creates significant new risk exposure that is not itself hedged at the
same time would appear to be indicative of prohibited proprietary
trading. For example, over-hedging, correlation trading, or pairs
trading strategies that generate profits through speculative,
proprietary risk-taking would fail to meet this criterion. Similarly, a
transaction involving a pair of positions that hedge each other with
respect to one type of risk exposure, but create or contain a residual
risk exposure would, taken together, constitute prohibited proprietary
trading and not risk-mitigating hedging if those positions were taken
collectively for the purpose of profiting from short-term movements in
the effective price of the residual risk exposure. However, the
proposal also recognizes that any hedging transaction will inevitably
give rise to certain types of new risk, such as counterparty credit
risk or basis risk reflecting the differences between the hedge
position and the related position; the proposed criterion only
prohibits the introduction of additional significant exposures through
the hedging transaction. In addition, proposed Sec.  --.5(b)(2)(iv)
only requires that no new and significant exposures be introduced at
the inception of the hedge, and not during the entire period that the
hedge is maintained, reflecting the fact that new, unanticipated risks
can and sometimes do arise out of hedging positions after the hedge is
established. The Agencies have proposed to address the appropriate
management of risks that arise out of a hedge position after inception
through Sec.  --.5(b)(2)(v) of the proposed rule.
    Sixth, Sec.  --.5(b)(2)(v) of the proposed rule requires that any
transaction conducted in reliance on the hedging exemption be subject
to continuing review, monitoring and management after the hedge
position is established. Such review, monitoring, and management must:
(i) Be consistent with the banking entity's written hedging policies
and procedures; (ii) maintain a reasonable level of correlation, based
upon the facts and circumstances of the underlying and hedging
positions and the risks and liquidity of those positions, to the risk
or risks the purchase or sale is intended to hedge or otherwise
mitigate; and (iii) mitigate any significant exposure arising out of
the hedge after inception. In accordance with a banking entity's
written internal hedging policies, procedures, and internal controls, a
banking entity should actively review and manage its hedging positions
and the risks that may arise out of those positions over time. A
banking entity's internal hedging policies should be designed to ensure
that hedges remain effective as correlations or other factors change.
In particular, a risk-mitigating hedge position typically should be
unwound as exposure to the underlying risk is reduced or increased as
underlying risk increases, as selective hedging activity would appear
to be indicative of prohibited proprietary trading.\160\ A banking
entity's written internal hedging policies, procedures, and internal
controls for monitoring and managing its hedges also should be
reasonably designed to prevent the occurrence of such prohibited
proprietary trading activity and be reasonably specific about the level
of hedging that is expected to be maintained regardless of
opportunities for profit associated with over- or under-hedging.
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    \160\ The Agencies note that in some cases, it may be
appropriate for a banking entity to unwind a hedge, even if the
underlying risk remains, if the cost of that hedge become
uneconomic, better hedging options become available, or the overall
risk profile of the banking entity has changed such that no longer
hedging the risk is consistent with appropriate risk management
practices.
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    Seventh, Sec.  --.5(b)(2)(vi) of the proposed rule requires that
the compensation arrangements of persons performing the risk-mitigating
hedging activities are designed not to reward proprietary risk-taking.
Hedging activities for which a banking entity has established a
compensation incentive structure that rewards speculation in, and
appreciation of, the market value of a covered financial position,
rather than success in reducing risk, are inconsistent with permitted
risk-mitigating hedging activities.
c. Documentation Requirement
    Section --.5(c) of the proposed rule imposes a documentation
requirement on certain types of hedging transactions. Specifically, for
any transaction that a banking entity conducts in reliance on the
hedging exemption that involves a hedge established at a level of
organization that is different than the level of organization
establishing the positions, contracts, or other holdings the risks of
which the hedging transaction is designed to reduce, the banking entity
must, at a minimum, document the risk-mitigating purpose of the
transaction and identify the risks of the individual or aggregated
positions, contracts, or other holdings of a banking entity that the
transaction is designed to reduce.\161\ Such documentation must be
established at the time the hedging transaction is effected, not after
the fact. The Agencies are concerned that hedging transactions
established at a different level of organization than the positions
being hedged may present or reflect heightened potential for prohibited
proprietary trading, as a banking entity may be able, after the fact,
to point to a particular, offsetting exposure within its organization
after a position is established and characterize that position as a
hedge even when, at the time the position was established, it was
intended to generate speculative proprietary gains, not mitigate risk.
To address this concern, the Agencies have proposed to require a
banking entity, when establishing a hedge at a different level of
organization than that establishing or responsible for the underlying
positions or risks being hedged, to document the hedging purpose of the
transaction and risks being hedged so as to establish a
contemporaneous, documentary record that will assist the Agencies in
assessing the actual reasons for which the position was established.
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    \161\ For example, a hedge would be established at a different
level of organization of the banking entity if multiple market
making desks were exposed to similar risks and, to hedge such risks,
a portfolio hedge was established at the direction of a supervisor
or risk manager responsible for more than one desk rather than at
each of the market making desks that established the initial
positions, contracts, or other holdings.
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d. Request for Comment
    The Agencies request comment on the proposed implementation of the
risk-mitigating hedging exemption with respect to proprietary trading.
In particular, the Agencies request comment on the following questions:
    Question 102. Is the proposed rule's approach to implementing the
hedging exemption effective? If not, what alternative approach would be
more effective?
    Question 103. Does the proposed multi-faceted approach
appropriately take into account and address the challenges associated
with differentiating prohibited proprietary trading from permitted
hedging activities? Should the approach include other elements? If so,
what elements and why? Should any of the proposed elements be revised
or eliminated? If so, why and how?
    Question 104. Does the proposed approach to implementing the
hedging exemption provide banking entities and market participants with
sufficient clarity regarding what constitutes permitted hedging
activities? If not, how could greater clarity be provided?

    Question 105. What impact will the proposed approach to
implementing the hedging exemption have on the hedging and risk
management activities of a banking entity and the services it provide
to its clients? If any of these impacts are positive, how can they be
amplified? If any of these impacts are negative, how can they be
mitigated?
    Question 106. What burden will the proposed approach to
implementing the hedging exemption have on banking entities? How can
any burden be minimized or eliminated in a manner consistent with the
language and purpose of the statute?
    Question 107. Are the criteria included in the hedging exemption
effective? Is the application of each criterion to potential
transactions sufficiently clear? Should any of the criteria be changed
or eliminated? Should other requirements be added?
    Question 108. Is the requirement that a transaction hedge or
otherwise mitigate one or more specific risks, including market risk,
counterparty or other credit risk, currency or foreign exchange risk,
interest rate risk, basis risk, or similar risks, arising in connection
with and related to individual or aggregated positions, contracts, or
other holdings of a banking entity effective? If not, what requirement
would be more effective? Does the proposed approach sufficiently
articulate the types of risks that a banking entity typically hedges?
Does the proposal sufficiently address application of the hedging
exemption to portfolio hedging strategies? If not, how should the
proposal be changed?
    Question 109. Does the manner in which section --.5 of the proposal
would implement the risk-mitigating hedging exemption effectively
address transactions that hedge or otherwise mitigate specific risks
arising in connection with and related to aggregated positions,
contracts, or other holdings of a banking entity? Do certain hedging
strategies or techniques that involve hedging the risks of aggregated
positions (e.g., portfolio hedging) (i) create the potential for abuse
of the hedging exemption or (ii) give rise to challenges in determining
whether a banking entity is engaged in exempt, risk-mitigating hedging
activity or prohibited proprietary trading? If so, what hedging
strategies and techniques, and how? Should additional restrictions,
conditions, or requirements be placed on the use of the hedging
exemption with respect to aggregated positions so as to limit potential
abuse of the exemption, assist banking entities and the Agencies in
determining compliance with the exemption, or otherwise improve the
effectiveness of the rule? If so, what additional restrictions,
conditions, or requirements, and why?
    Question 110. Is the requirement that the transaction be reasonably
correlated to the risk or risks the transaction is intended to hedge or
otherwise mitigate effective? If not, how should the requirement be
changed? Should some specific level of correlation and/or hedge
effectiveness be required? Should the proposal specify in greater
detail how correlation should be measured? Should the proposal require
hedges to be effective in periods of financial stress? Does the
proposal sufficiently reflect differences in levels of correlation
among asset classes? If not, how could it better do so?
    Question 111. Is the requirement that the transaction not give
rise, at the inception of the hedge, to significant exposures that are
not themselves hedged in a contemporaneous transaction effective? Does
the requirement establish an appropriate range for legitimate hedging
while constraining impermissible proprietary trading? Is this
requirement sufficiently clear? If not, what alternative would be more
effective and/or clearer? Are there types of risk-mitigating hedging
activities that may give rise to new and significant exposures that
should be permitted under the hedging exemption? If so, what
activities? Should the requirement that no significant exposure be
introduced be extended for the duration of the hedging position? If so,
why?
    Question 112. Is the requirement that any transaction conducted in
reliance on the hedging exemption be subject to continuing review,
monitoring and management after the transaction is established
effective? If not, what alternative would be more effective?
    Question 113. Is the requirement that the compensation arrangements
of persons performing risk-mitigating hedging activities at a banking
entity be designed not to reward proprietary risk-taking effective? If
not, how should the requirement be changed? Are there other types of
compensation incentives that should be clearly referenced as
consistent, or inconsistent, with permitted risk-mitigating hedging
activity? Are there specific and identifiable characteristics of
compensation arrangements that clearly incentivize prohibited
proprietary trading?
    Question 114. Is the proposed documentation requirement effective?
If not, what alternative would be more effective? Are there certain
additional types of hedging transactions that should be subject to the
documentation requirement? If so, what transactions and why? Should all
types of hedging transactions be subject to the documentation
requirement? If so, why? Should banking entities be required to
document more aspects of a particular transactions (e.g., all of the
criteria applicable to Sec.  --.5(b) of the proposed rule)? If so, what
aspects and why? What burden would the proposed documentation
requirement place on banking entities? How might such burden be reduced
or eliminated in a manner consistent with the language and purpose of
the statute?
    Question 115. Aside from the required documentation, do the
substantive requirements of the proposed risk-mitigating hedging
exemption suggest that additional documentation would be required to
achieve compliance with the proposed rule? If so, what burden would
this additional documentation requirement place on banking entities?
How might such burden be reduced or eliminated in a manner consistent
with the language and purpose of the statute?
4. Section --.6: Other Permitted Trading Activities
    Section --.6 of the proposed rule permits a banking entity to
engage in certain other trading activities described in section
13(d)(1) of the BHC Act. These permitted activities include trading in
certain government obligations, trading on behalf of customers, trading
by insurance companies, and trading outside of the United States by
certain foreign banking entities. Section --.6 of the proposed rule
does not contain all of the statutory exemptions contained in section
13(d)(1) of the BHC Act. Several of these exemptions appear, either by
plain language or by implication, to be intended to apply only to
covered fund activities and investments, and so the Agencies have not
proposed to include them in the proposed rule's proprietary trading
provisions.\162\ Those exemptions are referenced in other portions of
the proposed rule pertaining to covered funds.
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    \162\ In particular, the proposed rule does not apply (i) the
exemption in section 13(d)(1)(E) of the BHC Act for SBICs and
certain public welfare or qualified rehabilitation investments, or
(ii) the exemptions in sections 13(d)(1)(G) and 13(d)(1)(I) of the
BHC Act for certain covered funds activities and investments, to the
proprietary trading provisions of subpart B.
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    The Agencies request comment on the proposed rule's approach to
implementing the exemptions contained in section 13(d)(1) of the BHC
Act to the proposed rule's proprietary trading provisions. In
particular, the Agencies

