposed to take into consideration the extent
to which a banking entity is engaged in the following activities:
     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 document;
     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.\324\
---------------------------------------------------------------------------

    \324\ See Joint Proposal, 76 FR 68,867; CFTC Proposal, 77 FR
8352.
---------------------------------------------------------------------------

The proposal recognized that there may be circumstances in which an
underwriter would hold securities that it could not sell in the
distribution for investment purposes. The Agencies stated that if the
unsold securities were acquired in connection with underwriting under
the proposed exemption, then the underwriter would be able to dispose
of such securities at a later time.\325\
---------------------------------------------------------------------------

    \325\ See id.
---------------------------------------------------------------------------

iii. Proposed Requirement That the Covered Financial Position Be a
Security
    Pursuant to Sec.  ----.4(a)(2)(ii) of the proposed exemption, a
banking entity would be permitted to purchase or sell a covered
financial position that is a security only in connection with its
underwriting activities.\326\ The proposal stated that this requirement
was meant to reflect the common usage and understanding of the term
``underwriting.'' \327\ It was noted, 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).\328\
---------------------------------------------------------------------------

    \326\ See proposed rule Sec.  ----.4(a)(2)(ii).
    \327\ See Joint Proposal, 76 FR 68,866; CFTC Proposal, 77 FR
8352.
    \328\ See Joint Proposal, 76 FR 68,866 n.132; CFTC Proposal, 77
FR 8352 n.138.
---------------------------------------------------------------------------

b. Comments on the Proposed Requirements That the Trade Be Effected
Solely in Connection With a Distribution for Which the Banking Entity
Is Acting as an Underwriter and That the Covered Financial Position Be
a Security
    In response to the proposed requirement that a purchase or sale be
``effected solely in connection with a distribution of securities'' for
which the ``banking entity is acting as underwriter,'' commenters
generally focused on the proposed definitions of ``distribution'' and
``underwriter'' and the types of activities that should be permitted
under the ``in connection with'' standard. Commenters did not directly
address the requirement in Sec.  ----.4(a)(2)(ii) of the proposed rule,
which provided that the covered financial position purchased or sold
under the exemption must be a security. A number of commenters
expressed general concern that the proposed underwriting exemption's
references to a ``purchase or sale of a covered financial position''
could be interpreted to require compliance with the proposed rule on a
transaction-by-transaction basis. These commenters indicated that such
an approach would be overly burdensome.\329\
---------------------------------------------------------------------------

    \329\ See, e.g., Goldman (Prop. Trading); SIFMA et al. (Prop.
Trading) (Feb. 2012).
---------------------------------------------------------------------------

i. Definition of ``Distribution''
    Several commenters stated that the proposed definition of
``distribution'' is too narrow,\330\ while one commenter stated that
the proposed definition is too broad.\331\ Commenters who viewed the
proposed definition as too narrow stated that it may exclude important
capital-raising and financing transactions that do not appear to
involve ``special selling efforts and selling methods'' or
``magnitude.'' \332\ In particular, these commenters stated that the
proposed definition of ``distribution'' may preclude a banking entity
from participating in commercial paper issuances,\333\ bridge
loans,\334\ ``at-the-market'' offerings or ``dribble out'' programs
conducted off issuer shelf registrations,\335\ offerings in response to
reverse inquiries,\336\ offerings through an automated execution
system,\337\ small private offerings,\338\ or selling security holders'
sales of securities of issuers with large market capitalizations that
are executed as underwriting transactions in the normal course.\339\
---------------------------------------------------------------------------

    \330\ See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman
(Prop. Trading); Wells Fargo (Prop. Trading); RBC.
    \331\ See Occupy.
    \332\ See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman
(Prop. Trading); Wells Fargo (Prop. Trading); RBC.
    \333\ See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman
(Prop. Trading); Wells Fargo (Prop. Trading). In addition, one
commenter expressed general concern that the proposed rule would
cause a reduction in underwriting services with respect to
commercial paper, which would reduce liquidity in commercial paper
markets and raise the costs of capital in already tight credit
markets. See Chamber (Feb. 2012).
    \334\ See Goldman (Prop. Trading); Wells Fargo (Prop. Trading);
RBC; LSTA (Feb. 2012).
    \335\ See Goldman (Prop. Trading).
    \336\ See SIFMA et al. (Prop. Trading) (Feb. 2012).
    \337\ See SIFMA et al. (Prop. Trading) (Feb. 2012).
    \338\ See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman
(Prop. Trading); Wells Fargo (Prop. Trading).
    \339\ See RBC.
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    Several commenters suggested that the proposed definition be
modified to

