relevant ABS or the asset pool supporting or referenced by the relevant
ABS.\377\ One of these commenters specifically stated that a conflicted
transaction ``should be defined in terms of the economic substance,
rather than the form or label of the transaction.'' \378\ Another one
of these commenters stated that ``it would be appropriate for the final
rule to include some kind of category that encompasses transactions
that substantially replicate the economic effects of a short sale of,
or credit default swap on, the relevant ABS.'' \379\ Additionally,
another commenter agreed that it would be appropriate for the final
rule to prohibit transactions that are ``substantially the economic
equivalent

of a direct bet against the relevant ABS.'' \380\
---------------------------------------------------------------------------

    \377\ See letters from AFR; AIC; Andrew Davidson.
    \378\ See letter from AFR.
    \379\ See letter from AIC.
    \380\ See letter from Andrew Davidson.
---------------------------------------------------------------------------

    Focusing Rule 192(a)(3)(iii) on transactions that are substantially
the economic equivalent of a transaction specified in Rule 192(a)(3)(i)
or Rule 192(a)(3)(ii), which, as explained above, commenters broadly
agreed give rise to a material conflict of interest, is designed to
address many of the concerns that commenters expressed regarding the
potentially overbroad application of the rule as proposed while still
prohibiting securitization participants from engaging in transactions
that result in material conflicts of interest with investors. As
adopted, final Rule 192(a)(3)(iii) will capture the types of
transactions through which the securitization participant could, in
economic substance, bet against the ABS or the asset pool supporting or
referenced by the relevant ABS in the same way as a short sale of the
ABS or a CDS referencing the ABS but without regard to the particular
form of the relevant transaction. This will help ensure that the rule
protects investors from purchasing ABS tainted by material conflicts of
interests as markets evolve and new forms of betting against an ABS or
its relevant asset pool that are distinct from a short sale or CDS, but
which are substantially the economic equivalent of such transactions,
may emerge.
    The types of transactions that are ``conflicted transactions'' for
purposes of Rule 192(a)(3)(iii) and that will be substantially the
economic equivalent of a transaction described in Rule 192(a)(3)(i) or
Rule 192(a)(3)(ii) will include a securitization participant entering
into the short-side of a derivative that references the credit
performance of the pool of assets underlying the relevant ABS and
pursuant to which the securitization participant would benefit if the
referenced asset pool performs adversely.\381\ One commenter stated
that taking a short position in the asset pool underlying or referenced
by the relevant ABS should not be a conflicted transaction because such
short activity does not raise the same material conflict of interest
concerns as are raised by shorting the relevant ABS itself.\382\ Other
commenters stated that taking a short position in some portion of the
asset pool underlying or referenced by the relevant ABS should not be a
conflicted transaction because such short activity does not raise the
same material conflict of interest concerns as are raised by shorting
the relevant ABS itself.\383\ In our view, however, a bet against the
asset pool supporting or referenced by an ABS should be captured as a
conflicted transaction. ABS are cash-flow vehicles that distribute cash
to investors based on the performance of the relevant asset pool for
such ABS. Therefore, a bet against the relevant asset pool is a bet
against the ABS itself, which presents the same type of material
conflict of interest raised by a short sale of the relevant ABS or a
CDS entered into with respect to the relevant ABS as addressed in Rule
192(a)(3)(i) and Rule 192(a)(3)(ii), respectively. Accordingly, it
would not be appropriate to allow a securitization participant to bet
against the performance of the relevant asset pool. In the context of
an ABS with an asset pool consisting of a large number of different and
distinct obligations, we recognize that a short transaction with
respect to a single asset or some non-sizeable portion of the assets in
that pool would generally not result in a short position with respect
to such asset or assets being substantially the economic equivalent of
a short sale of the relevant ABS itself or a CDS or credit derivative
pursuant to which the securitization participant would be entitled to
receive payments upon the occurrence of specified credit events in
respect of the relevant ABS. However, if the relevant assets do
represent a sizeable portion of the asset pool supporting or referenced
by the relevant ABS, then entering into a transaction with respect to
such assets can present the same investor protection concerns that
Section 27B was intended to address. Under the final rule, such a
transaction can be a conflicted transaction based on the facts and
circumstances.\384\
---------------------------------------------------------------------------

    \381\ One commenter specifically requested an exception to the
final rule for a riskless principal transaction where a
securitization participant that is a broker-dealer intermediates a
trade for a customer by entering into a conflicted transaction and
offsetting that conflicted transaction by entering into a
contemporaneous transaction with a third-party. See letter from SFA
II. This type of activity is eligible for the bona fide market-
making activities exception discussed in detail in Section II.G
subject to satisfaction of the conditions applicable to the
exception. Therefore, we do not believe that a separate exception is
necessary for this type of activity.
    \382\ See letter from SIFMA I.
    \383\ See, e.g., letters from AIC (stating its belief that the
rule, as proposed, was intended to prohibit taking a short position
with respect to a material concentration of the assets underlying
the ABS and that an investor would not consider such a position with
respect to a single asset or obligor to be material); LSTA II
(requesting clarification that the rule does not apply to
transactions related to individual assets or a group of assets held
by a securitization vehicle).
    \384\ Even if such transaction is a conflicted transaction, it
could be eligible for the risk-mitigating hedging activities
exception if the conditions applicable to the exception are
satisfied. See the discussion in Section II.E. below.
---------------------------------------------------------------------------

    Commenters stated that the definition of conflicted transaction
should not capture the use of CDS index-based hedging strategies where
the relevant ABS only represents a minimal component of the index.\385\
Whether or not a transaction with respect to such index is a conflicted
transaction under Rule 192(a)(3)(iii) will be a facts and circumstances
determination based on the composition and characteristics of the
relevant index. In particular, securitization participants will need to
determine if a short position with respect to such index is
substantially the economic equivalent of a short sale of the relevant
ABS itself or a CDS or credit derivative pursuant to which the
securitization participant would be entitled to receive payments upon
the occurrence of specified credit events in respect of the relevant
ABS. If the relevant ABS or the asset pool supporting or referenced by
such ABS does not represent a sizeable portion of the index, then
entering into a transaction with respect to such index will not present
the same investor protection concerns that Section 27B addresses. In
such a scenario, the adverse performance of the asset pool supporting
or referenced by such ABS would not have enough of an economic impact
on the performance of the relevant index for a short position with
respect to that index to be substantially the economic equivalent of a
transaction described in Rule 192(a)(3)(i) or Rule 192(a)(3)(ii).\386\
However, if the relevant ABS or the asset pool does represent a

sizeable portion of the index, then entering into a transaction with
respect to such index presents the same investor protection concerns
that Section 27B addresses. Under the final rule, such a transaction
could be a conflicted transaction based on the facts and
circumstances.\387\
---------------------------------------------------------------------------

    \385\ See, e.g., letters from AFME (requesting an exception for
transactions involving the purchase or sale of an index including
ABS where those ABS constitute a de minimis portion of the overall
index); ICI (specifically requesting clarification that a fund or
adviser, as a fiduciary on behalf of another fund or other client,
taking a position on an ABS index that includes ABS of an affiliated
securitization participant, would not be a conflicted transaction);
SIFMA I (recommending that, if an ABS is referenced in an index, a
short position in that index should be carved out of the prohibition
as long as the ABS represents less than a threshold percentage of
that index and citing the language adopted in Regulation RR, which
limits the exclusion to indices where the subject ABS represents no
more than 10% of the dollar-weighted average of all instruments in
the index).
    \386\ For example, a transaction with respect to an index that
includes a class of the relevant ABS and that is permissible under
12 CFR 373.12(d) will not be a conflicted transaction for purposes
of the final rule given that the restrictions on the composition of
the relevant index will not result in a short position with respect
to such index being substantially the economic equivalent of a
transaction described in Rule 192(a)(3)(i) or Rule 192(a)(3)(ii). We
also believe that it would be inconsistent for an index hedge that
is permissible under 12 CFR 373.12(d) to be impermissible under this
rule.
    \387\ Even if such transaction is a conflicted transaction, it
could be eligible for the risk-mitigating hedging activities
exception if the conditions applicable to the exception are
satisfied. See the discussion in Section II.E. below.
---------------------------------------------------------------------------

    Although we do not believe that a general interest rate or currency
exchange rate hedge will be captured as a transaction that is
substantially the economic equivalent of a transaction described in
Rule 192(a)(3)(i) or Rule 192(a)(3)(ii), we are specifying in final
Rule 192(a)(3)(iii) that, for the avoidance of doubt, any transaction
that only hedges general interest rate or currency exchange risk is not
a conflicted transaction in order to avoid uncertainty and to not
unnecessarily limit or discourage the prudent management of general
interest rate and currency exchange risks by securitization
participants. The inclusion of this language will also directly address
the concerns raised by commenters that the rule as proposed could
inadvertently prohibit the hedging of general interest rate and foreign
exchange risks by a securitization participant.\388\ We do not believe
that Section 27B was intended to restrict the ability of a
securitization participant to manage its general interest rate and/or
foreign exchange risk exposures. The language that we are adding to
final Rule 192(a)(3)(iii) expressly allows for a securitization
participant's continued ability to hedge general interest rate or
foreign exchange exposure, and by extension, a securitization
participant will not need to rely on the risk-mitigating hedging
activities exception under the final rule to enter into such
transactions.\389\ The qualifier ``general'' has been included to
specify that the relevant transaction must relate to overall market
movements and not the idiosyncratic credit risk of the relevant ABS.
This is consistent with the suggestion of commenters that the
definition of ``conflicted transaction'' should not capture interest
rate or currency exchange hedges that are not related to the credit
risk of the relevant ABS.\390\ As adopted, Rule 192(a)(3)(iii) will
permit any transaction that only hedges general interest rate or
currency exchange risk. Other transactions unrelated to the
idiosyncratic credit performance of the ABS, such as hedging of general
market risk, are not conflicted transactions, and thus are not subject
to the prohibition in Rule 192(a)(1). The inclusion of this ``for the
avoidance of doubt'' language in the definition of conflicted
transaction also does not limit the scope of the risk-mitigating
hedging activities exception or any other exception to the final rule.
Each of the exceptions to the final rule is discussed in detail below.
---------------------------------------------------------------------------

    \388\ See, e.g., letters from MFA II (requesting that the
Commission expressly permit interest rate hedging, currency hedging,
and other non-credit related hedging); SFA II (stating that hedging
transactions that are not related to the credit risk of the relevant
ABS should not be subject to the conditions in the proposed risk-
mitigating hedging activities exception); SIFMA I (focusing on
``interest rate, currency or other non-credit related trading and
hedging activities'').
    \389\ This approach would be generally consistent with the
suggestion of a commenter that proposed 17 CFR 230.192(a)(3)(iii)(C)
should be revised to capture only a decline in the market value of
the relevant ABS relative to similar ABS. We agree that the market
value of an ABS can decline due to macro-economic shifts that affect
the entire ABS market, such as interest rate changes, that are
beyond the control of a securitization participant.
    \390\ See, e.g., letters from MFA II (requesting that the
Commission expressly permit interest rate hedging, currency hedging,
and other non-credit related hedging); SFA II (stating that
transactions that are not related to the credit risk of the relevant
ABS should not be conflicted transactions, such as transactions
``related to overall market movements'').
---------------------------------------------------------------------------

    Commenters expressed concerns that the rule as proposed would
prohibit the ordinary course pre-securitization and issuance activities
of market participants, such as the provision of warehouse financing or
the transfer of assets into a securitization vehicle.\391\ As stated in
the Proposing Release, the rule is not designed to hinder routine
securitization activities that do not give rise to the risks that
Section 27B addresses.\392\ This includes the provision of warehouse
financing and the transfer or sale of assets into the relevant
securitization vehicle, which are standard activities in connection
with the issuance of ABS. Such normal-course activities are not
prohibited by final Rule 192(a)(3)(iii) as they are not transactions
that are substantially the economic equivalent of a transaction
described in final Rule 192(a)(3)(i) or final Rule 192(a)(3)(ii).\393\
As described in further detail below, the customary mechanics of
secured loans, such as warehouse financing facilities, do not render
that financing facility a conflicted transaction under Rule
192(a)(3)(iii) because they do not provide a mechanism for the
financing provider to benefit from the adverse performance of the asset
pool supporting or referenced by the relevant ABS. Similarly, the
transfer or sale of assets to a securitization vehicle does not provide
the transferor or seller a mechanism for such entity to benefit from
the adverse performance of the asset pool supporting or referenced by
the relevant ABS as, absent some other transaction that may need to be
separately analyzed, such entity no longer has exposure to the
performance of such assets.
---------------------------------------------------------------------------