request comment on the following questions:
    Question 116. Is the proposed rule's approach of identifying which
of the statutory exemptions contained in section 13(d)(1) of the BHC
Act apply to the proposed rule's proprietary trading provisions
effective and/or consistent with the language and purpose of the
statute? If not, what alternative would be more effective and/or
consistent with the language and purpose of the statute?
    Question 117. Are there statutory exemptions that should apply to
the proposed rule's proprietary trading provisions that were not
included? If so, what exemptions and why?
    Question 118. Are there statutory exemptions that were included in
the proposed rule's proprietary trading provisions that should not have
been included? If so, what exemptions and why?
a. Permitted Trading in Government Obligations
    Section --.6(a) of the proposed rule, which implements section
13(d)(1)(A) of the BHC Act,\163\ permits the purchase or sale of a
covered financial position that is: (i) An obligation of the United
States or any agency thereof; \164\ (ii) an obligation, participation,
or other instrument of or issued by the Government National Mortgage
Association, the Federal National Mortgage Association, the Federal
Home Loan Mortgage Corporation, a Federal Home Loan Bank, the Federal
Agricultural Mortgage Corporation or a Farm Credit System institution
chartered under and subject to the provisions of the Farm Credit Act of
1971 (12 U.S.C. 2001 et seq.); or (iii) an obligation issued by any
State or any political subdivision thereof.\165\ The proposed rule also
clarifies that these obligations include limited as well as general
obligations of the relevant government entity. The Agencies note that,
consistent with the statutory language, the types of instruments
described with respect to the enumerated government-sponsored entities
include not only obligations of such entities, but also participations
and other instruments of or issued by such entity. This would include,
for example, pass-through or participation certificates that are issued
and guaranteed by one of these government-sponsored entities (e.g., the
Federal National Mortgage Association and the Federal Home Loan
Mortgage Corporation) in connection with their securitization
activities.
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    \163\ Section 13(d)(1)(A) of the BHC Act permits a banking
entity to purchase, sell, acquire or dispose securities and other
instruments described in section 13(h)(4) of the BHC Act if those
securities or other instruments are specified types of government
obligations, notwithstanding the prohibition on proprietary trading.
See 12 U.S.C. 1851(d)(1)(A).
    \164\ The Agencies propose that United States ``agencies'' for
this purpose will include those agencies described in section
201.108(b) of the Board's Regulation A. See 12 CFR 201.108(b). The
Agencies also note that the terms of the exemption would encompass
the purchase or sale of enumerated government obligations on a
forward basis (e.g., in a to-be-announced market).
    \165\ Consistent with the statutory language, the proposed rule
does not extend the government obligations exemption to transactions
in obligations of an agency of any State or political subdivision
thereof.
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    The Agencies request comment on the proposed rule's approach to
implementing the government obligation exemption. In particular, the
Agencies request comment on the following questions:
    Question 119. Is the proposed rule's application to trading in
government obligations sufficiently clear? Should such obligations
expressly include, for example, instruments issued by third parties but
insured or guaranteed by an enumerated government entity or otherwise
backed by its full faith and credit?
    Question 120. Should the Agencies adopt an additional exemption for
proprietary trading in State or municipal agency obligations under
section 13(d)(1)(J) of the BHC Act? If so, how would such an exemption
promote and protect the safety and soundness of banking entities and
the financial stability of the United States?
    Question 121. Should the Agencies adopt an additional exemption for
proprietary trading in options or other derivatives referencing an
enumerated government obligation under section 13(d)(1)(J) of the BHC
Act? For example, should the Agencies provide an exemption for options
or other derivatives with respect to U.S. government debt obligations?
If so, how would such an exemption promote and protect the safety and
soundness of banking entities and the financial stability of the United
States?
    Question 122. Should the Agencies adopt an additional exemption for
proprietary trading in the obligations of foreign governments and/or
international and multinational development banks under section
13(d)(1)(J) of the BHC Act? If so, what types of obligations should be
exempt? How would such an exemption promote and protect the safety and
soundness of banking entities and the financial stability of the United
States?
    Question 123. Should the Agencies adopt an additional exemption for
proprietary trading in any other type of government obligations under
section 13(d)(1)(J) of the BHC Act? If so, how would such an exemption
promote and protect the safety and soundness of banking entities and
the financial stability of the United States?
    Question 124. Are the definitions of ``government security'' and
``municipal security'' in sections 3(a)(42) and 3(a)(29) of the
Exchange Act helpful in determining the proper scope of this exemption?
If so, please explain their utility and how incorporating such
definitions into the exemption would be consistent with the language
and purpose of section 13 of the BHC Act.
b. Permitted Trading on Behalf of Customers
    Section 13(d)(1)(D) of the BHC Act permits a banking entity to
purchase or sell a covered financial position on behalf of customers,
notwithstanding the prohibition on proprietary trading. Section --.6(b)
of the proposed rule implements this section. Because the statute does
not specifically define when a transaction would be conducted ``on
behalf of customers,'' the proposed rule identifies three categories of
transactions that, while they may involve a banking entity acting as
principal for certain purposes, appear to be on behalf of customers
within the purpose and meaning of the statute. As proposed, only
transactions meeting the terms of these three categories would be
considered on behalf of customers for purposes of the exemption.
    Section --.6(b)(i) of the proposed rule provides that a purchase or
sale of a covered financial position is on behalf of customers if the
transaction (i) is conducted by a banking entity acting as investment
adviser, commodity trading advisor, trustee, or in a similar fiduciary
capacity for a customer and for the account of that customer, and (ii)
involves solely covered financial positions of which the banking
entity's customer, and not the banking entity or any subsidiary or
affiliate of the banking entity, is beneficial owner (including as a
result of having long or short exposure under the relevant covered
financial position). This category is intended to capture a wide range
of trading activity conducted in the context of customer-driven
investment or commodity advisory, trust, or fiduciary services, so long
as that activity is structured in a way that the customer, and not the
banking entity providing those services, benefits from any gains and
suffers from any losses on such covered financial positions.\166\ A
transaction that is

structured so as to involve a listed form of relationship but
nonetheless allows gains or losses from trading activity to inure to
the benefit or detriment of the banking entity would fall outside the
scope of this category.
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    \166\ For example, in the case of a banking entity acting as
investment adviser to a registered mutual fund, any trading by the
banking entity in its capacity of investment adviser and on behalf
of that fund would be permitted pursuant to Sec.  --.6(b)(i) of the
proposed rule, so long as the relevant criteria were met.
---------------------------------------------------------------------------

    Section --.6(b)(ii) of the proposed rule provides that a
transaction is on behalf of customers if the banking entity is acting
as riskless principal. These type of transactions are similarly
customer-driven and do not expose the banking entity to gains or losses
on the value of the traded positions, notwithstanding the fact that the
banking entity technically acts as principal. The Agencies note that
the proposed language describing riskless principal transactions
generally mirrors that used in the Board's Regulation Y, OCC
interpretive letters, and the SEC's Rule 3a5-1 under the Exchange
Act.\167\
---------------------------------------------------------------------------

    \167\ See 12 CFR 225.28(b)(7)(ii); 17 CFR 240.3a5-1(b); OCC
Interpretive Letter 626 (July 7, 1993).
---------------------------------------------------------------------------