include some or all of these types of offerings.\340\ For example, two
commenters requested that the definition explicitly include all
offerings of securities by an issuer.\341\ One of these commenters
further requested a broader definition that would include any offering
by a selling security holder that is registered under the Securities
Act or that involves an offering document prepared by the issuer.\342\
Another commenter suggested that the rule explicitly authorize certain
forms of offerings, such as offerings under Rule 144A, Regulation S,
Rule 101(b)(10) of Regulation M, or the so-called ``section 4(1\1/2\)''
of the Securities Act, as well as transactions on behalf of selling
security holders.\343\ Two commenters proposed approaches that would
include the resale of notes or other debt securities received by a
banking entity from a borrower to replace or refinance a bridge
loan.\344\ One of these commenters stated that permitting a banking
entity to receive and resell notes or other debt securities from a
borrower to replace or refinance a bridge loan would preserve the
ability of a banking entity to extend credit and offer customers a
range of financing options. This commenter further represented that
such an approach would be consistent with the exclusion of loans from
the proposed definition of ``covered financial position'' and the
commenter's recommended exclusion from the definition of ``trading
account'' for collecting debts previously contracted.\345\
---------------------------------------------------------------------------

    \340\ See Goldman (Prop. Trading); SIFMA et al. (Prop. Trading)
(Feb. 2012); RBC.
    \341\ See Goldman (Prop. Trading) (stating that this would
capture, among other things, commercial paper issuances, issuer
``dribble out'' programs, and small private offerings, which involve
the purchase of securities directly from an issuer with a view
toward resale, but may not always be clearly distinguished by
``special selling efforts and selling methods'' or by
``magnitude''); SIFMA et al. (Prop. Trading) (Feb. 2012).
    \342\ See SIFMA et al. (Prop. Trading) (Feb. 2012). This
commenter indicated that expanding the definition of
``distribution'' to include both offerings of securities by an
issuer and offerings by a selling security holder that are
registered under the Securities Act or that involve an offering
document prepared by the issuer would ``include, for example, an
offering of securities by an issuer or a selling security holder
where securities are sold through an automated order execution
system, offerings in response to reverse inquiries and commercial
paper issuances.'' Id.
    \343\ See RBC.
    \344\ See Goldman (Prop. Trading); RBC. In addition, one
commenter requested the Agencies clarify that permitted underwriting
activities include the acquisition and resale of securities issued
in lieu of or to refinance bridge loan facilities, irrespective of
whether such activities qualify as ``distributions'' under the
proposal. See LSTA (Feb. 2012).
    \345\ See Goldman (Prop. Trading).
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    One commenter, however, stated that the proposed definition of
``distribution'' is too broad. This commenter suggested that the
underwriting exemption should only be available for registered
offerings, and the rule should preclude a banking entity from
participating in a private placement. According to the commenter,
permitting a banking entity to participate in a private placement may
facilitate evasion of the prohibition on proprietary trading.\346\
---------------------------------------------------------------------------

    \346\ See Occupy.
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ii. Definition of ``Underwriter''
    Several commenters stated that the proposed definition of
``underwriter'' is too narrow.\347\ Other commenters, however, stated
that the proposed definition is too broad, particularly due to the
proposed inclusion of selling group members.\348\
---------------------------------------------------------------------------

    \347\ See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman
(Prop. Trading); Wells Fargo (Prop. Trading).
    \348\ See AFR et al. (Feb. 2012); Public Citizen; Occupy
(suggesting that the Agencies exceeded their statutory authority by
incorporating the Regulation M definition of ``underwriter,'' rather
than the Securities Act definition of ``underwriter'').
---------------------------------------------------------------------------

    Commenters requesting a broader definition generally stated that
the Agencies should instead use the Regulation M definition of
``distribution participant'' or otherwise revise the definition of
``underwriter'' to incorporate the concept of a ``distribution
participant,'' as defined under Regulation M.\349\ According to these
commenters, using the term ``distribution participant'' would better
reflect current market practice and would include dealers that
participate in an offering but that do not deal directly with the
issuer or selling security holder and do not have a written agreement
with the underwriter.\350\ One commenter further represented that the
proposed provision for selling group members may be less inclusive than
the Agencies intended because individual selling dealers or dealer
groups may or may not have written agreements with an underwriter in
privity of contract with the issuer.\351\ Another commenter requested
that, if the ``distribution participant'' concept is not incorporated
into the rule, the proposed definition of ``underwriter'' be modified
to include a person who has an agreement with an affiliate of an issuer
or selling security holder (e.g., an agreement with a parent company to
distribute the issuer's securities).\352\
---------------------------------------------------------------------------