    \391\ See, e.g., letters from AFME (requesting that certain pre-
securitization transactions be expressly carved out of the
definition of conflicted transaction); SFA I (stating that the final
rule should not prohibit warehouse financing or the sale of assets
into a securitization); SFA II (requesting a specific exception for
such activities); SIFMA I (requesting that certain pre-
securitization transactions be expressly carved out of the
definition of conflicted transaction); SIFMA II (requesting that
certain pre-securitization transactions be expressly carved out of
the definition of conflicted transaction).
    \392\ See Proposing Release at 9679.
    \393\ As discussed above in Section II.B.3., warehouse lenders
that are not affiliated with a named securitization participant and
that engage only in warehouse lending activity with respect to an
ABS are not sponsors under the final rule. However, if the warehouse
lender is an affiliate or subsidiary of another securitization
participant, it will be subject to the prohibition in Rule 192(a).
---------------------------------------------------------------------------

    Similarly, the final rule is not designed to disincentivize an
underwriter, placement agent, or initial purchaser from intermediating
an ABS transaction for a customer, client, or counterparty where the
securitization participant does not take a short position with respect
to the relevant ABS. Rule 192(a)(3)(iii) captures, in relevant part,
the purchase or sale of any financial instrument ``(other than the
relevant asset-backed security)'' or entry into a transaction that is
substantially the economic equivalent of a transaction described in
Rule 192(a)(3)(i) or Rule 192(a)(3)(ii). The inclusion of the language
``(other than the relevant asset-backed security)'' is designed to
specify that merely entering into an agreement to serve as a
securitization participant with respect to an ABS and engaging in a
purchase or sale of the ABS as an underwriter, placement agent, or
initial purchaser for such ABS is not itself a conflicted
transaction.\394\
---------------------------------------------------------------------------

    \394\ The short sale of the relevant ABS is separately covered
under Rule 192(a)(3)(i).
---------------------------------------------------------------------------

    The Commission received a comment that the prohibition should not
apply to transactions that terminate prior to the issuance of the
relevant ABS.\395\ As explained above in Section II.C.3., the
prohibition on material conflicts of interest will not apply if the
relevant ABS is never actually sold to an investor. However, if an ABS
is created and sold, then the rule's prohibition will apply beginning
on the date on which there was an agreement by the relevant person to
become a securitization participant with respect to the relevant ABS
and will end one

year after the date of the first closing of the sale of such ABS. We do
not believe that it would be appropriate to allow a securitization
participant to bet against the performance of an asset pool while, for
example, after reaching an agreement to become a securitization
participant, simultaneously marketing an ABS to investors that
references or is collateralized by that same asset pool even if the
relevant bet is closed out prior to the issuance of the relevant ABS.
As discussed in detail in Section II.E.3. below, a securitization
participant may rely on the risk-mitigating hedging activities
exception for transactions entered into prior to the issuance of the
relevant ABS when the conditions to the exception are satisfied.
---------------------------------------------------------------------------

    \395\ See letter from SFA II.
---------------------------------------------------------------------------

    The Commission also received a comment that the prohibition should
not apply to any transaction relating to all or a portion of the pool
of assets underlying the ABS that terminates on or prior to the date on
which such assets are included in the securitization.\396\ Rule
192(a)(3)(iii) as adopted captures a transaction that is substantially
the economic equivalent of a short sale of the relevant ABS itself or a
CDS or credit derivative pursuant to which the securitization
participant would be entitled to receive payments upon the occurrence
of specified credit events in respect of the relevant ABS. As discussed
above, ABS are cash-flow vehicles that distribute cash to investors
based on the performance of the relevant asset pool for such ABS, and,
therefore, a bet against the relevant asset pool is a bet against the
ABS itself.
---------------------------------------------------------------------------

    \396\ See letter from SIFMA II.
---------------------------------------------------------------------------

    In response to the comment, if a securitization participant engages
in a transaction with respect to a pool of assets that, during the
duration of the transaction, neither underlies the relevant ABS nor is
referenced by the relevant ABS, then that transaction will not be
substantially the economic equivalent of a transactions described in
Rule 192(a)(3)(i) or Rule 192(a)(3)(ii). Therefore, including a
specific exception for such transactions is unnecessary. However, as
discussed in detail above, if the transaction is with respect to a pool
of assets with characteristics that replicate the idiosyncratic credit
performance of pool of assets that is already underlying or referenced
by the relevant ABS, then whether such transaction is a conflicted
transaction under the final rule will be a facts and circumstances
determination.
    Several commenters questioned whether the intrinsic feature of
certain risk-management transactions documented as synthetic ABS
transactions would be captured under Rule 192(a)(3)(iii) and suggested
that the final rule should not prohibit balance sheet synthetic
securitizations used for risk-mitigation purposes.\397\ Another
commenter generally stated that the rule should not include any
exception from the prohibition for conflicts that are ``inherent'' to
the securitization.\398\ Section 27B specifically applies to synthetic
ABS transactions, and, for the reasons discussed below, we are adopting
a definition of conflicted transaction that captures the relevant
conflict of interest in the context of the issuance of a new synthetic
ABS. However, Section 27B also provides an exception for risk-
mitigating hedging activity; \399\ therefore, we believe that it is
consistent with Section 27B to allow for the conflicted transaction
that arises in the context of a synthetic ABS as described below to be
eligible for the risk-mitigating hedging activities exception if it
satisfies the conditions to the exception.
---------------------------------------------------------------------------

    \397\ See, e.g., letters from ABA (urging the Commission to
clarify that CRT transactions are not per se ``conflicted
transactions'' and that they are generally permissible unless they
evidence an intentional bet against a separate ABS by a
securitization participant for that separate ABS); AFME (noting that
synthetic securitizations are important credit risk and balance
sheet management tools for banks); Fannie and Freddie (requesting
that the Commission modify the proposed definition of conflicted
transaction to make clear that it does not encompass the
Enterprises' entry into the associated transaction agreements
necessary to effect CRT securities issuances); HPC (requesting that
CRTs, regardless of sponsor, be excluded from the definition of
conflicted transaction or, alternatively, that they be allowed under
the risk-mitigating hedging exception); IACPM (stating the breadth
of proposed Rule 192(a)(3)(iii) would make credit portfolio
management via synthetic ABS functionally untenable); SIFMA I
(stating its belief that neither the text of the statute or the
legislative history empowered the Commission to ban entire classes
or categories of securitization transactions).
    \398\ See letter from AFR.
    \399\ 15 U.S.C. 77z-2a(a)(1) and 15 U.S.C. 77z-2a(c)(1).
---------------------------------------------------------------------------

    As discussed in the Proposing Release, the relevant material
conflict of interest in the context of the issuance of a new synthetic
ABS arises when the securitization participant engages in a transaction
(such as CDS contract(s) with the synthetic ABS issuer) where cash paid
by investors to acquire the newly created synthetic ABS will fund the
relevant contract(s) and be available to make a payment to the
securitization participant upon the occurrence of an adverse event with
respect to the assets included in the reference pool.\400\ In economic
substance, if the reference pool for the synthetic ABS performs
adversely, then the securitization participant benefits at the expense
of the investors in the synthetic ABS. Pursuant to the final rule, this
arrangement will result in a conflicted transaction with respect to the
investors in the synthetic ABS because it is substantially the economic
equivalent of a bet against such ABS itself. Additionally, if the
reference pool for the synthetic ABS collateralizes a separate ABS with
respect to which the relevant securitization participant is a
securitization participant under the final rule, this arrangement will
result in a conflicted transaction with respect to the investors in the
ABS collateralized by such reference pool as being substantially the
economic equivalent of a bet against such ABS itself. Such transaction,
in economic substance, is the same as the securitization participant
entering into a bilateral CDS on the ABS that is collateralized by such
reference pool. As discussed in the Proposing Release, in certain
synthetic ABS structures, the relevant agreement that the
securitization participant enters into with the special purpose entity
that issues the synthetic ABS may in some circumstances not be
documented in the form of a swap; however, the terms of such agreement
are structured to replicate the terms of a swap pursuant to which the
special purpose entity that issues the synthetic ABS is obligated to
make a payment to the securitization participant upon the occurrence of
certain adverse events with respect to the reference pool.\401\ Such an
agreement will be a conflicted transaction under Rule 192(a)(3)(iii)
due to the economic substance of the transaction.
---------------------------------------------------------------------------

    \400\ See Proposing Release at 9695. As discussed above, the
inclusion of the language ``(other than the relevant asset-backed
security)'' in Rule 192(a)(3)(iii) is designed to specify that
merely entering into an agreement to serve as a securitization
participant with respect to an ABS and engaging in a purchase or
sale of the ABS as an underwriter, placement agent, or initial
purchaser for such ABS is not itself a conflicted transaction.
    \401\ See Proposing Release at 9695.
---------------------------------------------------------------------------

    Like a short sale or credit default swap, the securitization
participant stands to benefit at the expense of the investors in the
synthetic ABS, and this results in a material conflict of interest with
investors and is a conflicted transaction for purposes of the final
rule. However, we also understand, as commenters stated, that
securitization participants may utilize synthetic ABS structures for
hedging purposes. Therefore, as discussed in detail in Section II.E.
below, we are adopting a change to the proposed risk-mitigating hedging
exception so that the issuance of synthetic ABS that are entered into

and maintained for hedging purposes are eligible for the risk-
mitigating hedging activities exception. To help ensure that these
types of transactions cannot be utilized as a bet by a securitization
participant against the credit performance of the reference assets, any
such transaction will need to satisfy each of the conditions to the
risk-mitigating hedging activities exception described in Section II.E.
If such transaction is not entered into for purposes of hedging an
existing long exposure of the securitization participant to the assets
included in the reference pool in accordance with the requirements of
the risk-mitigating hedging activities exception, then such activity
will not qualify for the exception and will be prohibited by the final
rule.
    Certain commenters also expressed concern that the proposed rule
could prohibit the normal-course servicing activity of a securitization
participant pursuant to its contractual rights and obligations under
the transaction documents for the relevant ABS, particularly with
respect to the servicing of distressed assets supporting the relevant
ABS.\402\ We recognize the role played by servicers over the life cycle
of an ABS to help minimize losses for ABS investors with respect to
distressed assets and understand that servicers may be entitled to
additional income or expense reimbursement when servicing distressed
assets that require the servicer to expend more of its time and
resources or require specialized skills.\403\ Accordingly, the final
rule is designed not to impede the ability of servicers to service the
assets supporting an ABS in accordance with the contractual covenants
applicable to the servicer in the transaction agreements for such ABS.
We understand that these covenants are subject to the negotiation of
investors prior to the closing of the relevant ABS and that such
covenants typically set forth a servicing standard that is designed to
direct the servicer to maximize the recovery value of the assets and,
by extension, support the overall performance of the ABS for the
benefit of the investors in such ABS.\404\ Restricting servicing
activity that is conducted in accordance with such servicing standards
could, in some cases, not only harm the ABS investors that the rule is
intended to protect but also impede the ability of the relevant
underlying obligors to avoid foreclosure or insolvency. As adopted, the
final rule will not prohibit such servicing activity as it is not
substantially the economic equivalent of a transaction described in
final Rule 192(a)(3)(i) or final Rule 192(a)(3)(ii). We also note that,
as discussed above in Section II.B.3.b.iii., persons that only perform
activities that are administrative, legal, due diligence, custodial, or
ministerial in nature with respect to an ABS are excluded from the
definition of ``sponsor.''
---------------------------------------------------------------------------