    Section --.6(b)(iii) of the proposed rule addresses trading for the
separate account of insurance policyholders by a banking entity that is
an insurance company. In particular, this part of the proposed rule
provides that a purchase or sale of a covered financial position is on
behalf of customers if:
     The banking entity is an insurance company engaging in the
transaction for a separate account;
     The banking entity is directly engaged in the business of
insurance and subject to regulation by a State insurance regulator or
foreign insurance regulator; \168\
---------------------------------------------------------------------------

    \168\ The proposed rule provides definitions of the terms
``State insurance regulator'' and ``foreign insurance regulator.''
See proposed rule Sec. Sec.  --.3(c)(4), (13).
---------------------------------------------------------------------------

     The banking entity purchases or sells the covered
financial position solely for a separate account established by the
insurance company in connection with one or more insurance policies
issued by that insurance company;
     All profits and losses arising from the purchase or sale
of the covered financial position are allocated to the separate account
and inure to the benefit or detriment of the owners of the insurance
policies supported by the separate account, and not the banking entity;
and
     The purchase or sale is conducted in compliance with, and
subject to, the insurance company investment and other laws,
regulations, and written guidance of the State or jurisdiction in which
such insurance company is domiciled.
    This category is included within the exemption for transactions on
behalf of customers because such insurance-related transactions are
generally customer-driven and do not expose the banking entity to gains
or losses on the value of separate account assets, even though the
banking entity may be treated as the owner of those assets for certain
purposes. However, to limit the potential for abuse of the exemption,
the proposed rule also includes related requirements designed to ensure
that the separate account trading activity is subject to appropriate
regulation and supervision under insurance laws and not structured so
as to allow gains or losses from trading activity to inure to the
benefit or detriment of the banking entity.\169\ The proposed rule
defines a ``separate account'' as an account established or maintained
by a regulated insurance company subject to regulation by a State
insurance regulator or foreign insurance regulator under which income,
gains, and losses, whether or not realized, from assets allocated to
such account, are, in accordance with the applicable contract, credited
to or charged against such account without regard to other income,
gains, or losses of the insurance company.\170\
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    \169\ The Agencies would not consider profits to inure to the
benefit of the banking entity if the banking entity were solely to
receive payment, out of separate account profits, of fees unrelated
to the investment performance of the separate account.
    \170\ See proposed rule Sec.  --.2(z).
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    The Agencies request comment on the proposed rule's approach to
implementing the exemption for trading on behalf of customers. In
particular, the Agencies request comment on the following questions:
    Question 125. Is the proposed rule's articulation of three
categories of transactions on behalf of customers effective and
sufficiently clear? If not, what alternative would be more effective
and/or clearer? Should any of the categories be eliminated? Should any
additional categories be added? Please explain.
    Question 126. Is the proposed rule's exemption of certain
investment adviser, commodity trading advisor, trustee or similar
fiduciary transactions effective? What other types of relationships are
or should be captured by the proposed rule's reference to ``similar
fiduciary relationships,'' and why? Is application of this part of the
exemption to particular transactions sufficiently clear? Should any
other specific types of fiduciary or other relationships be specified
in the rule? If so, what types and why? What impact will the proposed
rule's implementation of the exemption have on the investment adviser,
commodity trading advisor, trustee or similar fiduciary activities of
banking entities? If such impacts are negative, how could they be
mitigated or eliminated in a manner consistent with the purpose and
language of the statute?
    Question 127. Is the proposed rule's exemption of riskless
principal transactions effective? If not, what alternative would be
more appropriate? Is the description of qualifying riskless principal
activity sufficiently clear? If not, how should it be clarified? Should
the riskless principal transaction exemption include a requirement that
the banking entity must purchase (or sell) the covered financial
position as principal at the same price to satisfy the customer buy (or
sell) order, exclusive of any explicitly disclosed markup or markdown,
commission equivalent, or other fee? Why or why not? Should the
riskless principal exemption include a requirement with respect to the
timeframe in which the principal transaction must be allocated to a
riskless principal or customer account? Why or why not?
    Question 128. Is the proposed rule's exemption of trading for
separate accounts by insurance companies effective? If not, what
alternative would be more appropriate? Does the proposed exemption
sufficiently address the variety of customer-driven separate account
structures typically used? If not, how should it address such
structures? Does the proposed exemption sufficiently address the
variety of regulatory or supervisory regimes to which insurance
companies may be subject?
    Question 129. What impact will the proposed rule's implementation
of the exemption have on the insurance activities of insurance
companies affiliated with banking entities? If such impacts are
negative, how could they be mitigated or eliminated in a manner
consistent with the purpose and language of the statute?
    Question 130. Should the term ``customer'' be defined for purposes
of the exemption for transactions on behalf of customers? If so, how
should it be defined? For example, would an appropriate definition be
(i) a continuing relationship in which the banking entity provides one
or more financial products or services prior to the time of the
transaction, (ii) a direct and substantive relationship between the
banking entity and a prospective customer prior to the transaction, or
(iii) a relationship initiated by the banking entity to a prospective
customer for purposes of the transaction?

    Question 131. Is the exemption for trading on behalf of customers
in the proposed rule over- or under-inclusive? If it is under-
inclusive, please discuss any additional activities that should qualify
as trading on behalf of customers under the rule. What are the
mechanics of the particular trading activity and how does it qualify as
being on behalf of customers? Are there certain requirements or
restrictions that should be placed on the activity, if permitted by the
rule, to prevent evasion of the prohibition on proprietary trading? How
would permitting the activity be consistent with the purpose and
language of section 13 of the BHC Act? If the proposed exemption is
over-inclusive, please explain what aspect of the proposed exemption
does not involve trading on behalf of customers within the language and
purpose of the statute.
c. Permitted Trading by a Regulated Insurance Company
    Section --.6(c) of the proposed rule implements section 13(d)(1)(F)
of the BHC Act,\171\ which permits a banking entity to purchase or sell
a covered financial position if the banking entity is a regulated
insurance company acting for its general account or an affiliate of an
insurance company acting for the insurance company's general account,
subject to certain conditions. Section --.6(d) of the proposed rule
generally restates the statutory requirements of the exemption, which
provide that:
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    \171\ See 12 U.S.C. 1851(d)(1)(F).
---------------------------------------------------------------------------

     The insurance company must directly engage in the business
of insurance and be subject to regulation by a State insurance
regulator or foreign insurance regulator;
     The insurance company or its affiliate must purchase or
sell the covered financial position solely for the general account of
the insurance company;
     The purchase or sale must be conducted in compliance with,
and subject to, the insurance company investment laws, regulations, and
written guidance of the State or jurisdiction in which such insurance
company is domiciled; and
     The appropriate Federal banking agencies, after
consultation with the Council and the relevant insurance commissioners
of the States, must not have jointly determined, after notice and
comment, that a particular law, regulation, or written guidance
described above is insufficient to protect the safety and soundness of
the banking entity or of the financial stability of the United
States.\172\
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    \172\ The Federal banking agencies have not proposed at this
time to determine, as part of the proposed rule, that the insurance
company investment laws, regulations, and written guidance of any
particular State or jurisdiction are insufficient to protect the
safety and soundness of the banking entity, or of the financial
stability of the United States. The Federal banking agencies expect
to monitor, in conjunction with the Federal Insurance Office
established under section 502 of the Dodd-Frank Act, the insurance
company investment laws, regulations, and written guidance of States
or jurisdictions to which exempt transactions are subject and make
such determinations in the future, where appropriate.

The proposed rule defines a ``general account'' as all of the assets of
the insurance company that are not legally segregated and allocated to
separate accounts under applicable State law.\173\
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    \173\ See proposed rule Sec.  --.3(c)(6).
---------------------------------------------------------------------------

    The Agencies request comment on the proposed rule's approach to
implementing the exemption for general account trading by insurance
companies. In particular, the Agencies request comment on the following
questions:
    Question 132. Should any of the statutory requirements for the
exemption be further clarified in the proposed rule? If so, how? Should
any additional requirements be added? If so, what requirements and why?
    Question 133. Does the proposed rule appropriately and clearly
define a general account for these purposes? If not, what alternative
definition would be more appropriate?
    Question 134. For purposes of the exemption, are the insurance
company investment laws, regulations, and written guidance of any
particular State or jurisdiction insufficient to protect the safety and
soundness of the banking entity, or of the financial stability of the
United States? If so, why?
    Question 135. What impact will the proposed rule's implementation
of the exemption have on the insurance activities of insurance
companies affiliated with banking entities? If such impacts are
negative, how could they be mitigated or eliminated in a manner
consistent with the purpose and language of the statute?
d. Permitted Trading Outside of the United States
    Section --.6(d) of the proposed rule implements section 13(d)(1)(H)
of the BHC Act,\174\ which permits certain foreign banking entities to
engage in proprietary trading that occurs solely outside of the United
States.\175\ This statutory exemption limits the extraterritorial
application of the prohibition on proprietary trading to the foreign
activities of foreign firms, while preserving national treatment and
competitive equality among U.S. and foreign firms within the United
States. Consistent with the statute, the proposed rule defines both the
type of foreign banking entities that are eligible for the exemption
and the circumstances in which proprietary trading by such an entity
will be considered to have occurred solely outside of the United
States.
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    \174\ Section 13(d)(1)(H) of the BHC Act permits a banking
entity to engage in proprietary trading, notwithstanding the
prohibition on proprietary trading, if it is conducted by a banking
entity pursuant to paragraph (9) or (13) of section 4(c) of the BHC
Act and the trading occurs solely outside of the United States and
the banking entity is not directly or indirectly controlled by a
banking entity that is organized under the laws of the United States
or of one or more States. See 12 U.S.C. 1851(d)(1)(H).
    \175\ This section's discussion of the concept ``solely outside
of the United States'' is provided solely for purposes of the
proposed rule's implementation of section 13(d)(1)(H) of the BHC
Act, and does not affect a banking entity's obligation to comply
with additional or different requirements under applicable
securities, banking, or other laws.
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i. Foreign Banking Entities Eligible for the Exemption
    Section --.6(d)(1)(i) of the proposed rule provides that, in order
to be eligible for the foreign trading exemption, the banking entity
must not be directly or indirectly controlled by a banking entity that
is organized under the laws of the United States or of one or more
States. This requirement limits the scope of the exemption to banking
entities that are organized under foreign law and controlled only by
entities organized under foreign law. Consistent with the statutory
language, a banking entity organized under the laws of the United
States or any State and the subsidiaries and branches of such banking
entity (wherever organized or licensed) may not rely on the
exemption.\176\ Similarly, a U.S. subsidiary or branch of a foreign
banking entity would not qualify for the exemption.
---------------------------------------------------------------------------