    \349\ See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman
(Prop. Trading); Wells Fargo (Prop. Trading). The term
``distribution participant'' is defined in Rule 100 of Regulation M
as ``an underwriter, prospective underwriter, broker, dealer, or
other person who has agreed to participate or is participating in a
distribution.'' 17 CFR 242.100.
    \350\ See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman
(Prop. Trading); Wells Fargo (Prop. Trading).
    \351\ See Goldman (Prop. Trading).
    \352\ See SIFMA et al. (Prop. Trading) (Feb. 2012). This
commenter also requested a technical amendment to proposed rule
Sec.  ----.4(a)(4)(ii) to clarify that the person is
``participating'' in a distribution, not ``engaging'' in a
distribution. See id.
---------------------------------------------------------------------------

    Other commenters opposed the inclusion of selling group members in
the proposed definition of ``underwriter.'' These commenters stated
that because selling group members do not provide a price guarantee to
an issuer, they do not provide services to a customer and their
activities should not qualify for the underwriting exemption.\353\
---------------------------------------------------------------------------

    \353\ See AFR et al. (Feb. 2012); Public Citizen.
---------------------------------------------------------------------------

    A number of commenters stated that it is unclear whether the
proposed underwriting exemption would permit a banking entity to act as
an authorized participant (``AP'') to an ETF issuer, particularly with
respect to the creation and redemption of ETF shares or ``seeding'' an
ETF for a short period of time when it is initially launched.\354\ For
example, a few commenters noted that APs typically do not perform some
or all of the activities that the Agencies proposed to consider to help
determine whether a banking entity is acting as an underwriter in
connection with a distribution of securities, including due diligence,
advising an issuer on market conditions and assisting in preparation of
a registration statement or offering documents, and participating in or
organizing a syndicate of investment banks.\355\
---------------------------------------------------------------------------

    \354\ See BoA; ICI Global; Vanguard; ICI (Feb. 2012); SSgA (Feb.
2012). As one commenter explained, an AP may ``seed'' an ETF for a
short period of time at its inception by entering into several
initial creation transactions with the ETF issuer and refraining
from selling those shares to investors or redeeming them for a
period of time to facilitate the ETF achieving its liquidity launch
goals. See BoA.
    \355\ See ICI Global; ICI (Feb. 2012); Vanguard.
---------------------------------------------------------------------------

    However, one commenter appeared to oppose applying the underwriting
exemption to certain AP activities. According to this commenter, APs
are generally reluctant to concede that they are statutory underwriters
because they do not perform all the activities associated with the
underwriting of an operating company's securities. Further, this
commenter expressed concern that, if an AP had to rely on the proposed
underwriting exemption, the AP could be subject to heightened risk of
incurring underwriting liability on the issuance of ETF shares traded
by the AP. As a result of these considerations,

the commenter believed that a banking entity may be less willing to act
as an AP for an ETF issuer if it were required to rely on the
underwriting exemption.\356\
---------------------------------------------------------------------------

    \356\ See SSgA (Feb. 2012).
---------------------------------------------------------------------------

iii. ``Solely in Connection With'' Standard
    To qualify for the underwriting exemption, the proposed rule
required a purchase or sale of a covered financial position to be
effected ``solely in connection with'' a distribution of securities for
which the banking entity is acting as underwriter. Several commenters
expressed concern that the word ``solely'' in this provision may result
in an overly narrow interpretation of permissible activities. In
particular, these commenters indicated that the ``solely in connection
with'' standard creates uncertainty about certain activities that are
currently conducted in the course of an underwriting, such as customary
underwriting syndicate activities.\357\ One commenter represented that
such activities are traditionally undertaken to: Support the success of
a distribution; mitigate risk to issuers, investors, and underwriters;
and facilitate an orderly aftermarket.\358\ A few commenters further
stated that requiring a trade to be ``solely'' in connection with a
distribution by an underwriter would be inconsistent with the
statute,\359\ may reduce future innovation in the capital-raising
process,\360\ and could create market disruptions.\361\
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    \357\ See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman
(Prop. Trading); BoA; Wells Fargo (Prop. Trading); Comm. on Capital
Markets Regulation.
    \358\ See Goldman (Prop. Trading).
    \359\ See Goldman (Prop. Trading); Wells Fargo (Prop. Trading);
SIFMA et al. (Prop. Trading) (Feb. 2012).
    \360\ See Goldman (Prop. Trading).
    \361\ See SIFMA et al. (Prop. Trading) (Feb. 2012).
---------------------------------------------------------------------------