    \402\ See, e.g., letters from AIC (requesting that the
Commission clarify that the exercise of a securitization
participant's rights under the ABS transaction documents does not
constitute a conflicted transaction with respect to that ABS); AFME
(providing as an example that actions of loan officers related to
refinancing, restructuring, or working out a defaulted loan could
constitute a conflicted transaction, as proposed); CREFC I
(suggesting an additional exception for the exercise of contractual
rights granted to, or performance of contractual obligations by, a
securitization participant with respect to the underlying assets or
the related asset-backed securities pursuant to the agreements
governing such transaction); LSTA II (focusing on, among other
things in the context of collateralized loan obligations, LIBOR
transaction amendments, loan restructurings, and refinancings).
    \403\ See letter from CREFC I.
    \404\ See letter from CREFC I (explaining that, for example, the
servicing standard for CMBS places requirements on the servicer with
a view to maximizing the recovery of principal and interest on the
mortgage loans).
---------------------------------------------------------------------------

    A number of commenters expressed concern that a securitization
participant financing an investor's long purchase of an ABS could be a
conflicted transaction under the proposed rule.\405\ We understand that
it is customary for financing arrangements of ABS to include borrowing
base mechanics, which are collateral arrangements that require the long
purchaser (borrower) to post cash or other collateral in order to
maintain a required collateralization level if the value of the
financed ABS declines. Customary transactions that are designed to
protect the financing provider from a decline in the value of the
collateral for its loan would not give rise to the investor protection
concerns addressed by Section 27B. In the event of a default by the
borrower, any additional collateral posted by the borrower would
customarily be available to the lender exercising its rights as a
secured creditor but would not provide an additional net benefit to the
lender.\406\ These types of customary mechanics of secured loans do not
render a financing facility a conflicted transaction under Rule
192(a)(3)(iii) because they do not provide a mechanism for the
financing provider to benefit from the adverse performance of the asset
pool supporting or referenced by the relevant ABS and are therefore not
substantially the economic equivalent of a transaction described in
final Rule 192(a)(3)(i) or final Rule 192(a)(3)(ii).
---------------------------------------------------------------------------

    \405\ See letters from IACPM (describing the margin posting
mechanics of certain financing transactions); SFA I (providing as an
example that, in a repurchase transaction, the repurchase buyer
(lender) has the right to protect its level of collateralization
through the borrowing base mechanics by marking the ABS to market
and that, when it does so in a declining market, it often will make
a margin call on the repurchase seller (borrower) for additional
cash or collateral); SFA II (requesting a specific exception for
financing activities); SIFMA II (requesting a specific exception for
financing arrangements).
    \406\ In such scenario, the lender would customarily apply any
such collateral to the satisfaction of the outstanding relevant loan
obligations of the borrower.
---------------------------------------------------------------------------

    Some commenters stated that MILNs and similar reinsurance
arrangements should not be captured as conflicted transactions.\407\ As
explained above in Section II.A.3., MILNs and similar reinsurance
arrangements do not meet the definition of ``asset-backed security''
for purposes of the final rule and transactions with respect to such
structures are not subject to the prohibition of the final rule.
Therefore, no changes to the conflicted transaction definition are
required to address the concerns of these commenters.
---------------------------------------------------------------------------

    \407\ See, e.g., letters from MBA (stating that MILNs, which are
reinsurance-based note structures, should not viewed as a conflicted
transaction); PMI Industry I (stating that MILNs should not be
considered conflicted transactions).
---------------------------------------------------------------------------

    Some commenters expressed concerns that entities, such as
investment advisers, may be in violation of the prohibition if they
engage in conflicted transactions on behalf of a client, customer, or
counterparty pursuant to a fiduciary duty.\408\ We do not believe that
a carve-out for conflicted transactions entered into pursuant to a
fiduciary duty would be appropriate or necessary. As discussed above in
Section II.B.3., Rule 192 will complement the existing Federal
fiduciary duties. Final Rule 192(a)(3)(iii) is focused on prohibiting a
securitization participant from entering into a bet against the ABS or
the asset pool supporting or referenced by an ABS. This approach is
designed to remove the incentive for a securitization participant to
select poor credit quality assets for the asset pool supporting or
referenced by an ABS. The final rule, therefore, prohibits an
investment adviser from entering into a conflicted transaction to allow
a fiduciary client to

profit from the adverse performance of an ABS with respect to which the
investment adviser structured and selected the asset pool in order to
sell such ABS to long investors. In response to the concerns of
commenters, the revised approach to affiliates and subsidiaries
described above in Section II.B.3.c. should help address situations
that do not involve these same investor protection concerns, such as
where there is no coordination or information sharing between the
relevant personnel of the investment adviser entering into the relevant
client transaction and the relevant investment personnel responsible
for the design and composition of the ABS.\409\ We recognize that
securitization participants, when entering into an agreement to
participate in the securitization, will need to consider potential
impacts related to their affiliates or subsidiaries (that meet the
definition of securitization participant in Rule 192(c)), as the
prohibition will restrict those affiliates and subsidiaries from
entering into conflicted transactions. A conflicted transaction entered
into by such an affiliate or subsidiary may fall within an available
exception, but, in any case, will still be covered by this rule.
Additionally, as discussed in detail in Section II.E.3. below, the
revised scope of the risk-mitigating hedging activities exception is
designed to not unnecessarily restrict the ability of an affiliate or
subsidiary of a securitization participant to hedge exposures that it
originates, retains, acquires, or finances in connection with the
ordinary course of its business but that is unrelated to the
securitization activities of the securitization participant (such as
its CLO business).
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    \408\ See, e.g., letters from ICI (stated that advisers are
fiduciaries and must act in the best interest of their clients,
including the funds they manage); SFA I (noting that not allowing a
securitization participant to execute such a transaction could cause
it to violate its fiduciary duties imposed by law); SFA II
(suggesting that the rule should not apply to any securitization
participant with a fiduciary duty to the issuer of the ABS pursuant
to the Advisers Act when the transaction is entered into by that
securitization participant on behalf of another client, fund or
account managed by the securitization participant and conducted in
accordance with that securitization participant's fiduciary duty to
that client, fund or account under the Advisers Act).
    \409\ See letter from LSTA IV (stating that many asset
management companies that manage CLOs often employ other strategies
managed by different personnel who have fiduciary duties to other
clients than the CLO and that ``[i]ncorporating information barriers
into any final rule would solve this problem and comport with other
provisions in the U.S. securities laws'').
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    We do not believe that the suggestion of certain commenters that
Rule 192(a)(3)(iii) should be limited in scope to only prohibit
transactions through which the securitization participant actually
profits from its bet against the ABS would be appropriate.\410\ As
discussed above, final Rule 192(a)(3)(iii) is focused on prohibiting a
securitization participant from entering into a bet against the ABS or
the asset pool supporting or referenced by the relevant ABS. This
approach is intended to remove the incentive for a securitization
participant to select poor credit quality assets for the asset pool
supporting or referenced by the ABS. If the prohibition were limited to
transactions through which the securitization participant actually
profits from its bet, it would fall short of implementing the statutory
prohibition and addressing the incentive to design transactions that
are intended to fail. Therefore, under Rule 192(a)(3)(iii), the
securitization participant need not ultimately profit from the
conflicted transaction in order for it to be prohibited.
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    \410\ See letters from ABA (suggesting a definition of profit
that focuses on income or gain generated as a result of a short
position or the settlement of loss protection); MFA II (suggesting
that the Commission replace ``benefit'' with ``profit'').
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    Certain commenters stated that the definition of ``conflicted
transaction'' should include an intent or knowledge element in order to
narrow the application of the final rule.\411\ However, another
commenter stated that intent should not be a required element.\412\
Section 27B does not include an intent or knowledge element and
provides, in relevant part, that a securitization participant ``shall
not . . . engage in any transaction that would involve or result in any
material conflict of interest.'' \413\ We believe that narrowing the
scope of the final rule to add an element of intent or knowledge is not
appropriate because the statute is clear in mandating the prohibition
of material conflicts of interest in ABS transactions. Narrowing the
scope of the rule to require knowledge or intent would frustrate the
statutory mandate of Section 27B. The final rule is intended to
prophylactically protect against the sale of ABS tainted by material
conflicts of interest; therefore an investor is able to rely on the
fact that it is unlawful for a securitization participant to bet
against the relevant ABS or the asset pool supporting or referenced by
an ABS. Introducing an element of knowledge or intent would not provide
the same level of prophylactic protection and would introduce an
element of uncertainty that an investor would need to consider with
each ABS transaction.
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    \411\ See, e.g., letters from AIC (stating that a requirement
that the securitization participant has actual knowledge of the
subject ABS and structures the transaction to fail would align the
rule with Section 27B); SFA II (requesting an exception for
transactions entered into by a third-party manager on behalf of a
securitization participant without the direction of the
securitization participant).
    \412\ See letter from AFR.
    \413\ 15 U.S.C. 77z-2a(a).
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    The Commission also received comment that the final rule should
include a provision authorizing it to exempt certain transactions from
the final rule.\414\ As discussed in detail below, we are adopting
specific exceptions to the rule's prohibition to implement the
exceptions provided for in Section 27B. We are not persuaded that any
additional exceptions are necessary in order to implement Section 27B,
nor do we believe that it is necessary to include a mechanism to
provide such additional exceptions in the future. The changes made from
the proposed rule to narrow the scope of the definition of conflicted
transaction as described in this section and the changes made from the
proposed rule to narrow the scope of the affiliates and subsidiaries of
a securitization participant that are subject to the rule as described
in Section II.B.3.c. above \415\ should generally ease compliance
burdens and mitigate the need for any additional exceptions to the
final rule. If the Commission determines that additional exceptions are
needed in the future, it can utilize available authorities under its
governing statutes, including Section 28 of the Securities Act, to
provide such exceptions.
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    \414\ See letters from AIC; SFA II; SIFMA II.
    \415\ See Section II.B.3.c. (discussing how paragraph (ii) of
the definition of a ``securitization participant'' as adopted will
only capture any affiliate (as defined in 17 CFR 230.405) or
subsidiary (as defined in 17 CFR 230.405) of a person described in
paragraph (i) of the definition if the affiliate or subsidiary: (A)
acts in coordination with a person described in paragraph (i) of the
definition; or (B) has access to or receives information about the
relevant asset-backed security or the asset pool supporting or
referenced by the relevant asset-backed security prior to the first
closing of the sale of the relevant asset-backed security).
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d. Materiality
    Consistent with Section 27B's prohibition of conflicts of interest
that are ``material,'' we are adopting, as proposed, a definition of
``conflicted transaction'' in Rule 192(a)(3) requires that there is a
substantial likelihood that a reasonable investor would consider the
relevant transaction important to the investor's investment decision,
including a decision whether to retain the asset-backed security. As
stated in the Proposing Release, this is derived from the ``reasonable
investor'' standard of materiality articulated in Basic v.
Levinson.\416\ The Commission received comments stating that this
longstanding standard would be inappropriate in this context,\417\ and
some commenters

recommended that the ``materially adverse'' standard utilized in the
Volcker Rule would be more appropriate.\418\ However, we continue to
believe that the ``reasonable investor'' materiality standard that is
applied throughout the securities laws should be used for purposes of
implementing Section 27B. This materiality standard is more appropriate
for purposes of implementing Section 27B than the other suggested
alternatives as it is focused on the perspective of the reasonable
investor in the ABS (not the securitization participant) and,
specifically, whether there is a substantial likelihood that such
reasonable investor would consider the relevant transaction important
to the investor's investment decision whether to acquire or retain the
ABS.\419\ Also, given that Section 27B was designated as a part of the
Securities Act, the existing materiality standard will be more familiar
to the broad base of securitization participants that are subject to
the rule that engage in the issuance of ABS as opposed to a new
standard that is not based on any jurisprudence related to the
Securities Act. In this regard, we note that the Volcker Rule and its
application relates to the Bank Holding Company Act, which is primarily
designed to address safety and soundness concerns applicable to bank
holding companies, as opposed to the investor protection focus of the
securities laws, including Section 27B.
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    \416\ See Basic v. Levinson, 485 U.S. 224, 231-32 (1988) (citing
TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976)).
    \417\ See, e.g., letters from AIC (explaining that it would be
difficult for a sponsor-affiliated portfolio company to perform a
Basic analysis); SFA II (stating that the proposed materiality
standard would be difficult to apply if the rule does not provide
for disclosure as a mitigant of a material conflict of interest);
SIFMA II (explaining that there are many non-adverse transactions
that a securitization participant enters into which a reasonable
investor would want to figure into their investment decision).
    \418\ See letters from ABA; AFME; SFA II; SIFMA I; SIFMA II.
    \419\ The transactions specified in Rule 192(a)(3)(i), Rule
192(a)(3)(ii), or Rule 192(a)(3)(iii) are prohibited under the final
rule to the extent that there is a substantial likelihood that a
reasonable investor would consider the transaction important to the
investor's investment decision, including whether to retain the ABS.
The application of the materiality standard does not, for example,
mean that a transaction that only hedges general interest rate or
current exchange risk (that is not a conflicted transaction under
Rule 192(a)(3)(iii)) is a conflicted transaction.
---------------------------------------------------------------------------