    \176\ Under the proposal, a ``State'' means any State, territory
or possession of the United States, and the District of Columbia.
See proposed rule Sec.  --.2(aa).
---------------------------------------------------------------------------

    Section --.6(d)(1)(ii) of the proposed rule incorporates the
statutory requirement that the banking entity must also conduct the
transaction pursuant to sections 4(c)(9) or 4(c)(13) of the BHC Act.
Section --.6(d)(2) clarifies when a banking entity would meet that
requirement, the criteria for which vary depending on whether or not
the banking entity is a foreign banking organization.\177\
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    \177\ Section --.6(d)(2) only addresses when a transaction will
be considered to have been conducted pursuant to section 4(c)(9) of
the BHC Act. Although the statute also references section 4(c)(13)
of the BHC Act, the Board has applied the authority contained in
that section solely to the foreign activities of U.S. banking
organizations which, by the express terms of section 13(d)(1)(H) of
the BHC Act, are unable to rely on the foreign trading exemption.

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

    Section 4(c)(9) of the BHC Act provides that the restrictions on
interests in nonbanking organizations contained in that statute do not
apply to the ownership of shares held or activities conducted by any
company organized under the laws of a foreign country the greater part
of whose business is conducted outside the United States, if the Board
by regulation or order determines that, under the circumstances and
subject to the conditions set forth in the regulation or order, the
exemption would not be substantially at variance with the purposes of
the BHC Act and would be in the public interest.\178\ The Board has
implemented section 4(c)(9) as part of subpart B of the Board's
Regulation K,\179\ which specifies a number of conditions and
requirements that a foreign banking organization must meet in order to
use such authority. Such conditions and requirements include, for
example, a qualifying foreign banking organization test that requires
the foreign banking organization to demonstrate that more than half of
its worldwide business is banking and that more than half of its
banking business is outside the United States. The proposed rule makes
clear that if a banking entity is a foreign banking organization, it
will qualify for the foreign trading exemption if the entity is a
qualifying foreign banking organization that conducts the transaction
in compliance with subpart B of the Board's Regulation K, and the
transaction occurs solely outside of the United States.
---------------------------------------------------------------------------

    \178\ See 12 U.S.C. 1843(c)(9).
    \179\ See 12 CFR 211.20 et seq.
---------------------------------------------------------------------------

    Section 13 of the BHC Act also applies to foreign companies that
control a U.S. insured depository institution but are not currently
subject to the BHC Act generally or to the Board's Regulation K--for
example, because the foreign company controls a savings association or
an FDIC-insured industrial loan company. Accordingly, the proposed rule
also clarifies when this type of foreign banking entity would be
considered to have conducted a transaction ``pursuant to section
4(c)(9)'' for purposes of the foreign trading exemption.\180\ In
particular, the draft rule proposes that to qualify for the foreign
trading exemption, such firms must meet at least two of three
requirements that evaluate the extent to which the foreign entity's
business is conducted outside the United States, as measured by assets,
revenues, and income. This test largely mirrors the qualifying foreign
banking organization test that is made applicable under section 4(c)(9)
of the BHC Act and Sec.  211.23(a) of the Board's Regulation K, except
that the test does not also require such a foreign entity to
demonstrate that more than half of its banking business is outside the
United States.\181\
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    \180\ The Board emphasizes that this clarification would be
applicable solely in the context of section 13(d)(1) of the BHC Act.
The application of section 4(c)(9) to foreign companies in other
contexts is likely to involve different legal and policy issues and
may therefore merit different approaches.
    \181\ See 12 U.S.C. 1843(c)(9); 12 CFR 211.23(a); proposed rule
Sec.  --.6(d)(2). This difference reflects the fact that foreign
entities subject to section 13 of the BHC Act, but not the BHC Act
generally, are likely to be, in many cases, predominantly commercial
firms. A requirement that such firms also demonstrate that more than
half of their banking business is outside the United States would
likely make the exemption unavailable to such firms and subject
their global activities to the prohibition on proprietary trading, a
result that the statute does not appear to have intended.
---------------------------------------------------------------------------

ii. Trading Solely Outside of the United States
    The proposed rule also clarifies when a transaction will be
considered to have occurred solely outside of the United States for
purposes of the exemption. In interpreting this aspect of the statutory
language, the proposal focuses on the extent to which material elements
of the transaction occur within, or are conducted by personnel within,
the United States. This focus seeks to avoid extraterritorial
application of the prohibition of proprietary trading outside the
United States while preserving competitive parity within U.S. markets.
The proposed rule does not evaluate solely whether the risk of the
transaction or management or decision-making with respect to the
transaction rests outside the United States, as such an approach would
appear to permit foreign banking entities to structure transactions so
as to be ``outside of the United States'' for risk and booking purposes
while engaging in transactions within U.S. markets that are prohibited
for U.S. banking entities.
    In particular, Sec.  --.6(d)(3) of the proposed rule provides that
a transaction will be considered to have occurred solely outside of the
United States only if four conditions are met:
     The transaction is conducted by a banking entity that is
not organized under the laws of the United States or of one or more
States;
     No party to the transaction is a resident of the United
States;
     No personnel of the banking entity that is directly
involved in the transaction is physically located in the United States;
\182\ and
---------------------------------------------------------------------------

    \182\ Personnel directly involved in the transaction would
generally not include persons performing purely administrative,
clerical, or ministerial functions.
---------------------------------------------------------------------------

     The transaction is executed wholly outside the United
States.

These four criteria are intended to ensure that a transaction executed
in reliance on the exemption does not involve U.S. counterparties, U.S.
trading personnel, U.S. execution facilities, or risks retained in the
United States. The presence of any of these factors would appear to
constitute a sufficient locus of activity in the U.S. marketplace so as
to preclude availability of the exemption.
    A resident of the United States is defined in Sec.  --.2(t) of the
proposed rule, and includes: (i) Any natural person resident in the
United States; (ii) any partnership, corporation or other business
entity organized or incorporated under the laws of the United States or
any State; (iii) any estate of which any executor or administrator is a
resident of the United States; (iv) any trust of which any trustee,
beneficiary or, if the trust is revocable, settlor is a resident of the
United States; (v) any agency or branch of a foreign entity located in
the United States; (vi) any discretionary or non-discretionary account
or similar account (other than an estate or trust) held by a dealer or
fiduciary for the benefit or account of a resident of the United
States; (vii) any discretionary account or similar account (other than
an estate or trust) held by a dealer or fiduciary organized or
incorporated in the United States, or (if an individual) a resident of
the United States; or (viii) any partnership or corporation organized
or incorporated under the laws of any foreign jurisdiction formed by or
for a resident of the United States principally for the purpose of
engaging in one or more transactions described in Sec.  --.6(d)(1) or
Sec.  --.13(c)(1) of the proposed rule.\183\ The proposed definition is
designed to capture the scope of U.S. counterparties, decision-makers
and personnel that, if involved in the transaction, would preclude that
transaction from being considered to have occurred solely outside the
United States. The Agencies note that the proposed definition is
similar but not identical to the definition of ``U.S. person'' for
purposes of the SEC's Regulation S, which governs securities offerings
and sales outside of the United

States that are not registered under the Securities Act.\184\
---------------------------------------------------------------------------