    A number of commenters stated that it is unclear whether certain
activities would qualify for the proposed underwriting exemption and
requested that the Agencies adopt an exemption that is broad enough to
permit such activities.\362\ Commenters stated that there are a number
of activities that should be permitted under the underwriting
exemption, including: (i) Creating a naked or covered syndicate short
position in connection with an offering; \363\ (ii) creating a
stabilizing bid; \364\ (iii) acquiring positions via overallotments
\365\ or trading in the market to close out short positions in
connection with an overallotment option or in connection with other
stabilization activities; \366\ (iv) using call spread options in a
convertible debt offering to mitigate dilution of existing
shareholders; \367\ (v) repurchasing existing debt securities of an
issuer in the course of underwriting a new series of debt securities in
order to stimulate demand for the new issuance; \368\ (vi) purchasing
debt securities of comparable issuers as a price discovery mechanism in
connection with underwriting a new debt security; \369\ (vii) hedging
the underwriter's exposure to a derivative strategy engaged in with an
issuer; \370\ (viii) organizing and assembling a resecuritized product,
including, for example, sourcing bond collateral over a period of time
in anticipation of issuing new securities; \371\ and (ix) selling a
security to an intermediate entity as part of the creation of certain
structured products.\372\
---------------------------------------------------------------------------

    \362\ See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman
(Prop. Trading); Wells Fargo (Prop. Trading); RBC.
    \363\ See SIFMA et al. (Prop. Trading) (Feb. 2012) (``The reason
for creating the short positions (covered and naked) is to
facilitate an orderly aftermarket and to reduce price volatility of
newly offered securities. This provides significant value to issuers
and selling security holders, as well as to investors, by giving the
syndicate buying power that helps protect against immediate
volatility in the aftermarket.''); RBC; Goldman (Prop. Trading).
    \364\ See SIFMA et al. (Prop. Trading) (Feb. 2012)
(``Underwriters may also engage in stabilization activities under
Regulation M by creating a stabilizing bid to prevent or slow a
decline in the market price of a security. These activities should
be encouraged rather than restricted by the Volcker Rule because
they reduce price volatility and facilitate the orderly pricing and
aftermarket trading of underwritten securities, thereby contributing
to capital formation.'').
    \365\ See RBC.
    \366\ See Goldman (Prop. Trading).
    \367\ See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman
(Prop. Trading) (stating that the call spread arrangement ``may make
a wider range of financing options feasible for the issuer of the
convertible debt'' and ``can help it to raise more capital at more
attractive prices'').
    \368\ See Wells Fargo (Prop. Trading). The commenter further
stated that the need to purchase the issuer's other debt securities
from investors may arise if an investor has limited risk tolerance
to the issuer's credit or has portfolio restrictions. According to
the commenter, the underwriter would typically sell the debt
securities it purchased from existing investors to new investors.
See id.
    \369\ See Wells Fargo (Prop. Trading).
    \370\ See Goldman (Prop. Trading).
    \371\ See ASF (Feb. 2012) (stating that, for example, a banking
entity may respond to customer or general market demand for highly-
rated mortgage paper by accumulating residential mortgage-backed
securities over time and holding such securities in inventory until
the transaction can be organized and assembled).
    \372\ See ICI (Feb. 2012) (stating that the sale of assets to an
intermediate asset-backed commercial paper or tender option bond
program should be permitted under the underwriting exemption if the
sale is part of the creation of a structured security). See also AFR
et al. (Feb. 2012) (stating that the treatment of a sale to an
intermediate entity should depend on whether the banking entity or
an external client is the driver of the demand and, if the banking
entity is the driver of the demand, then the near term demand
requirement should not be met). Two commenters stated that the
underwriting exemption should not permit a banking entity to sell a
security to an intermediate entity in the course of creating a
structured product. See Occupy; Alfred Brock. These commenters were
generally responding to a question on this issue in the proposal.
See Joint Proposal, 76 FR 68,868-68,869 (question 78); CFTC
Proposal, 77 FR 8354 (question 78).
---------------------------------------------------------------------------

c. Final Requirement That the Banking Entity Act as an Underwriter for
a Distribution of Securities and the Trading Desk's Underwriting
Position Be Related to Such Distribution
    The final rule requires that the banking entity act as an
underwriter for a distribution of securities and the trading desk's
underwriting position be related to such distribution.\373\ This
requirement is substantially similar to the proposed rule,\374\ but
with five key refinements. First, to address commenters' confusion
about whether the underwriting exemption applies on a transaction-by-
transaction basis, the phrase ``purchase or sale'' has been modified to
instead refer to the trading desk's ``underwriting position.'' Second,
to balance this more aggregated position-based approach, the final rule
specifies that the trading desk is the organizational level of a
banking entity (or across one or more affiliated banking entities) at
which the requirements of the underwriting exemption will be assessed.
Third, the Agencies have made important modifications to the definition
of ``distribution'' to better capture the various types of private and