    As stated in the Proposing Release, the use of the reasonable
investor standard in this context does not imply that a transaction
otherwise prohibited under the final rule would be permitted if
disclosure of the conflicted transaction is made by the securitization
participant to the relevant investor.\420\ The prohibition will apply
to transactions that are bets against the relevant ABS whether or not
such transactions are disclosed to investors in the ABS. While certain
commenters suggested that disclosure could adequately mitigate material
conflicts of interest,\421\ other commenters opposed any disclosure-
based exception to the rule.\422\ Consistent with the proposal and the
prohibition in Section 27B, we have not included an exception to the
final rule based on disclosure of potential material conflicts of
interest because the final rule is designed to prevent the sale of ABS
that are tainted by material conflicts of interest by prohibiting a
securitization participant from entering into a conflicted transaction
with respect to ABS that it creates or sells to investors. If the final
rule were to include a disclosure-based exception, compliance with the
rule could become a check-the-box exercise that would permit
securitization participants to enter into a transaction prohibited by
Section 27B, thereby allowing securitization participants to bet
against the same ABS that they are creating or selling to investors
when such conflicted transaction is disclosed. Even if disclosure of a
conflicted transaction reduced the likelihood that an investor would
invest in a tainted ABS, the incentive for a securitization participant
to enter into the conflicted transaction might remain and investors
might not benefit from the mandated investor protection of Section 27B.
Furthermore, even if the relevant conflict is disclosed to investors,
that does not mean that the relevant conflict is not material to the
decision of the investor to purchase, retain, or sell the relevant ABS.
---------------------------------------------------------------------------

    \420\ Proposing Release at 9696.
    \421\ See, e.g., letters from ABA (stating that, except with
respect to certain categories of conflicted transactions such as
short sales of the relevant ABS, disclosure would be appropriate to
protect investors where there are inherent conflicts of interest);
AIC (stating that disclosure is a valuable tool and should be used
where possible to mitigate the materiality of the relevant
conflict); MFA II (stating that the rules should permit disclosure
as a means of addressing conflicts of interest).
    \422\ See letters from AFR; Better Markets.
---------------------------------------------------------------------------

    Similarly, as stated in the Proposing Release, the use of the
reasonable investor standard does not imply that a transaction
otherwise prohibited by the final rule will be permitted if an investor
selected or approved the assets underlying the ABS.\423\ We are not
persuaded, as suggested by some commenters, that the prohibition should
not apply with respect to an ABS where the investor selects or approves
the asset underlying the relevant ABS.\424\ Even if an investor in an
ABS is given accurate information about the pool of assets underlying
the ABS, and consents to the asset pool on the basis of such
information, a securitization participant could nonetheless structure
the ABS or construct the underlying asset pool in a way that would
position the securitization participant to benefit from the adverse
performance of the assets underlying the ABS, including in ways that
investors may not understand. Additionally, as explained in the
Proposing Release, we are concerned that an exclusion dependent on
investor consent could cause some securitization participants to
pressure investors to provide consent to the portfolio of underlying
assets as a condition to participating in an ABS offering, which would
undermine the effectiveness and purpose of such disclosure and the
meaningfulness of the investor's consent.
---------------------------------------------------------------------------

    \423\ Proposing Release at 9697.
    \424\ See letters from SFA II; SIFMA II.
---------------------------------------------------------------------------

E. Exception for Risk-Mitigating Hedging Activities

1. Proposed Exception
    The Commission proposed to implement the exception for risk-
mitigating hedging activity in Section 27B(c) by proposing that the
prohibition in proposed Rule 192(a), subject to certain specified
conditions, would not apply to the risk-mitigating hedging activities
of a securitization participant in connection with and related to
individual or aggregated positions, contracts, or other holdings of the
securitization participant arising out of its securitization
activities, including the origination or acquisition of assets that it
securitizes, except that the initial distribution of an asset-backed
security would not be eligible for the exception. The proposed rule was
consistent with Section 27B(c), which provides that the prohibition in
Section 27B(a) does not apply to risk-mitigating hedging activities in
connection with positions or holdings arising out of the underwriting,
placement, initial purchase, or sponsorship of an ABS, provided that
such activities are designed to reduce the specific risks to the
underwriter, placement agent, initial purchaser, or sponsor associated
with positions or holdings arising out of such underwriting, placement,
initial purchase, or sponsorship.\425\ In order to distinguish
permitted risk-mitigating hedging activities from prohibited conflicted
transactions, the Commission proposed the following three conditions
that would need to be satisfied in order for a securitization
participant to rely on the risk-mitigating hedging activities
exception:
---------------------------------------------------------------------------

    \425\ 15 U.S.C. 77z-2a(c)(1).
---------------------------------------------------------------------------

     That, at the inception of the hedging activity and at the
time of any

adjustments to the hedging activity, the risk-mitigating hedging
activity is designed to reduce or otherwise significantly mitigate one
or more specific, identifiable risks arising in connection with and
related to identified positions, contracts, or other holdings of the
securitization participant, based upon the facts and circumstances of
the identified underlying and hedging positions, contracts or other
holdings and the risks and liquidity thereof;
     That the risk-mitigating hedging activity is subject, as
appropriate, to ongoing recalibration by the securitization participant
to ensure that the hedging activity satisfies the requirements of the
exception and does not facilitate or create an opportunity to benefit
from a conflicted transaction other than through risk-reduction; and
     That the securitization participant has established, and
implements, maintains, and enforces, an internal compliance program
that is reasonably designed to ensure the securitization participant's
compliance with the requirements set out in paragraph (b)(1) of the
exception, including reasonably designed written policies and
procedures regarding the risk-mitigating hedging activities that
provide for the specific risk and risk-mitigating hedging activity to
be identified, documented, and monitored.
2. Comments Received
    A number of commenters stated that the risk-mitigating hedging
exception, as proposed, would be too narrow to facilitate the effective
credit portfolio management of securitization participants.\426\ In
particular, commenters expressed concerns that the exception, as
proposed, would restrict the ability of securitization participants to
hedge interest rate, foreign exchange, and other risks that are not
materially related to the credit risk of the relevant ABS or the asset
pool supporting or referenced by the relevant ABS.\427\ While certain
commenters supported the proposed conditions applicable to the
exception,\428\ other commenters stated that the proposed conditions
would be unnecessarily prohibitive or difficult to implement.\429\ The
Commission also received comments specifically requesting that
synthetic securitizations used for risk-mitigation purposes should be
permitted under the risk-mitigating hedging exemption.\430\ These
comments are addressed in detail below.
---------------------------------------------------------------------------

    \426\ See, e.g., letters from AIMA/ACC (stating that is
uncertain whether the scope of the exception is sufficiently clear
so as to be relied upon); AFME (focusing on CRT transactions);
Andrew Davidson (stating its belief that the proposed exception is
too narrow); IACPM (stating its belief that, as proposed, the
exception is too narrow to facilitate effective credit portfolio
management activities); SFA II (expressing concern about the ability
of securitization participants to limit credit, interest rate, and
other risks); SIFMA II (stating that the proposed formulation of the
exception would unintentionally limit important business activity).
    \427\ See, e.g., letters from HPC (focusing specifically to
interest rate risk hedging); MFA II (expressing a preference that
the Commission not construe such transactions as conflicted
transactions); SIFMA I (stating that these hedging activities are
unrelated to the concerns that motivated Section 27B).
    \428\ See letters from AARP (describing the proposed conditions
and agreeing that exceptions for hedging transactions, to the extent
narrowly drawn and clearly defined, are appropriate); AFR (stating
that hedge positions must never be greater than the actual exposure
of the securitization participant); Better Markets (stating that the
compliance program requirement will strengthen the ability of the
Commission to police the use of the exception).
    \429\ See letters from ABA (expressing concerns that the
compliance program requirement would create limitations and
confusion given the scope of securitization participants that would
be subject to the rule); AIMA/ACC (expressing concern that the
conditions would require facts and circumstances determinations);
IACPM (expressing concerns regarding the conditions on the basis
that credit portfolio management activities are rarely directed
calibrated to the risks of specific securitization activities); SFA
I (requesting that the ongoing recalibration requirement be
eliminated), SIFMA II (requesting that the ongoing recalibration
requirement should be eliminated).
    \430\ See letters from AFME (specifically supporting SIFMA's
recommendations); Andrew Davidson (suggesting that CRTs be
specifically exempted or evaluated against a separate set of rules);
Fannie and Freddie (requesting as one alternative that the
Commission amend the exception to permit the Enterprises to continue
to engage in CRT issuances following conservatorship); HPC
(expressing a preference that credit risk transfer transactions be
carved out of the definition of conflicted transactions, but
suggesting inclusion as risk-mitigating hedging as an alternative);
LSTA III (stating that the risk-mitigating hedging activities
exception should include permitted risk transfer transactions); PGGM
Credit Risk Sharing dated Mar. 27, 2023 (``PGGM'') (advocating for
an exception for on-balance-sheet synthetic securitizations); SFA II
(requesting that the exclusion of initial distribution of ABS be
removed to permit prudent risk transfer transactions); SIFMA II
(stating its belief that synthetic securitization should fall under
the risk mitigating hedging activities exception under most
circumstances).
---------------------------------------------------------------------------

3. Final Rule
    We are adopting the risk-mitigating hedging activities exception
with certain modifications from the proposal in response to comments
received. Consistent with Section 27B, we are adopting a risk-
mitigating hedging activities exception that permits securitization
participants to continue to hedge their risk exposures. Subject to the
conditions discussed in detail below, the final rule provides an
exception for risk-mitigating hedging activities of a securitization
participant in connection with and related to individual or aggregated
positions, contracts, or other holdings of the securitization
participant, including those arising out of its securitization
activities, such as the origination or acquisition of assets that it
securitizes.
    Given that the accumulation of assets prior to the issuance of an
ABS is a fundamental component of assembling an ABS prior to its sale,
consistent with the proposal, the final risk-mitigating hedging
activities exception allows for a securitization participant to not
only hedge retained ABS positions (in compliance, as applicable, with
Regulation RR) \431\ but also hedge exposures arising out of the assets
that are originated or acquired by the securitization participant in
connection with warehousing assets in advance of an ABS issuance. Also
consistent with the proposal, the final risk-mitigating hedging
activities exception allows for the relevant hedging activity related
to a securitization participant's securitization activity to be done on
an aggregated basis and would not require that the exempt hedging be
conducted on a trade-by-trade basis. Given the nature of the ABS market
and the types of assets that collateralize ABS (such as receivables or
mortgages), it may not be possible for a securitization participant to
enter into a hedge with respect to an ABS or any of its underlying
assets on an individualized basis. Such hedge may also need to be
aggregated with hedges of risks that are unrelated to the relevant ABS
and the asset pool supporting or referenced by such ABS. Therefore,
this approach to the risk-mitigating hedge exception should allow
securitization participants sufficient flexibility to design their
securitization-related hedging activities in a way that is not unduly
complicated or cost prohibitive.
---------------------------------------------------------------------------