    \183\ See proposed rule Sec.  --.2(t).
    \184\ See 17 CFR 230.902(k).
---------------------------------------------------------------------------

iii. Request for Comment
    The Agencies request comment on the proposed rule's approach to
implementing the foreign trading exemption. In particular, the Agencies
request comment on the following questions:
    Question 136. Is the proposed rule's implementation of the foreign
trading exemption effectively delineated? If not, what alternative
would be more effective and/or clearer?
    Question 137. Are the proposed rule's provisions regarding when an
activity will be considered to have been conducted pursuant to section
4(c)(9) of the BHC Act effective and sufficiently clear? If not, what
alternative would be more effective and/or clearer? Do those provisions
effectively address the application of the foreign trading exemption to
foreign banking entities not subject to the BHC Act generally? If not,
how should the proposed rule apply the exemption?
    Question 138. Are the proposed rule's provisions regarding when an
activity will be considered to have occurred solely outside the United
States effective and sufficiently clear? If not, what alternative would
be more effective and/or clearer? Should any requirements be modified
or removed? If so, which requirements and why? Should additional
requirements be added? If so, what requirements and why?
    Question 139. Is the proposed rule's definition of ``resident of
the United States'' effective and sufficiently clear? If not, what
alternative would be more effective and/or clearer? Is the definition
over- or under-inclusive? If so, why? Should the definition more
closely track, or incorporate by reference, the definition of ``U.S.
person'' under the SEC's Regulation S under the Securities Act? If so,
why?
    Question 140. Does the proposed rule effectively define a resident
of the United States for these purposes? If not, how should the
definition be altered?
    Question 141. Should the Agencies use the authority provided in
section 13(d)(1)(J) of the BHC Act to allow U.S.-controlled banking
entities to engage in proprietary trading pursuant to section 4(c)(13)
of the BHC Act outside of the United States under certain
circumstances? If so, under what circumstances should this be permitted
and how would such activity promote and protect the safety and
soundness of banking entities and the financial stability of the United
States?
e. Discretionary Exemptions for Proprietary Trading Under Section
13(d)(1)(J) of the BHC Act
    Section 13(d)(1)(J) of the BHC Act permits the Agencies to grant,
by rule, other exemptions from the prohibition on proprietary trading
if the Agencies determine that the exemption would promote and protect
the safety and soundness of the banking entity and the financial
stability of the United States.\185\ The Agencies have not, at this
time, proposed any such discretionary exemptions with respect to the
prohibition on proprietary trading. The Agencies request comment as
follows:
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    \185\ See 12 U.S.C. 1851(d)(1)(J). In addition to permitting the
Agencies to provide additional exemptions from the prohibition on
proprietary trading, section 13(d)(1)(J) also states that the
Agencies may provide additional exemptions from the prohibition on
investing in or sponsoring a covered fund, as discussed in Part
III.C.5 of this Supplementary Information.
---------------------------------------------------------------------------

    Question 142. Should the Agencies adopt any exemption from the
prohibition on proprietary trading under section 13(d)(1)(J) of the BHC
Act? If so, what exemption and why? How would such an exemption promote
and protect the safety and soundness of banking entities and the
financial stability of the United States?
5. Section --.7: Reporting and Recordkeeping Requirements Applicable to
Trading Activities
    Section --.7 of the proposed rule, which implements in part section
13(e)(1) of the BHC Act,\186\ requires certain banking entities to
comply with the reporting and recordkeeping requirements specified in
Appendix A of the proposed rule. In addition, Sec.  --.7 requires
banking entities to comply with the recordkeeping requirements in Sec.
--.20 of the proposed rule, related to the banking entity's compliance
program,\187\ as well as any other reporting or recordkeeping
requirements that the relevant Agency may impose to evaluate the
banking entity's compliance with the proposed rule.\188\ Proposed
Appendix A requires a banking entity with significant trading
activities to furnish periodic reports to the relevant Agency regarding
various quantitative measurements of its trading activities and create
and retain records documenting the preparation and content of these
reports. The measurements vary depending on the scope, type, and size
of trading activities. In addition, proposed Appendix B contains a
detailed commentary regarding the characteristics of permitted market
making-related activities and how such activities may be distinguished
from trading activities that, even if conducted in the context of a
banking entity's market-making operations, would constitute prohibited
proprietary trading.
---------------------------------------------------------------------------

    \186\ Section 13(e)(1) of the BHC Act requires the Agencies to
issue regulations regarding internal controls and recordkeeping to
ensure compliance with section 13. See 12 U.S.C. 1851(e)(1). Section
--.20 and Appendix C of the proposed rule also implement section
13(e)(1) of the BHC Act.
    \187\ See Supplementary Information, Part III.D.
    \188\ See proposed rule Sec.  --.7.
---------------------------------------------------------------------------

    A banking entity must comply with proposed Appendix A's reporting
and recordkeeping requirements only if it has, together with its
affiliates and subsidiaries, trading assets and liabilities the average
gross sum of which (on a worldwide consolidated basis) is, as measured
as of the last day of each of the four prior calendar quarters, equal
to or greater than $1 billion.\189\ The Agencies have not proposed to
extend the reporting and recordkeeping requirements to banking entities
with smaller amounts of trading activity, as it appears that the more
limited benefits of applying these requirements to such banking
entities, whose trading activities are typically small, less complex,
and easier to supervise, would not justify the burden associated with
complying with the reporting and recordkeeping requirements.
---------------------------------------------------------------------------

    \189\ See proposed rule Sec.  --.7(a). The Agencies note that
this $1 billion trading asset and liability threshold is the same
standard that is used in the Market Risk Capital Rules for
determining which bank holding companies and insured depository
institutions must calculate their risk-based capital requirements
for trading positions under those rules. These banking entities
maintain large and complex portfolios of trading assets and are
therefore the most likely to be engaged in the types of trading
activities that will require significant oversight of compliance
with the restrictions on proprietary trading.
---------------------------------------------------------------------------

a. General Approach to Reporting and Recordkeeping Requirements
    The reporting and recordkeeping requirements of Sec.  --.7 and
Appendix A of the proposed rule are an important part of the proposed
rule's multi-faceted approach to implementing the prohibition on
proprietary trading. These requirements are intended, in particular, to
address some of the difficulties associated with (i) identifying
permitted market making-related activities and distinguishing such
activities from prohibited proprietary trading and (ii) identifying
certain trading activities resulting in material exposure to high-risk
assets or high-risk trading strategies. To do so, the proposed rule
requires certain

banking entities to calculate and report detailed quantitative
measurements of their trading activity, by trading unit. These
measurements will help banking entities and the Agencies in assessing
whether such trading activity is consistent with permitted trading
activities in scope, type and profile. The quantitative measurements
that must be reported under the proposed rule are generally designed to
reflect, and to provide meaningful information regarding, certain
characteristics of trading activities that appear to be particularly
useful in differentiating permitted market making-related activities
from prohibited proprietary trading. For example, the proposed
quantitative measurements measure the size and type of revenues
generated, and the types of risks taken, by a trading unit. Each of
these measurements appears to be useful in assessing whether a trading
unit is (i) engaged in permitted market making-related activity or (ii)
materially exposed to high-risk assets or high-risk trading strategies.
Similarly, the proposed quantitative measurements also measure how much
revenue is generated per such unit of risk, the volatility of a trading
unit's profitability, and the extent to which a trading unit trades
with customers. Each of those characteristics appears to be useful in
assessing whether a trading unit is engaged in permitted market making-
related activity.
    However, the Agencies recognize that no single quantitative
measurement or combination of measurements can accurately identify
prohibited proprietary trading without further analysis of the context,
facts, and circumstances of the trading activity. In addition, certain
quantitative measurements may be useful for assessing one type of
trading activity, but not helpful in assessing another type of trading
activity. As a result, the Agencies propose to use a variety of
quantitative measurements to help identify transactions or activities
that warrant more in-depth analysis or review.
    To be effective, this approach requires identification of useful
quantitative measurements as well as judgment regarding the type of
measurement results that suggest a further review of the trading unit's
activity is warranted. The Agencies intend to take a heuristic approach
to implementation in this area that recognizes that quantitative
measurements can only be usefully identified and employed after a
process of substantial public comment, practical experience, and
revision. In particular, the Agencies note that, although a variety of
quantitative measurements have traditionally been used by market
participants and others to manage the risks associated with trading
activities, these quantitative tools have not been developed, nor have
they previously been utilized, for the explicit purpose of identifying
trading activity that warrants additional scrutiny in differentiating
prohibited proprietary trading from permitted market making-related
activities. Additional study and analysis will be required before
quantitative measurements may be effectively designed and employed for
that purpose.
    Consistent with this heuristic approach, the proposed rule includes
a large number of potential quantitative measurements on which public
comment is sought, many of which overlap to some degree in terms of
their informational value. Not all of these quantitative measurements
may ultimately be adopted, depending on their relative strengths,
weaknesses, costs, and benefits. The Agencies note that some of the
proposed quantitative measurements may not be relevant to all types of
trading activities or may provide only limited benefits, relative to
cost, when applied to certain types of trading activities. In addition,
certain quantitative measurements may be difficult or impracticable to
calculate for a specific covered trading activity due to differences
between asset classes, market structure, or other factors. The Agencies
have therefore requested comment on a large number of issues related to
the relevance, practicability, costs, and benefits of the quantitative
measurements proposed. The Agencies also seek comment on whether the
quantitative measurements described in the proposal may be appropriate
to use in assessing compliance with section 13 of the BHC Act.
    In addition to the proposed quantitative measurements, a banking
entity may itself develop and implement other quantitative measurements
in order to effectively monitor its covered trading activities for
compliance with section 13 of the BHC Act and the proposed rule and to
establish, maintain, and enforce an effective compliance program, as
required by Sec.  --.20 of the proposed rule and Appendix C. The
Agencies note that the proposed quantitative measurements in Appendix A
are intended to assist banking entities and Agencies in monitoring
compliance with the proprietary trading restrictions and, thus, are
related to the compliance program requirements in Sec.  --.20 of the
proposed rule and proposed Appendix C. Nevertheless, implementation of
the proposed quantitative measurements under Appendix A would not
necessarily provide all the data necessary for the banking entity to
establish an effective compliance program, and a banking entity may
need to develop and implement additional quantitative measurements. The
Agencies recognize that appropriate and effective quantitative
measurements may differ based on the profile of the banking entity's
businesses in general and, more specifically, of the particular trading
unit, including types of instruments traded, trading activities and
strategies, and history and experience (e.g., whether the trading desk
is an established, successful market maker or a new entrant to a
competitive market). In all cases, banking entities must ensure that
they have robust measures in place to identify and monitor the risks
taken in their trading activities, to ensure the activities are within
risk tolerances established by the banking entity, and to monitor for
compliance with the proprietary trading restrictions in the proposed
rule.
    To the extent that data regarding measurements, as set forth in the
proposed rule, are collected, the Agencies propose to utilize the
automatic two-year conformance period provided in section 13 of the BHC
Act to carefully review that data, further study the design and utility
of these measurements, and if necessary, propose changes to the
reporting requirements as the Agencies believe are needed to ensure
that these measurements are as effective as possible.\190\ This
heuristic, gradual approach to implementing reporting requirements for
quantitative measurements would be intended to ensure that the
requirements are formulated in a manner that maximizes their utility
for identifying trading activity that warrants additional scrutiny in
assessing compliance with the prohibition on proprietary trading, while
limiting the risk that the use of quantitative measurements could
inadvertently curtail permissible market making-related activities that
provide an important service to market participants and the capital
markets at large.
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    \190\ Section 13(c)(2) of the BHC Act provides banking entities
two years from the date that the proposed rule becomes effective
(with the possibility of up to three, one-year extensions) to bring
their activities, investments, and relationships into compliance
with section 13, including the prohibition on proprietary trading.
See 12 U.S.C. 1851(c)(2).
---------------------------------------------------------------------------

    In addition, the Agencies request comment on the use of numerical
thresholds for certain quantitative

measurements that, if reported by a banking entity, would require the
banking entity to review its trading activities for compliance and
summarize that review to the relevant Agency. The Agencies have not
proposed specific numerical thresholds in the proposal because
substantial public comment and analysis would be beneficial prior to
formulating and proposing specific numerical thresholds. Instead, the
Agencies intend to carefully consider public comments that are provided
on this issue and to separately determine whether it would be
appropriate to propose, subsequent to finalizing the current proposal,
such numerical thresholds.
    The Agencies request comment on the proposed approach to
implementing reporting requirements for proprietary trading. In
particular, the Agencies request comment on the following questions:
    Question 143. Is the use of the proposed reporting requirements as
part of the multi-faceted approach to implementing the prohibition on
proprietary trading appropriate? Why or why not?
    Question 144. Is the proposed gradual approach to implementing
reporting requirements effective? If not, what approach would be more
effective? For example, should the Agencies defer reporting of
quantitative measurements until banking entities have developed and
refined their compliance programs through the supervision and
examination process? What would be the costs and benefits of such an
approach?
    Question 145. What role, if any, could or should the Office of
Financial Research (``OFR'') play in receiving and analyzing banking
entities' reported quantitative measurements? Should reporting to the
OFR be required instead of reporting to the relevant Agency, and would
such reporting be consistent with the composition and purpose of OFR?
In the alternative, should reporting to either (i) only the relevant
Agency (or Agencies) or (ii) both the relevant Agency (or Agencies) and
OFR be required? If so, why? What are the potential costs and benefits
of reporting quantitative measurements to the OFR? Please explain.
    Question 146. Is there an alternative manner in which the Agencies
should develop and propose the reporting requirements for quantitative
measurements? If so, how should they do so?
    Question 147. Does the proposed approach provide sufficient time
for the development and implementation of effective reporting
requirements? If not, what alternative approach would be preferable?
    Question 148. Should a trading unit be permitted not to furnish a
quantitative measurement otherwise required under Appendix A if it can
demonstrate that the measurement is not, as applied to that unit,
calculable or useful in achieving the purposes of the Appendix with
respect to the trading unit's covered trading activities? How might a
banking entity make such a demonstration?
    Question 149. Is the manner in which the Agencies propose to
utilize the conformance period for review of collected data and
refinement of the reporting requirements effective? If not, what
process would be more effective?
    Question 150. Is the proposed $1 billion trading asset and
liability threshold, which is also currently used in the Market Risk
Capital Rules for purposes of identifying which banks and bank holdings
companies must comply with those rules, an appropriate standard for
triggering the reporting and recordkeeping requirements of the proposed
rule? Why or why not? If not, what alternative standard would be a
better benchmark for triggering the reporting and recordkeeping
requirements?
    Question 151. What are the typical trading activities (e.g., market
making-related activities) of a banking entity with less than $1
billion in gross trading assets and liabilities? How complex are those
trading activities?
    Question 152. Should the proposed $1 billion trading and asset
liability threshold used for triggering the reporting and recordkeeping
requirements adjust each time the thresholds for complying with the
Market Risk Capital Rules adjust, or otherwise be adjusted over time?
If not, how and when should the numerical threshold be adjusted?
    Question 153. Should all banking entities be required to comply
with the reporting and recordkeeping requirements set forth in Appendix
A in order to better protect against prohibited proprietary trading,
rather than only those banking entities that meet the proposed $1
billion trading asset and liability threshold? Why or why not?
    Question 154. Should banking entities that fall under the proposed
$1 billion trading asset and liability threshold be required to comply
with the reporting and recordkeeping provisions for a pilot period in
order to help inform judgment regarding the levels of quantitative
measurements at such entities and the appropriate frequency and scope
of examination by the relevant Agency for such banking entities? Why or
why not?
b. Proposed Appendix A--Purpose and Definitions
    Section I of proposed Appendix A describes the purpose of the
appendix, which is to specify reporting requirements that are intended
to assist banking entities that are engaged in significant trading
activities and the Agencies in identifying trading activities that
warrant further review or examination to verify compliance with the
proprietary trading restrictions, including whether an otherwise-
permitted activity under Sec. Sec.  --.4 through --.6(a) of the
proposed rule is consistent with the requirement that such activity not
result, directly or indirectly, in a material exposure by the banking
entity to high-risk assets and high-risk trading strategies. In
particular, section I provides that the purpose of the appendix is to
assist the relevant Agency and banking entities in:
     Better understanding and evaluating the scope, type, and
profile of the banking entity's covered trading activities;
     Monitoring the banking entity's covered trading
activities;
     Identifying covered trading activities that warrant
further review or examination by the banking entity to verify
compliance with the proprietary trading restrictions;
     Evaluating whether the trading activities of trading units
engaged in market making-related activities under Sec.  --.4(b) of the
proposed rule are consistent with the requirements governing permitted
market making-related activities;
     Evaluating whether the trading activities of trading units
that are engaged in permitted trading activity under Sec. Sec.  --.4,
--.5, or --.6(a) of the proposed rule (e.g., permitted underwriting,
market making-related activity, risk-mitigating hedging, or trading in
certain government obligations) are consistent with the requirement
that such activity not result, directly or indirectly, in a material
exposure by the banking entity to high-risk assets and high-risk
trading strategies;
     Identifying the profile of particular trading activities
of the banking entity, and the individual trading units of the banking
entity, to help establish the appropriate frequency and scope of
examination by the relevant Agency of such activities; and
     Assessing and addressing the risks associated with the
banking entity's trading activities.
    The types of trading and market making-related activities in which
banking entities engage is often highly

complex, and any quantitative measurement is capable of producing both
``false negatives'' and ``false positives'' that suggest that
prohibited proprietary trading is occurring when it is not, or vice
versa. Recognizing this, section I of proposed Appendix A makes clear
that the quantitative measurements that may be required to be reported
would not be intended to serve as a dispositive tool for identifying
permissible or impermissible activities.
    Section II of proposed Appendix A defines relevant terms used in
the appendix. These include certain definitions that clarify how and
when certain calculations must be made, as well as a definition of
``trading unit'' that governs the level of organization at which a
banking entity must calculate quantitative measurements. The proposed
definition of ``trading unit'' covers multiple organizational levels of
a banking entity, including:
     Each discrete unit engaged in the coordinated
implementation of a revenue generation strategy that participates in
the execution of any covered trading activity; \191\
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    \191\ As noted in Appendix A, the Agencies expect that this
would generally be the smallest unit of organization used by the
banking entity to structure and control its risk-taking activities
and employees, and would include each unit generally understood to
be a single ``trading desk.'' For example, if a banking entity has
one set of employees engaged in market making-related activities in
the equities of U.S. non-financial corporations, and another set of
employees engaged in market making-related activities in the
equities of U.S. financial corporations, the two sets of employees
would appear to be part of a single trading unit if both sets of
employees structure and control their trading activities together,
making and executing highly coordinated decisions about required
risk levels, inventory levels, sources of revenue growth and similar
features. On the other hand, if the risk decisions and revenue
strategies are considered and executed separately by the two sets of
employees, with only loose coordination, they would appear to be two
distinct trading units. In determining whether a set of employees
constitute a single trading unit, important factors would likely
include whether compensation is strongly linked to the group's
performance, whether risk levels and trading limits are managed and
set jointly or separately, and whether trades are booked together or
separately.
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     Each organizational unit used to structure and control the
aggregate risk-taking activities and employees of one or more trading
units described above;
     All trading operations, collectively; and
     Any other unit of organization specified by the relevant
Agency with respect to a particular banking entity.\192\
---------------------------------------------------------------------------

    \192\ This latter prong of the definition has been included to
ensure that the Agencies have the ability to require banking
entities to report quantitative measurements in other ways to
prevent a banking entity from organizing its trading operations so
as to undermine the effectiveness of the reporting requirement.
---------------------------------------------------------------------------