    \431\ This standard would not broaden, limit, or otherwise
modify the requirements applicable to a securitization participant
pursuant to Regulation RR.
---------------------------------------------------------------------------

    In a change from the proposal, the initial issuance of a synthetic
ABS will be eligible for the risk-mitigating hedging activities
exception set forth in the final rule. This change is intended to allow
for the initial issuance of a synthetic ABS that the relevant
securitization participant enters into and maintains as a hedge. This
change is also consistent with the requests of certain commenters.\432\
As discussed

above in Section II.D.3., the relevant material conflict of interest in
the context of the issuance of a new synthetic ABS arises when the
securitization participant engages in a transaction (such as CDS
contract(s) with the synthetic ABS issuer) where cash paid by investors
to acquire the newly created synthetic ABS would fund the relevant
contract(s) and be available to make a payment to the securitization
participant upon the occurrence of an adverse event with respect to the
assets included in the reference pool.\433\ If such activity is not
entered into for purposes of hedging an exposure of the securitization
participant to the assets included in the reference pool, then such
activity will not qualify for the risk-mitigating hedging exception.
---------------------------------------------------------------------------

    \432\ See letters from AFME (specifically supporting SIFMA's
recommendations); Andrew Davidson (suggesting that CRTs be
specifically exempted or evaluated against a separate set of rules);
Fannie and Freddie Letter (requesting as one alternative that the
Commission amend the exception to permit the Enterprises to continue
to engage in CRT issuances following conservatorship); HPC
(expressing a preference that credit risk transfer transactions be
carved out of the definition of conflicted transactions, but
suggesting inclusion as risk-mitigating hedging as an alternative);
LSTA III (stating that the risk-mitigating hedging activities
exception should include permitted risk transfer transactions); PGGM
(advocating for an exception for on-balance-sheet synthetic
securitizations); SFA II (requesting that the exclusion of initial
distribution of ABS be removed to permit prudent risk transfer
transactions); SIFMA II (stating its belief that synthetic
securitization should fall under the risk mitigating hedging
activities exception under most circumstances).
    \433\ See Section II.D.3. (discussing how the inclusion of the
language ``(other than the relevant asset-backed security)'' in Rule
192(a)(3)(iii) is designed to specify that merely entering into an
agreement to serve as a securitization participant with respect to
an ABS and engaging in a purchase or sale of the ABS as an
underwriter, placement agent, or initial purchaser for such ABS is
not itself a conflicted transaction).
---------------------------------------------------------------------------

    However, we understand that the Enterprises and other market
participants utilize synthetic ABS structures for hedging purposes. To
the extent that such transactions mitigate a specific and identifiable
risk exposure of the securitization participant, we agree that such
transactions should be permitted under the risk-mitigating hedging
exception. Section 27B specifically applies to synthetic ABS
transactions and provides an exception for risk-mitigating hedging
activity; \434\ therefore, we believe that it is consistent with
Section 27B to allow a synthetic ABS as described above to be eligible
for the risk-mitigating hedging activities exception if it is entered
into and maintained for risk-mitigating hedging purposes. We understand
that commentators have expressed concerns about the systemic risk
implications of CRTs.\435\ However, we are adopting this rule pursuant
to our congressional mandate under Section 27B, which focuses on
investor protection rather than mitigating systemic risk. To ensure
that these types of transactions cannot be utilized as a bet by a
securitization participant against the performance of the reference
assets, the rule as adopted requires any such transaction to satisfy
each of the conditions to the risk-mitigating hedging activities
exception described below.
---------------------------------------------------------------------------

    \434\ 15 U.S.C. 77z-2a(a)(1) and 15 U.S.C. 77z-2a(c)(1).
    \435\ See, e.g., Matt Wirz and Peter Rudegeair, Big Banks Cook
Up New Way to Unload Risk, Wall Street J. (Nov. 7, 2023), available
at https://www.wsj.com/finance/banking/bank-synthetic-risk-transfers-basel-endgame-62410f6c.
---------------------------------------------------------------------------

    A number of commenters stated that the risk-mitigating hedging
activities exception should encompass interest rate, currency, and
other hedging activities that are not materially related to the credit
risk of the relevant ABS or the asset pool supporting or referenced by
the relevant ABS.\436\ As described in Section II.D.3., general
interest rate hedges and currency exchange hedges entered into by a
securitization participant are not conflicted transactions.
Furthermore, hedges that are unrelated to the credit performance of the
relevant ABS or the asset pool supporting or referenced by the relevant
ABS will not be conflicted transactions as they are not substantially
the economic equivalent of a transaction described in Rule 192(a)(3)(i)
or Rule 192(a)(3)(ii). Therefore, we are not including such activities
in the risk-mitigating hedging exception because securitization
participants engaging in such transactions will not need to rely on any
exception to the rule.
---------------------------------------------------------------------------

    \436\ See, e.g., letters from HPC (referring specifically to
interest rate risk hedging); LSTA III (stating the risk-mitigating
hedging activities exception should include interest rate, currency,
and other non-credit related trading and hedging activities); MFA II
(stating that the exception for risk-mitigating hedging activity
should specifically include interest rate and currency hedging, but
expressing a preference that the Commission not construe such
transactions as conflicted transactions at all).
---------------------------------------------------------------------------

    In a change from the proposal, the risk-mitigating hedging
activities exception will apply to the risk-mitigating hedging
activities of a securitization participant in connection with and
related to individual or aggregated positions, contracts or other
holdings of the securitization, ``including those'' arising out of its
securitization activities, such as the origination or acquisition of
assets that is securities, rather than only those positions, contracts
or other holding of a securitization participant arising out of its
securitization activities. The addition of the phrase ``including
those'' is designed to not unnecessarily restrict the ability of an
affiliate or subsidiary of a securitization participant to hedge
exposures that it may originate, retain, acquire, or finance in
connection with the ordinary course of its business but that may be
unrelated to the securitization activities of the securitization
participant.\437\ For example, if an underwriter of an ABS has an
affiliate or subsidiary (that is subject to the rule) that acquires, in
its ordinary course of business, a long position in such ABS, the
affiliate or subsidiary will be able to rely on the risk-mitigating
hedging activities exception to hedge that long position, subject to
the conditions of the exception. This change is also responsive to the
concerns of certain commenters that stated that the risk-mitigating
hedging activities exception should not be limited to the hedging of
exposures arising out of a securitization participant's securitization
activities.\438\
---------------------------------------------------------------------------

    \437\ If the relevant affiliate or subsidiary is not a
securitization participant under the final rule because it does not
act in coordination with the named securitization participant and
does not have access to or receive information about the relevant
ABS or the asset pool underlying or referenced by the relevant ABS
prior to the first closing of the sale of the relevant ABS, then
such affiliate or subsidiary will not need to rely on the risk-
mitigating hedging activities exception. See Section II.B.3.c. above
(discussing the application of the final rule to affiliates and
subsidiaries). By including both a narrower definition of the
affiliates and subsidiaries of a securitization participant that are
subject to the final rule's prohibition and an expanded risk-
mitigating hedging activities exception, the final rule is designed
to provide securitization participants with more than one way to
approach the compliance of the activities of their affiliates and
subsidiaries with the requirements of the final rule.
    \438\ See, e.g., letters from IACPM (stating that credit
portfolio managers use credit portfolio management transactions to
hedge risks wholly unrelated to the institution's securitization
exposures); LSTA IV (stating that deleting this requirement is
necessary to capture hedging activities that are related to
positions that did not arise out of securitization activities);
SIFMA II (stating that this requirement could have adverse and
unintended effects on everyday operations and risk management
practices of financial institutions and their affiliates); SFA II
(suggesting that the Commission broaden the exception by deleting
this requirement).
---------------------------------------------------------------------------

    Other commenters requested an exception for hedging related to
intermediation and financing services provided by a securitization
participant.\439\ As discussed above in Section II.D.3., providing
financing to a long purchaser of an ABS is not a conflicted transaction
under Rule 192(a)(3). If the person providing such financing is a
securitization participant with respect to the relevant ABS and

desires to enter into a hedge with respect to its financing exposure
that would constitute a conflicted transaction under the rule, then
such person can enter into that hedge so long as such hedge satisfies
the requirements of the risk-mitigating hedging activities exception.
The risk-mitigating hedging activities exception applies to the
individual or aggregated positions, contracts, or other holdings of the
securitization participant, and this risk-mitigating hedging activity
will be covered by the exception. Therefore, creating an expanded or
separate exception for such hedging activity would be redundant.
Intermediary functions of a securitization participant are separately
addressed by the bona fide market-making activities exception in 17 CFR
230.192(b)(3) (``Rule 192(b)(3)''), which is discussed in detail in
Section II.G. below and addresses the hedging of market-making
positions.
---------------------------------------------------------------------------

    \439\ See letters from IACPM (stating that, if banks are unable
to engage in effectively hedging their portfolio, they may simply
reduce the activity that gives risk to the risk by reducing lending
activities altogether and thereby constraining access to credit or
other financial transactions); SIFMA I (stating that the exception
should include transactions that hedge risk where a sponsor serves
as an intermediary to facilitate a customer's exposure or when a
sponsor provides financing to ABS investors).
---------------------------------------------------------------------------

    Some commenters focused on the hedging of long ABS positions that
are purchased by a securitization participant with respect to such ABS
and requested that hedging such long positions should be allowed for
under the exception.\440\ As discussed above in Section II.D.3., the
long purchase of an ABS is not a conflicted transaction under Rule
192(a)(3). Also, subject to the conditions discussed below, the
exception does not preclude the hedging of a long position in an ABS by
a securitization participant. The risk-mitigating hedging activities
exception applies to the individual or aggregated positions, contracts,
or other holdings of the securitization participant, and this risk-
mitigating hedging activity will be covered by the exception.
Therefore, creating an expanded or separate exception for such hedging
activity would be redundant. Also, as described in Section II.B.3.c.
above, we are making changes from the proposed rule to narrow the scope
of the affiliates and subsidiaries that are subject to the rule, which
should mitigate the concerns of commenters regarding the hedging
activities of affiliates and subsidiaries within large, diversified
financial institutions being unnecessarily restricted.\441\
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    \440\ See letters from SFA II (focusing on large, diversified
financial institutions); SIFMA II (also focusing on large,
diversified financial institutions).
    \441\ See Section II.B.3.c. (discussing how paragraph (ii) of
the definition of a ``securitization participant'' as adopted will
only capture any affiliate (as defined in 17 CFR 230.405) or
subsidiary (as defined in 17 CFR 230.405) of a person described in
paragraph (i) of the definition only if the affiliate or subsidiary:
(A) acts in coordination with a person described in paragraph (i) of
the definition; or (B) has access to or receives information about
the relevant asset-backed security or the asset pool supporting or
referenced by the relevant asset-backed security prior to the first
closing of the sale of the relevant asset-backed security).
---------------------------------------------------------------------------