    The definition of ``trading unit'' is intended to capture multiple
layers of a banking entity's organization structure, including
individual trading desks, intermediate divisions that oversee a variety
of trading desks, and all trading operations in the aggregate. As
described below, under the proposal, the quantitative measurements
specified in section IV of proposed Appendix A must be calculated and
reported for each such ``trading unit.'' Accordingly, the definition of
trading unit is purposefully broad and captures multiple levels of
organization so as to ensure that quantitative measurements provide
meaningful information, at both a granular and aggregate level, to help
banking entities and the Agencies evaluate the quantitative profile of
trading operations in a variety of contexts.
    The Agencies expect that the scope and nature of trading units to
which the quantitative measurements are applied would have an important
impact on the informational content and utility of the resulting
measurements. Applying a quantitative measurement to a trading unit at
a level that aggregates a variety of distinct trading activities may
obscure or ``smooth'' differences between distinct lines of business,
asset categories and risk management processes in a way that renders
the measurement relatively uninformative, because it does not
adequately reflect the specific characteristics of the trading
activities being conducted. Similarly, applying a quantitative
measurement to a trading unit at a highly granular level could, if it
captured only a narrow portion of activity that is conducted as part of
a broader business strategy, introduce meaningless ``noise'' into the
measure or result in a measurement that is idiosyncratic in nature.
This highly granular application could render the measurement
relatively uninformative because it would not accurately reflect the
entirety of the trading activities being conducted. In order to address
the potential weaknesses of applying the quantitative measurements at
an aggregate and a granular level, respectively, the proposal requires
reporting at both levels. The informational inputs required to
calculate any particular quantitative measurement at either level are
the same. Consequently, it is expected that, depending on the nature of
the systems of a particular institution, there may be little, if any,
incremental burden associated with calculating and reporting
quantitative measurements at multiple levels.
    The Agencies request comment on the proposed reporting requirements
in Appendix A. In particular, the Agencies request comment on the
following questions:
    Question 155. Are the ways in which the proposed rule would make
use of reported quantitative measurements effective? If not, what uses
would be more effective? Should the proposed rule instead use
quantitative measurements as a dispositive tool for identifying
prohibited proprietary trading? If so, what types of quantitative
measurements should be employed, what numerical amount would indicate
impermissible proprietary trading activity, and why? Should the
quantitative measurements play a less prominent role than proposed in
identifying prohibited proprietary trading and why?
    Question 156. Are the proposed definitions of terms provided in
Appendix A effective? If not, how should the definitions be amended?
    Question 157. Is the proposed definition of ``trading unit''
effective? Is it sufficiently clear? If not, what alternative
definition would be more effective and/or clearer? Should the
definition include more or less granular levels of activity? If so,
what specific criteria should be used to determine the appropriate
level of granularity?
    Question 158. If you are a banking entity, how would your trading
activity be categorized, in terms of quantity and type, under the
proposed definition of trading unit in Appendix A? For each trading
unit type, what categories of quantitative measurements (e.g., risk-
management measurements) or specific quantitative measurements (e.g.,
Stressed Value-at-Risk (``Stress VaR'')) are best suited to assist in
distinguishing prohibited proprietary trading from permitted trading
activity?
    Question 159. Is the proposed rule's requirement that quantitative
measurements be reported at multiple levels of organization, including
for quantitative measurements historically reported on an aggregate
basis (e.g., Value-at-Risk (``VaR'') or Stress VaR) appropriate? If
not, what alternative would be more effective? What burdens are
associated with such a requirement? How might those burdens be reduced
or limited? Please quantify your answers, to the extent feasible.
c. Proposed Appendix A--Scope of Required Reporting
    Part III of proposed Appendix A defines the scope of the reporting
requirements. The proposed rule adopts a tiered approach that requires
banking entities with the most extensive trading activities to report
the largest number of quantitative measurements, while

banking entities with smaller trading activities have fewer or no
reporting requirements. This tiered approach is intended to reflect the
heightened compliance risks of banking entities with extensive trading
activities and limit the regulatory burden imposed on banking entities
with relatively small or no trading activities, which appear to pose
significantly less compliance risk.
Banking Entities With Gross Trading Assets and Liabilities of $5
Billion or More
    For any banking entity that has, together with its affiliates and
subsidiaries, trading assets and liabilities the average gross sum of
which (on a worldwide consolidated basis), as measured as of the last
day of each of the four prior calendar quarters, equals or exceeds $5
billion, the proposal would require the banking entity to furnish
quantitative measurements for all trading units of the banking entity
engaged in trading activity subject to Sec. Sec.  --.4, --.5, or
--.6(a) of the proposed rule (i.e., permitted underwriting and market
making-related activity, risk-mitigated hedging, and trading in certain
government obligations). The scope of data to be furnished depends on
the activity in which the trading unit is engaged. First, for the
trading units of such a banking entity that are engaged in market
making-related activity pursuant to Sec.  --.4(b) of the proposed rule,
proposed Appendix A requires that a banking entity furnish seventeen
quantitative measurements.\193\ Second, all trading units of such a
banking entity engaged in trading activity subject to Sec. Sec.
--.4(a), --.5, or --.6(a) of the proposed rule would be required to
report five quantitative measurements designed to measure the general
risk and profitability of the trading unit.\194\ The Agencies expect
that each of these general types of measurements will be useful in
assessing the extent to which any permitted trading activity involves
exposure to high-risk assets or high-risk trading strategies. These
requirements would apply to all type of trading units engaged in
underwriting and market making-related activity, risk-mitigated
hedging, and trading in certain government obligations. These
additional measurements are designed to help evaluate the extent to
which the quantitative profile of a trading unit's activities is
consistent with permissible market making-related activities.
---------------------------------------------------------------------------

    \193\ See proposed rule Appendix A.III.A. These seventeen
quantitative measurements are discussed further below.
    \194\ See proposed rule Appendix A.III.A. These five
quantitative measurements are: (i) Comprehensive Profit and Loss;
(ii) Comprehensive Profit and Loss Attribution; (iii) VaR and Stress
VaR; (iv) Risk Factor Sensitivities; and (v) Risk and Position
Limits. Each of these and other quantitative measurements discussed
in proposed Appendix A are discussed in detail below.
---------------------------------------------------------------------------

Banking Entities With Gross Trading Assets and Liabilities Between $1
Billion and $5 Billion
    For any banking entity that has, together with its affiliates and
subsidiaries, trading assets and liabilities the average gross sum of
which (on a worldwide consolidated basis), as measured as of the last
day of each of the four prior calendar quarters, equals or exceeds $1
billion but is less than $5 billion, the proposal would require
quantitative measurements to be furnished for trading units that are
engaged in market making-related activity subject to Sec.  --.4(b) of
the proposed rule. Trading units of such banking entities that are
engaged in market making-related activities must report eight
quantitative measurements that are designed to help evaluate the extent
to which the quantitative profile of a trading unit's activities is
consistent with permissible market making-related activities.\195\ The
proposal applies a smaller number of measurements to a smaller universe
of trading units for this class of banking entities because they are
likely to pose lesser compliance risk and fewer supervisory and
examination challenges. A less burdensome reporting regime, coupled
with other elements of the proposal (e.g., the compliance program
requirement), is likely to be equally as effective in ensuring
compliance with section 13 of the BHC Act and the proposed rule for
banking entities with smaller trading operations.
---------------------------------------------------------------------------

    \195\ See proposed rule Appendix A.III.A. These eight
quantitative measurements are (i) Comprehensive Profit and Loss;
(ii) Comprehensive Profit and Loss Attribution; (iii) Portfolio
Profit and Loss; (iv) Fee Income and Expense; (v) Spread Profit and
Loss; (vi) VaR; (vii) Volatility of Comprehensive Profit and Loss
and Volatility of Portfolio Profit and Loss; and (viii)
Comprehensive Profit and Loss to Volatility Ratio and Portfolio
Profit and Loss to Volatility Ratio.
---------------------------------------------------------------------------

Frequency of Calculation and Reporting
    Section III.B of proposed Appendix A specifies the frequency of
required calculation and reporting of quantitative measurements. Under
the proposed rule, each required quantitative measurement must be
calculated for each trading day. Required quantitative measurements
must be reported to the relevant Agency on a monthly basis, within 30
days of the end of the relevant calendar month, or on such other
reporting schedule as the relevant Agency may require. Section III.C of
proposed Appendix A requires a banking entity to create and retain
records documenting the preparation and content of any quantitative
measurement furnished by the banking entity, as well as such
information as is necessary to permit the relevant Agency to verify the
accuracy of such measurements, for a period of 5 years. This would
include records for each trade and position.
    Question 160. Is the proposed tiered approach to identifying which
banking entities and trading units must comply with the reporting
requirements effective? If not, what alternative would be more
effective? Does the proposal strike the appropriate balance between the
potential benefits of the reporting requirements for monitoring and
assuring compliance and the potential costs of those reporting
requirements? If not, how could that balance be improved? Should the
relevant gross trading assets and liabilities threshold for any
category be increased or reduced? If so, why?
    Question 161. Should the $1 billion and $5 billion gross trading
assets and liabilities thresholds used to identify the extent to which
a banking entity is required to furnish quantitative measurements be
increased or reduced? If so, why? Should the thresholds be indexed in
some way to account for fluctuations in capital markets activity over
time? If so, what would be an appropriate method of indexation?
    Question 162. Is the proposed $5 billion trading asset and
liability threshold an appropriate standard for triggering enhanced
reporting requirements under the proposed rule? Why or why not? If not,
what alternative standard would be a better benchmark for triggering
enhanced reporting requirements?
    Question 163. Should the proposed $5 billion trading and asset
liability threshold used for triggering enhanced reporting requirements
under the proposed rule be subject to adjustment over time? If so, how
and when should the numerical threshold be adjusted?
    Question 164. Is there a different criterion other than gross
trading assets and liabilities that would be more appropriate for
identifying banking entities that must furnish quantitative
measurements? If so, what is the alternative criterion, and why would
it be more appropriate? Are worldwide gross trading assets and
liabilities the appropriate criterion for foreign-based banking
entities? If not, what alternative criterion would be more appropriate,
and why?
    Question 165. Are the quantitative measurements specified for the
various types of banking entities and trading