    One commenter focused specifically on hedging by a securitization
participant in the context of tender option bonds (``TOBs'') and
requested that the risk-mitigating hedging activities exception clearly
state that hedges with respect to the underlying asset of a TOB are
permissible to the extent that the sponsor either provides credit
enhancement on the asset or the ABS issued or where the sponsor
assigns, subordinates its right of payment on the hedge to or otherwise
provides the benefit of the hedge to the ABS investors ahead of its
benefiting therefrom.\442\ We do not believe that a special exception
for TOBs is necessary. This is because the risk-mitigating hedging
activities exception, subject to the conditions discussed below,
generally allows for the risk-mitigating hedging activities of a
securitization participant in connection with and related to individual
or aggregated positions, contracts, or other holdings of the
securitization participant, including those arising out of its
securitization activities, such as the origination or acquisition of
assets that it securitizes. This includes hedging by a securitization
participant of its retained and/or guaranteed exposures arising out of
its ABS activity regardless of whether the relevant ABS is a TOB
transaction or some or other type of ABS. Therefore, to the extent that
the hedging activity of a securitization participant in connection with
a TOB satisfies the conditions applicable to the exception, then such
hedging activity will be permitted risk-mitigating hedging activity for
purposes of the rule.
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    \442\ See letter from SIFMA dated Mar. 27, 2023 (making
comparisons to the treatment of TOBs under Regulation RR and
explaining its belief that ``TOBs are a well-known form of
securitization, akin to repo and securities lending finance, with
unique features and functions, that are formed with high-grade or
credit enhanced assets and which do not carry the risks the Proposed
Rule is designed to address.'') In a typical TOB transaction, tax-
exempt municipal securities are deposited into a special purpose
trust that issues two classes of securities: floating rate
securities with a put option marketed to short-term institutional
investors, like a municipal money market fund, and inverse floating
rate securities which are retained by the trust or marketed to long-
term institutional investors.
---------------------------------------------------------------------------

    As described above in Section II.D.3., one commenter expressed a
concern that using the phrase ``directly or indirectly'' in proposed
Rule 192(a)(1) could be potentially interpreted to create a
misalignment between the scope of the entities subject to the
prohibition and the scope of the exceptions to the rule that apply to
the activities of a securitization participant.\443\ The final rule
does not prohibit a securitization participant from using an affiliate
or subsidiary as an intermediary for the purpose of effecting risk-
mitigating hedging activity. This is because the risk-mitigating
hedging activities exception is available to a ``securitization
participant,'' which is defined to include not only the underwriter,
placement agent, initial purchaser, or sponsor of an ABS but also any
affiliate or subsidiary who is acting in coordination with such person
or who has access to or receives information about the relevant ABS or
the asset pool underlying or referenced by the relevant ABS.\444\ For
example, it is not inconsistent with the exception for risk-mitigating
hedging activities for an entity to retain a position in an ABS for
which it is an underwriter, placement agent, initial purchaser, or
sponsor, under the final rule and to hedge that exposure by causing one
of its subsidiaries to enter into the relevant hedge and pass through
the economics of that hedge back to the parent entity.
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    \443\ See letter from SIFMA II.
    \444\ If the affiliate or subsidiary is not acting in
coordination with such person or does not have access to or receive
information about the relevant ABS or the asset pool underlying or
referenced by the relevant ABS, then such affiliate or subsidiary is
not subject to the prohibition of the final rule and does not need
to avail itself of the risk-mitigating hedging activities exception.
---------------------------------------------------------------------------

    Each of the specific conditions applicable to the risk-mitigating
hedging activities exception is described in detail below.
a. Specific Risk Identification and Calibration Requirements
    We are adopting proposed 17 CFR 230.192(b)(1)(ii)(A) (``Rule
192(b)(1)(ii)(A)'') as proposed. Therefore, the first condition to the
risk-mitigating hedging activities exception is that, at inception of
the hedging activity and at the time of any adjustments to the hedging
activity, the risk-mitigating hedging activity of the securitization
participant is designed to reduce or otherwise significantly mitigate
one or more specific, identifiable risks arising in connection with and
related to identified positions, contracts, or other holdings of the
securitization participant, based upon the facts and circumstances of
the identified underlying and hedging positions, contracts, or other
holdings and the risks and liquidity thereof. This condition is an
essential requirement of the exception to help ensure that the relevant
hedging activity is risk-mitigating.

    One commenter generally supported a clear standard that the
relevant hedging activity must never result in a short position with
respect to the relevant ABS.\445\ Other commenters stated that the
requirement that the relevant hedged risks are ``specific, identifiable
risks'' is unrealistic as securitization participants conduct credit
portfolio management on a portfolio basis and that such requirement
could unduly limit risk-mitigating activities.\446\ One commenter
generally stated that is unclear how the condition should be
interpreted due to the subjectivity involved in risk assessment and
identifying a necessary degree of risk-mitigating hedging in any given
circumstance.\447\
---------------------------------------------------------------------------

    \445\ See letter from AFR.
    \446\ See letters from Andrew Davidson (stating that a firm will
generally enter into risk mitigating hedges on a portfolio rather
than on identified positions); IACPM (stating that credit portfolio
management transactions may be designed to address portfolio credit
and other risks not related to an institution's securitization
exposures).
    \447\ See letter from AIMA/ACC.
---------------------------------------------------------------------------

    We recognize that various activities of a securitization
participant, such as acquiring a portfolio of assets in anticipation of
issuing an ABS or retaining a portion of an ABS issuance with respect
to which it is a securitization participant, expose the securitization
participant to the risk that such positions could decline in value. We
also recognize that securitization participants may currently hedge
such risks on an aggregated basis. Therefore, as discussed above, the
final exception applies broadly to hedging of the individual or
aggregated positions, contracts, or other holdings of the
securitization participant. The final exception specifically allows for
hedging on an aggregated basis, consistent with the rule as proposed.
    Although the relevant risks are permitted under 17 CFR
230.192(b)(1)(i) (``Rule 192(b)(1)(i)'') to be hedged on an aggregated
basis to address more than one exposure, we continue to believe that
such risks need to be specific and identifiable at the inception of the
hedging activity, as well as at the time of any adjustments to the
hedging activity, and must arise in connection with and be related to
identified positions, contracts, or other holdings of the
securitization participant. Without this condition, it would be
impractical or impossible to determine whether the securitization
participant has overhedged. This condition will prohibit a
securitization participant from engaging in speculative activity that
is designed to gain exposure to incremental risk by, for example,
entering into a CDS contract referencing a retained ABS exposure where
the notional amount of the CDS exceeds the amount of the securitization
participant's relevant exposure to that ABS, and any other aggregated
exposures, that are intended to be hedged. Such a transaction would
provide the securitization participant with an opportunity to profit
from a decline in the value of the relevant retained exposure rather
than simply to reduce its risk to it. For the same reason, we are not
persuaded by the suggestion from certain commenters that the final rule
allow, under the risk-mitigating hedging activity exception, for the
hedging of specific, identifiable positions, contracts, or other
holdings of a securitization that do not exist at the time of the
hedging activity but that may exist at some point in the future.\448\
Under such a standard, a securitization participant would, for example,
be allowed to overhedge its exposure to the relevant ABS or the asset
pool underlying or referenced by such ABS on the mere basis that it may
at some point in the future increase its exposure to such assets even
if it ultimately never does so.
---------------------------------------------------------------------------

    \448\ See letter from SIFMA II (providing, as an example, that
this would allow for the hedging of exposures to assets that are not
yet included in the asset pool underlying or referenced by the
relevant ABS); LSTA IV (stating that, at a minimum, the ``identified
positions, contracts, or other holdings'' need to include not only
current positions, contracts, or other holdings, but also future
positions, contracts, or other holdings, as hedged are sometimes
arranged in advance). As described above in Section II.D.3., a
transaction entered into by a securitization participant that is not
entered into with respect to the relevant ABS is only a conflicted
transaction under the final rule if it is substantially the economic
equivalent of a transaction described in final Rule 192(a)(3)(i) or
final Rule 192(a)(3)(ii) with respect to the relevant ABS.
---------------------------------------------------------------------------

    One commenter stated that the requirement that the condition apply
at the inception of the hedging activity and at the time of any
adjustments to the hedging activity should be deleted.\449\ We
recognize that the risks of the relevant exposures are dynamic and may
change over time and that new risks may emerge in a way that would make
the hedging activity that was designed at inception less effective. As
explained above in Section II.C.3., the prohibition of the rule only
applies for a limited timeframe with respect to the relevant ABS,\450\
and this first condition of the risk-mitigating hedging activities
exception does not restrict a securitization participant from making
adjustments to a hedge over time. However, consistent with the investor
protection mandate of Section 27B and recognizing that a securitization
participant's exposures may change over time, it is important that the
requirements of this condition, as stated in the Proposing Release,
must apply not only at the inception of the hedging activity but also
whenever such hedging activity is subsequently adjusted during the time
period in which the prohibition applies.\451\ Therefore, any changed or
new risks that are being hedged, including those being hedging on an
aggregated basis, will need to be specifically identified, and the
adjusted hedging activity needs to be designed to address them, in
order for the exception to apply.
---------------------------------------------------------------------------

    \449\ See letter from Andrew Davidson.
    \450\ See Section II.C.3. for a discussion of the time period
during which the prohibition applies.
    \451\ Id.
---------------------------------------------------------------------------

    We are adopting 17 CFR 230.192(b)(1)(ii)(B) (``Rule
192(b)(1)(ii)(B)'') with certain modifications in response to comments
received on the proposal. Specifically, the second condition of the
exception is that the risk-mitigating hedging activity is required to
be subject, as appropriate, to ongoing recalibration by the
securitization participant to ensure that such hedging activity
satisfies the requirements applicable to the first condition of the
exception and does not facilitate or create an opportunity to
materially benefit from a conflicted transaction other than through
risk-reduction. This condition is designed to prevent a position that
initially functions as a hedge to develop into a prohibited bet against
the relevant ABS.
    One commenter stated that the rule should provide that the relevant
hedging activity must never result in a short position with respect to
the relevant ABS.\452\ Other commenters expressed concerns that this
condition could unduly limit a securitization participant's risk-
management abilities.\453\
---------------------------------------------------------------------------

    \452\ See letter from AFR.
    \453\ See, e.g., letters from Andrew Davidson (stating that it
would be difficult and costly for a firm which engages in overall
portfolio hedging to comply with this requirement); IACPM (stating
its belief that this condition does not accurately reflect the way
credit portfolio managers manage risk in the context of credit
portfolio management transactions, which can be used to hedge risks
wholly unrelated to the institution's securitization exposures); SFA
II (requesting that the ongoing recalibration requirement be
replaced with a requirement that the primary benefit of the risk-
mitigating hedging activity is risk reduction and not the
facilitation or creation of an opportunity to realize some other
benefit from a conflicted transaction); SIFMA II (suggesting as an
alternative that the primary benefit of the risk-mitigating activity
is risk reduction).
---------------------------------------------------------------------------

    We continue to believe that the recalibration requirement is a
necessary condition to the exception so that subsequent changes to the
hedging

arrangements do not result in those arrangements functioning as
conflicted transactions that would otherwise be prohibited by the final
rule. For example, if a securitization participant enters into a hedge
that is permitted under the exception at inception and the risk
exposure of the securitization participant is subsequently reduced such
that its hedge fails to achieve its designed purpose and constitutes a
bet against the relevant ABS, the securitization participant should be
required to adjust or recalibrate its hedge to continue to rely on the
exception. Otherwise, securitization participants could reduce their
exposures after entering into a hedge in order to achieve a net short
position, which would constitute a bet against the ABS. The second
condition is designed to prevent that very conduct.
    In a change from the proposal, the risk-mitigating hedging activity
is required to be subject, as appropriate, to ongoing recalibration by
the securitization participant to ensure that such hedging activity
does not facilitate or create an opportunity to ``materially'' benefit
from a conflicted transaction other than through risk-reduction. We
recognize that it may not be possible for a securitization participant
to immediately recalibrate its hedging positions given the liquidity,
maturity, and depth of the relevant market for such hedging positions.
For example, if there is an unexpected early prepayment of the relevant
positions being hedged, a securitization participant may be unable to
immediately reduce its related hedge. The addition of the word
``materially'' is designed to address this concern and not unduly
disrupt normal course hedging activities that do not present material
conflicts of interest with ABS investors. We believe that this standard
is more appropriate than stipulating, as some commenters suggested,
that to meet the risk-mitigating hedging activities exception, it is
necessary that the ``primary benefit'' of such activity must be risk
reduction.\454\ These commenters did not specify how to calculate or
otherwise determine whether the primary benefit of a risk-mitigating
hedging activity is risk reduction, and the term ``primary benefit''
implies that a securitization participant could, as a ``secondary
benefit'' to the activity, materially profit from a net short position
with respect to the relevant ABS. This standard would allow a
securitization participant to enter into a bet against the relevant ABS
in contradiction to the statutory prohibition.
---------------------------------------------------------------------------

    \454\ See letters from SFA II (suggesting a requirement that the
primary benefit of the risk-mitigating hedging activity is risk
reduction and not the facilitation or creation of an opportunity to
realize some other benefit of a conflicted transaction); SIFMA II
(suggesting a requirement that the primary benefit of the risk-
mitigating hedging activity is risk reduction); LSTA IV (supporting
SIFMA's suggestion).
---------------------------------------------------------------------------

    One comment requested that the recalibration requirement only apply
with respect to the hedging of aggregated holdings and not an
individual position.\455\ We believe that the recalibration requirement
should apply to both the hedging of individual and aggregate positions
as the relevant concerns that a securitization participant should not
be able to bet against the relevant ABS are the same regardless of
whether the relevant exposures are hedged on an aggregated or
individualized basis.
---------------------------------------------------------------------------

    \455\ See letter from SIFMA I.
---------------------------------------------------------------------------

    Overall, we believe that the first and second conditions as adopted
should not unduly disrupt normal course hedging activities that do not
present material conflicts of interest with ABS investors and therefore
should reduce the compliance burden from that of the proposed
exception. In response to the comment that there is subjectivity
involved in risk assessment and identifying a necessary degree of risk-
mitigating hedging in any given circumstance,\456\ the final rule does
not include an exact negative correlation standard in the risk-
mitigating hedging activities exception out of concern that such a
standard could be unattainable in many circumstances given the
potential complexity of positions, market conditions at the time of the
hedge transaction, availability of hedging products, costs of hedging,
and other circumstances at the time of the transaction that would make
a hedge with exact negative correlation impractical or unworkable. For
example, a securitization participant may not be able to hedge its
exposure on an individualized basis and may have to enter into a
broader-based hedging transaction. However, the presence of negative
correlation will generally indicate that the hedging activity reduced
the risks it was designed to address. The first and second conditions
to the risk-mitigating hedging activities exception will serve to
promote risk-mitigating hedging activity where there is negative
correlation between the risk being hedged and the corresponding hedged
position because the relevant risk will be required to be specifically
identified and the risk-mitigating hedging activity cannot facilitate
or create an opportunity to benefit from a conflicted transaction other
than through risk reduction. The first and second conditions to the
risk-mitigating hedging activities exception also allow for
consideration of the facts and circumstances of the particular exposure
or exposures and the related hedging activity, including the type of
position being hedged, market conditions, depth and liquidity of the
market for the underlying and hedging positions, and type of risk being
hedged.
---------------------------------------------------------------------------

    \456\ See letter from AIMA/ACC.
---------------------------------------------------------------------------

    Consistent with the proposal, the risk-mitigating hedging
activities exception also does not require that a hedge be entered into
contemporaneously (i.e., at the exact time that a risk is incurred or
within a prescribed time period after a risk is incurred). Rather, both
the first and second conditions are premised on the relevant hedging
activity, whenever it is entered into or adjusted, being designed to
mitigate a specifically identified risk and not to function as a bet
against the relevant ABS. The hedging activity will cease to qualify
for the risk-mitigating hedging activities exception if it is no longer
reducing a specific risk to the securitization participant in
connection with its individual or aggregates positions, contracts, or
other holdings, for example if the securitization participant failed to
unwind its risk-mitigating hedging activities after disposing of the
position or holding being hedged. This is because the securitization
participant will no longer be engaged in risk-mitigating hedging
activities in connection with such position or holding.
    As an alternative to the first and second conditions, one commenter
suggested a condition that the hedging activity relates to an ABS, or
any asset or assets supporting or referenced by an ABS, issued under an
established and documented risk mitigation program established by the
original sponsor of such asset-backed security.\457\ We do not believe
that this alternative would be appropriate because the suggested
alternative condition fails to specify that the relevant activity
cannot result in an overhedged position that constitutes a bet against
the relevant ABS or the asset pool supporting or referenced by such
ABS. This is the exact type of activity that the rule is intended to
prohibit.
---------------------------------------------------------------------------

    \457\ See letter from IACPM.
---------------------------------------------------------------------------

b. Compliance Program Requirement
    We are adopting 17 CFR 230.192(b)(1)(ii)(C) (``Rule
192(b)(1)(ii)(C)'') as proposed. Therefore, the third condition to the

exception is that the securitization participant has established, and
implements, maintains, and enforces, an internal compliance program
that is reasonably designed to ensure the securitization participant's
compliance with the requirements applicable to the exception, including
reasonably designed written policies and procedures regarding the risk-
mitigating hedging activities that provide for the specific risk and
risk-mitigating hedging activity to be identified, documented, and
monitored. This condition is designed to promote robust compliance
efforts and to help ensure that activity that would qualify for the
exception is indeed risk-mitigating while also recognizing that
securitization participants are positioned to determine the particulars
of effective risk-mitigating hedging activities policies and procedures
for their own business. Additionally, as discussed in Section IV, this
condition will enhance the benefits of the rule by assuring investors
that a securitization participant is less likely to engage in
activities that are prohibited by Rule 192 if it has a program to
monitor ongoing compliance with the rule. We believe it is important
that reasonably designed written policies and procedures provide for
the specific risk and the risk-mitigating hedging activities to be
identified, documented, and monitored to help facilitate the
securitization participant's compliance with the conditions specified
in Rule 192(b)(1)(ii)(A) and Rule 192(b)(1)(ii)(B), which require that
the risk-mitigating hedging activity be tied to such risks at inception
and over the time period that the prohibition of the rule would apply
and that the activity be subject to ongoing recalibration as
appropriate, as discussed above.
    A number of commenters expressly supported including a compliance
program requirement.\458\ However, one commenter stated that the
potential confusion regarding this requirement would undercut the
ability of securitization participants to rely on the exception and
that it is not clear that such condition is within the scope of the
congressional intent of Section 27B.\459\ Other commenters also stated
that the compliance program condition would be unnecessarily burdensome
and have the potential to create unintended consequences.\460\ In
subsequent letters, certain of these commenters requested that the
condition should be rephrased so that the compliance program is
required to be reasonably designed to ``result in'' compliance with the
requirements of the exception rather than to ``ensure'' compliance with
those requirements and that the policies and procedures of a
securitization participant should not provide for the monitoring of the
risk-mitigating hedging activity.\461\
---------------------------------------------------------------------------

    \458\ See letters from AARP; Better Markets.
    \459\ See letter from ABA.
    \460\ See letters from AFME (supporting SIFMA's suggestions);
SFA I (expressing concern that the proposed compliance program
requirement would apply to a broader range of entities that those
subject to the Volcker Rule); SIFMA I (initially suggesting that the
compliance program be deleted in its entirety).
    \461\ See letters from SFA II; SIFMA II.
---------------------------------------------------------------------------

    In response to the comment that the compliance program condition
would undercut the ability of a securitization participant to rely on
the exception and that it is not clear that such condition is within
the scope of the congressional intent of Section 27B, we recognize that
certain securitization participants may need to create a new compliance
program to comply with this condition and that this may result in
increased compliance costs. However, Section 27B(b) requires that the
Commission adopt rules to implement the prohibition in Section 27B(a)
against a securitization participant engaging in any transaction that
would involve or result in any material conflict of interest with
respect to any investor in a transaction arising out of the ABS
activity of a securitization participant. The compliance program
condition is necessary to help ensure that the activities of a
securitization participant relying on the risk-mitigating hedging
activities exception are indeed risk-mitigating hedging activities, and
not the type of transactions that would involve or result in a material
conflict of interest between a securitization participant for an ABS
and an investor in such ABS. Given that the ABS exposures of a
securitization participant and the financial instruments that are
utilized to hedge such exposures can be inherently complex, requiring a
securitization participant to establish and enforce an internal
compliance program will help that entity adequately evaluate and track
its ABS exposures and monitor its hedging activity in a way that is
reasonably designed to help prevent violations of the rule. Similarly,
given that the exposure of a securitization participant can change over
time, we continue to believe that it is necessary that securitization
participants develop reasonably designed policies and procedures
regarding their risk-mitigating hedging activities that provide for the
specific activities to be monitored on an ongoing basis. We also
believe that it is important for this condition to apply to all
securitization participants that seek to rely on this exception given
that the focus of Section 27B is investor protection.
    However, to avoid imposing a one-size-fits-all requirement that may
unduly burden securitization participants that are different in size or
that make markets in different financial instruments, this condition
recognizes that a securitization participant that engages in risk-
mitigating hedging activity is well positioned to design its own
individual internal compliance program to reflect the size, complexity,
and activities of the securitization participant. This should help ease
compliance costs as the relevant securitization participant can tailor
its compliance program to its particular business model. As a general
matter, we recognize that costs of the final rule potentially may have
a proportionally greater effect on small entities, as such costs may be
a relatively greater percentage of the total cost of operations for
smaller entities than larger entities, and thus small entities may be
less able to bear such costs relative to larger entities. However, the
potentially less complex securitization activities of small entities
and their correspondingly less complex compliance considerations may
counterbalance such costs as compared to larger and more diversified
securitization participants. In addition, the changes discussed above
to refine the scope of the definition of ``conflicted transaction'' and
the scope of covered affiliates and subsidiaries are designed to ease
the compliance program burden on securitization participants by
narrowing the scope of the types of transactions and relevant entities
that are subject to the rule's prohibition.\462\ This should also
reduce the cost of developing policies and procedures regarding the
risk-mitigating hedging activity that provide for the specific

activity to be identified, documented, and monitored over time.
---------------------------------------------------------------------------

    \462\ See Section II.D.3. (discussing how Rule 192(a)(3)(iii) as
adopted only applies to the purchase or sale of any financial
instrument that is substantially the economic equivalent of a
transaction described in Rule 192(a)(3)(i) or Rule 192(a)(3)(ii) and
provides that, for the avoidance of doubt, any transaction that only
hedges general interest rate or currency exchange risk is not a
conflicted transaction) and Section II.B.3.c. (discussing how
paragraph (ii) of the definition of a ``securitization participant''
as adopted will only capture any affiliate (as defined in 17 CFR
230.405) or subsidiary (as defined in 17 CFR 230.405) of a person
described in paragraph (i) of the definition if the affiliate or
subsidiary: (A) acts in coordination with a person described in
paragraph (i) of the definition; or (B) has access to or receives
information about the relevant asset-backed security or the asset
pool supporting or referenced by the relevant asset-backed security
prior to the first closing of the sale of the relevant asset-backed
security).
---------------------------------------------------------------------------

    In response to comments that the compliance program requirement
should specify that it would only apply to any securitization
participant utilizing the exception,\463\ adding that language would be
redundant. Rule 192(b)(1)(ii)(C) sets forth a condition to utilizing
the exception in Rule 192(b)(1)(i) and does not separately require that
a securitization participant satisfy the compliance program requirement
if it is not utilizing the exception.
---------------------------------------------------------------------------

    \463\ See letters from SFA II; SIFMA II.
---------------------------------------------------------------------------

    As described above, certain commenters stated that the compliance
program condition should be revised to provide that such program is
reasonably designed to ``result in'' a securitization participant's
compliance with the requirements of the exception rather than to
``ensure'' such securitization participant's compliance because the
word ``ensure'' could be inconsistent with a reasonably designed
standard \464\ We are adopting the condition as proposed. The
reasonably designed to ``ensure'' formulation is used in numerous other
Commission rules, including a similar condition to the risk-mitigating
hedging activities to the Volcker Rule.\465\ Furthermore, we do not
believe that the ``ensure'' formulation is inconsistent with the rule's
``reasonably designed'' standard as the two components will work
together to require that a securitization participant designs a
sufficiently detailed internal compliance program that promotes
compliance with the requirements applicable to the exception.
---------------------------------------------------------------------------

    \464\ See letters from SFA II; SIFMA II. These commenters did
not also address the same concerns regarding the similar formulation
of the compliance program condition to the bona fide market-making
activities exception.
    \465\ See, e.g., 17 CFR 255.5(b)(1)(i), 17 CFR 240.17g-8(a), 17
CFR 240.15Fh-5(b), 17 CFR 240.15c3-5(c)(2).
---------------------------------------------------------------------------

    One commenter suggested that any securitization participant relying
on the exception for risk-mitigating hedging activities should be
required to affirmatively certify that it is undertaking such activity
for the sole purpose of hedging a risk arising in connection with its
securitization activities and not for the purpose of generating
speculative profits.\466\ Certain commenters also suggested that a
responsible party at the securitization participant should be required
to certify the effectiveness of the applicable written policies and
procedures prior to their implementation and on an ongoing basis.\467\
Consistent with the discussion of this in the Proposing Release, we did
not include certification requirements in the final rule because we
believe that the conditions to the risk-mitigating hedging activity
exception are sufficiently robust to prevent the exception from
resulting in conflicted transactions in contradiction to Section 27B's
prohibition.
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    \466\ See letter from Better Markets.
    \467\ See letters from AARP; Better Markets.
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F. Exception for Liquidity Commitments

1. Proposed Approach
    The Commission proposed to implement the exception for liquidity
commitments in Section 27B(c) by proposing that the prohibition in
proposed Rule 192(a) would not apply when a securitization participant
engages in purchases or sales of ABS made pursuant to, and consistent
with, commitments of the securitization participant to provide
liquidity for the relevant ABS. This approach was consistent with
Section 27B(c), which provides that the prohibition in Section 27B(a)
does not apply to purchases or sales of ABS made pursuant to, and
consistent with, commitments of the underwriter, placement agent,
initial purchaser, or sponsor, or any affiliate or subsidiary of any
such entity, to provide liquidity for the ABS.\468\
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    \468\ 15 U.S.C. 77z-2a(c)(2)(A).
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2. Comments Received
    A number of commenters supported the proposed exception to exclude
transactions pursuant to and consistent with commitments to provide
liquidity for the relevant ABS. One commenter specifically supported
limiting the exception to ``purchases and sales'' of ABS on the basis
that such approach would be consistent with Section 27B(c).\469\
Another commenter supported the Commission statement in the Proposing
Release that the prohibition in proposed Rule 192(a) would not apply to
liquidity commitments that promote the full and timely interest payment
to ABS investors.\470\ One commenter requested that the Commission
confirm that ``dollar roll'' transactions for Enterprise mortgage-
backed securities would fall within the exception for liquidity
commitments.\471\
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    \469\ See letter from Better Markets.
    \470\ See letter from ICI (noting that its concern regarding
typical liquidity arrangements for asset-backed commercial paper
(``ABCP'') markets would be addressed by the Commission's example
that commitments to promote full and timely interest payments to ABS
investors would meet the liquidity commitment exception).
    \471\ See letter from Fannie and Freddie.
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3. Final Rule
    We are adopting the exception for liquidity commitments in 17 CFR
230.192(b)(2) (``Rule 192(b)(2)'') as proposed. Specifically, under the
final exception, purchases or sales of the relevant ABS made pursuant
to, and consistent with, commitments of the securitization participant
to provide liquidity for such ABS are not prohibited by the final rule.
We understand that commitments to provide liquidity may take a variety
of forms in addition to purchases and sales of the ABS, such as
commitments to promote full and timely interest payments to ABS
investors or to provide financing to accommodate differences in the
payment dates between the ABS and the underlying assets.\472\ As
discussed above in Section II.D.3., such as an extension of credit by a
securitization participant that functions to support the performance of
the securitization rather than to benefit from its adverse performance
will not be a conflicted transaction under the final rule. Therefore, a
securitization participant will not need to rely on any exception to
the rule to enter into such extension of credit.
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    \472\ For example, a sponsor of ABCP may provide a liquidity
facility if a tranche of $3 million of the ABCP matures on the 30th
day of the month, yet only $2 million of the underlying receivables
match that maturity. If there is an inability to repay the $1
million shortfall by issuing new commercial paper, the sponsor may
provide a loan secured by the receivables to provide for the $1
million shortfall.
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    With respect to the commenter who raised concerns about ``dollar
roll transactions,'' in the context of the Enterprise ABS market, we
understand that dollar roll transactions are utilized as a form of
short-term financing that are similar to a repurchase agreement;
however, unlike a typical repurchase agreement, a similar security may
be returned to the seller rather than the original security.\473\ As
adopted, the liquidity commitments exception will apply when a
securitization participant engages in purchases or sales of Enterprise
ABS made pursuant to, and consistent with, commitments of the
securitization participant to provide liquidity for the relevant ABS.
To the extent that the purchases and sales of the relevant Enterprise
ABS in a dollar roll transaction are consistent with a commitment of
the securitization participant to provide liquidity for the relevant
ABS, then such dollar roll

transaction will be eligible for the liquidity commitment exception.
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    \473\ See Financial Accounting Manual for Federal Reserve Banks,
Jan. 2017, Paragraph 40.13, Board of Governors of the Federal
Reserve System, available at https://www.federalreserve.gov/federal-reserve-banks/fam/chapter-4-system-open-market-account.htm.
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    As described above in Section II.D.3., one commenter expressed a
concern that using the phrase ``directly or indirectly'' in proposed
Rule 192(a)(1) could be potentially interpreted to create a
misalignment between the scope of the entities subject to the
prohibition and the scope of the exceptions to the rule that apply to
the activities of a securitization participant.\474\ The final rule
does not prohibit a securitization participant from utilizing an
affiliate or subsidiary as an intermediary for the purpose of
fulfilling its liquidity commitment obligations with respect to the
relevant ABS. This is because the liquidity commitments exception is
available to a ``securitization participant,'' which is defined to
include not only the underwriter, placement agent, initial purchaser,
or sponsor of an ABS but also any affiliate or subsidiary who is acting
in coordination with such person or who has access to or receives
information about the relevant ABS or the asset pool underlying or
referenced by the relevant ABS. For example, it is not inconsistent
with the exception for liquidity commitments in Rule 192(b)(2) for an
entity that it is an underwriter, placement agent, initial purchaser,
or sponsor with respect to an ABS under the final rule to provide
liquidity for the ABS by causing one of its subsidiaries to engage in
purchases and sales of the relevant ABS.
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    \474\ See letter from SIFMA II.
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G. Exception for Bona Fide Market-Making Activities

1. Proposed Approach
    The Commission proposed to implement the exception for bona fide
market-making activity in Section 27B(c) by proposing that the
prohibition in proposed Rule 192(a), subject to specified conditions,
would not apply to certain bona fide market-making activities conducted
by a securitization participant. This approach was consistent with
Section 27B(c), which provides that the prohibition in Section 27B(a)
does not apply to purchases or sales of ABS made pursuant to and
consistent with bona fide market-making in the ABS.\475\ Subject to
specified conditions, the proposed exception would apply to bona fide
market-making activity, including market-making related hedging, of a
securitization participant conducted in connection with and related to
an ABS, the assets underlying such ABS, or financial instruments that
reference such ABS or underlying assets. In order to distinguish
permitted bona fide market-making activity from prohibited conflicted
transactions, the Commission proposed the following five conditions
that would need to be satisfied in order for a securitization
participant to rely on the bona fide market-making activities
exception:
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    \475\ 15 U.S.C. 77z-2a(c)(2)(B).
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     That the securitization participant routinely stands ready
to purchase and sell one or more types of the financial instruments set
forth in proposed 17 CFR 230.192(b)(3)(i) (``Rule 192(b)(3)(i)'') as a
part of its market-making related activities in such financial
instruments, and is willing and available to quote, purchase and sell,
or otherwise enter into long and short positions in those types of
financial instruments, in commercially reasonable amounts and
throughout market cycles on a basis appropriate for the liquidity,
maturity, and depth of the market for the relevant types of such
financial instruments;
     That the securitization participant's market-making
related activities are designed not to exceed, on an ongoing basis, the
reasonably expected near term demands of clients, customers, or
counterparties, taking into account the liquidity, maturity, and depth
of the market for the relevant types of financial instruments;
     That the compensation arrangements of the persons
performing the market-making activity of the securitization participant
are designed not to reward or incentivize conflicted transactions;
     That the securitization participant would be required to
be licensed or registered to engage in the relevant market-making
activity, in accordance with applicable laws and self-regulatory
organization (``SRO'') rules; and
     That the securitization participant would be required to
have established and must implement, maintain, and enforce an internal
compliance program that is reasonably designed to ensure the
securitization participant's compliance with the requirements of the
bona fide market-making activities exception, including reasonably
designed written policies and procedures that demonstrate a process for
prompt mitigation of the risks of its market-making positions and
holdings.
2. Comments Received
    Most commenters that addressed this aspect of the final rule
provided comments related to the proposed conditions to the exception.
Certain commenters supported the proposed conditions.\476\ Other
commenters focused on the compliance program requirement and stated
that it would be unduly burdensome and inappropriate.\477\ In
subsequent letters, certain of the commenters suggested that the
compliance program requirement should only apply to any securitization
participant utilizing or relying on the exception and that the license
and registration requirement should only apply to a securitization
participant to the extent that it is required to be licensed or
registered to engage in market-making activity by applicable law and
self-regulatory organization rules.\478\ The Commission also received
comments that the bona fide market-making activities exception should
be available in the case of the initial distribution of an ABS.\479\
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    \476\ See letters from AARP; Better Markets Letter.
    \477\ See letters from ABA (stating that the compliance program
requirement could be confusing); AIC (stating that compliance would
be burdensome for organizations not already subject to the Volcker
Rule).
    \478\ See letters from SFA II; SIFMA II.
    \479\ See letters from SFA II (focusing on synthetic ABS and
suggesting the deletion of the exclusion of the initial distribution
of an ABS from the bona fide market-making activities exception);
SIFMA II (stating that is unclear why the initial distribution of an
ABS should not be considered bona fide market-making activity).
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3. Final Rule
    We are adopting the bona fide market-making activities exception
largely as proposed, with a technical modification from the proposal to
one of the conditions as discussed in further detail below. Consistent
with Section 27B, we are adopting a bona fide market-making activities
exception that is designed to distinguish permitted bona fide market-
making activity from prohibited conflicted transactions, while
permitting securitization participants to continue providing
intermediation services in less liquid and illiquid markets.
Specifically, subject to the specified conditions discussed in detail
below, the final rule provides an exception for bona fide market-making
activities, including market-making related hedging, of a
securitization participant conducted in connection with and related to
ABS with respect to which the prohibition in Rule 192(a)(1) applies,
the assets underlying such ABS, or financial instruments that reference
such ABS or underlying assets or with respect to which the prohibition
in paragraph (a)(1) applies, except that the initial distribution of an
ABS is not bona fide market-making activity for purposes of Rule
192(b)(3). Consistent with the proposed rule, because the prohibition
in Rule 192(a)(1) extends to

transactions such as the purchase of a credit derivative with respect
to the relevant ABS or the assets underlying the relevant ABS,\480\ the
final bona fide market-making activities exception applies to market-
making in not only the ABS that will be subject to the prohibition of
the final rule but, as described in Rule 192(b)(3)(i), also the assets
underlying such ABS as well as financial instruments that reference
such ABS or the assets underlying such ABS. This would capture CDS or
other credit derivative products with payment terms that are tied to
the performance of the ABS or its underlying assets. Consistent with
this reasoning, the final bona fide market-making activities exception
will also apply to bona fide market-making in any other financial
instrument with respect to which the prohibition in Rule 192(a)(1)
applies. The addition of this language is designed to more
appropriately align the text relating to the scope of the exception
with the text relating to the scope of the categories of transactions
that are captured by the definition of conflicted transaction. For
example, as discussed in Section II.D.3., if a securitization
participant engages in a CDS transaction with respect to a pool of
assets with characteristics that replicate the idiosyncratic credit
performance of the pool of assets that underlies the relevant ABS, then
such CDS could be, depending on the facts and circumstances, a
conflicted transaction that is prohibited by Rule 192(a)(1) even if it