units effective? If not, what alternative set of measurements would be
more effective? For each type of trading unit, does the proposal strike
the appropriate balance between the potential benefits of the reporting
requirements for monitoring and assuring compliance and the potential
costs of those reporting requirements? If not, how could that balance
be improved?
    Question 166. Should banking entities with gross trading assets and
liabilities between $1 billion and $5 billion also be required to
calculate and report some of the quantitative measurements proposed for
banking entities meeting the $5 billion threshold for purposes of
assessing whether the banking entity's underwriting, market making,
risk-mitigating hedging, and trading in certain government obligations
activities involve a material exposure to high-risk assets or high-risk
trading strategies? If so, which quantitative measurements and why? If
not, why not?
    Question 167. Is the proposed frequency of reporting effective? If
not, what frequency would be more effective? Should the quantitative
measurements be required to be reported quarterly, annually, or upon
the request of the applicable Agency and why?
d. Proposed Appendix A--Quantitative Measurements
    Section IV of proposed Appendix A describes, in detail, the
individual quantitative measurements that must be furnished. These
measurements are grouped into the following five broad categories, each
of which is described in more detail below:
     Risk-management measurements--VaR, Stress VaR, VaR
Exceedance, Risk Factor Sensitivities, and Risk and Position Limits;
     Source-of-revenue measurements--Comprehensive Profit and
Loss, Portfolio Profit and Loss, Fee Income and Expense, Spread Profit
and Loss, and Comprehensive Profit and Loss Attribution;
     Revenues-relative-to-risk measurements--Volatility of
Comprehensive Profit and Loss, Volatility of Portfolio Profit and Loss,
Comprehensive Profit and Loss to Volatility Ratio, Portfolio Profit and
Loss to Volatility Ratio, Unprofitable Trading Days based on
Comprehensive Profit and Loss, Unprofitable Trading Days based on
Portfolio Profit and Loss, Skewness of Portfolio Profit and Loss, and
Kurtosis of Portfolio Profit and Loss;
     Customer-facing activity measurements--Inventory Turnover,
Inventory Aging, and Customer-facing Trade Ratio; and
     Payment of fees, commissions, and spreads measurements--
Pay-to-Receive Spread Ratio.
    The Agencies have proposed these quantitative measurements because,
taken together, these measurements appear useful for understanding the
context in which trading activities occur and identifying activities
that may warrant additional scrutiny to determine whether these
activities involve prohibited proprietary trading because the trading
activity either is inconsistent with permitted market making-related
activities or presents a material exposure to high-risk assets or high-
risk trading strategies. As described below, different quantitative
measurements are proposed to identify different aspects and
characteristics of trading activity for the purpose of helping to
identify prohibited proprietary trading, and the Agencies expect that
the quantitative measurements will be most useful for this purpose when
implemented and reviewed collectively, rather than in isolation. The
Agencies believe that, in the aggregate, many banking entities already
collect and review many of these measurements as part of their risk
management activities, and expect that many of the quantitative
measurements proposed would be readily computed and monitored at the
multiple levels of organization that are included in proposed Appendix
A's definition of ``trading unit,'' to which they would apply.
    The first set of quantitative measurements relates to risk
management, and includes VaR, Stress VaR, VaR Exceedance, Risk Factor
Sensitivities, and Risk and Position Limits. These measurements are
widely used by banking entities to measure and manage trading risks and
activities. In the case of VaR, Stress VaR, VaR Exceedance, and Risk
Factor Sensitivities, these measures provide internal, model-based
assessments of overall risk, stated in terms of large but plausible
losses that may occur or changes in revenue that would be expected to
result from movements in underlying risk factors. In the case of Risk
and Position Limits, the measure provides an explicit assessment of
management's expectation of how much risk is required to perform
permitted market-making and hedging activities. With the exception of
Stress VaR, each of these measurements are routinely used to manage and
control risk taking activities, and are also used by some banking
entities for purposes of calculating regulatory capital and allocating
capital internally. In the context of permitted market making-related
activities, these risk management measures are useful in assessing
whether the actual risk taken is consistent with the level of principal
risk that a banking entity must retain in order to service the near-
term demands of customers. Significant, abrupt or inconsistent changes
to key risk management measures, such as VaR, that are inconsistent
with prior experience, the experience of similarly situated trading
units and management's stated expectations for such measures may
indicate impermissible proprietary trading. In addition, indicators of
unanticipated or unusual levels of risk taken, such as a significant
number of VaR Exceedance or breaches of internal Risk and Position
Limits, may suggest behavior that is inconsistent with appropriate
levels of risk and may warrant further scrutiny.
    The second set of quantitative measurements relates to the source
of revenues, and includes Comprehensive Profit and Loss, Portfolio
Profit and Loss, Fee Income, Spread Profit and Loss, and Comprehensive
Profit and Loss Attribution. These measurements are intended to capture
the extent, scope, and type of profits and losses generated by trading
activities and provide important context for understanding how revenue
is generated by trading activities. Because permitted market making-
related activities seek to generate profits by providing customers with
intermediation and related services while maintaining, and to the
extent practicable minimizing, the risks associated with any asset or
risk inventory required to meet customer demands, these revenue
measurements would appear to provide helpful information to banking
entities and the Agencies regarding whether actual revenues are
consistent with these expectations. The Agencies note that although
banking entities already routinely calculate and analyze the extent and
source of revenues derived from their trading activities, calculating
the proposed source of revenue measurements according to the
specifications described in proposed Appendix A may require banking
entities to implement new processes to calculate and furnish the
required data.
    The third set of measurements relates to realized risks and revenue
relative to realized risks, and includes Volatility of Profit and Loss,
Comprehensive Profit and Loss to Volatility Ratio and Portfolio Profit
and Loss to Volatility Ratio, Unprofitable Trading Days based on
Comprehensive Profit and Loss and Unprofitable Trading Days based on

Portfolio Profit and Loss, and Skewness of Portfolio Profit and Loss
and Kurtosis of Portfolio Profit and Loss. These measurements are
intended to provide banking entities and the Agencies with ex post,
data-based assessments of risk, as a supplement to internal, model-
based assessments of risk, and give further context around the
riskiness of underlying trading activities and the profitability of
these activities relative to the risks taken. Some of these
measurements, such as the skewness and kurtosis measurements, are
proposed in order to capture asymmetric, ``fat tail'' risks that (i)
are not well captured by simple volatility measures, (ii) may not be
well captured by internal risk measurement metrics, such as VaR, and
(iii) can be associated with proprietary trading strategies that seek
to earn short-term profits by taking exposures to these types of risks.
The Agencies expect that these realized-risk and revenue-relative-to-
realized-risk measurements would provide information useful in
assessing whether trading activities are producing revenues that are
consistent, in terms of the degree of risk that is being assumed, with
typical market making-related activities. Market making and related
activities seek to generate profitability primarily by generating fees,
commissions, spreads and other forms of customer revenue that are
relatively, though not completely, insensitive to market fluctuations
and generally result in a high level of revenue relative to risk over
an appropriate time frame. In contrast, proprietary trading strategies
seek to generate revenue primarily through favorable changes in asset
valuations. The Agencies note that each of the proposed measurements
relating to realized risks and revenues relative to realized risks are
generally consistent with existing revenue, risk, and volatility data
routinely collected by banking entities with large trading operations
or are simple, standardized functions of such data.
    The fourth set of quantitative measurements relates to customer-
facing activity measurements, and includes Inventory Risk Turnover,
Inventory Aging, and Customer-facing Trade Ratio. These measurements
are intended to provide banking entities and Agencies with meaningful
information regarding the extent to which trading activities are
directed at servicing the demands of customers. Quantitative
measurements such as Inventory Risk Turnover and Inventory Aging assess
the extent to which size and volume of trading activity is aimed at
servicing customer needs, while the Customer-facing Trade Ratio
provides directionally useful information regarding the extent to which
trading transactions are conducted with customers. The Agencies expect
that these measurements will be useful in assessing whether permitted
market making-related activities are focused on servicing customer
demands. Although the Agencies understand that banking entities
typically measure inventory aging and turnover in the context of cash
instruments (e.g., equity and debt securities), they note that applying
these measurements, as well as the Customer-facing Trade Ratio
generally, would require banking entities to implement new processes to
calculate and furnish the related data.
    The fifth set of quantitative measurements relates to the payment
of fees, commissions, and spreads, and includes the Pay-to-Receive
Spread Ratio. This measurement is intended to measure the extent to
which trading activities generate revenues for providing intermediation
services, rather than generate expenses paid to other intermediaries
for such services. Because market making-related activities ultimately
focus on servicing customer demands, they typically generate
substantially more fees, spreads and other sources of customer revenue
than must be paid to other intermediaries to support customer
transactions. Proprietary trading activities, however, that generate
almost no customer facing revenue will typically pay a significant
amount of fees, spreads and commissions in the execution of trading
strategies that are expected to benefit from short-term price
movements. Accordingly, the Agencies expect that the proposed Pay-to-
Receive Spread Ratio measurement will be useful in assessing whether
permitted market making-related activities are primarily generating,
rather than paying, fees, spreads and other transactional revenues or
expenses. A level of fees, commissions, and spreads paid that is
inconsistent with prior experience, the experience of similarly
situated trading units and management's stated expectations for such
measures could indicate impermissible proprietary trading.
    For each individual quantitative measurement, proposed Appendix A
describes the measurement, provides general guidance regarding how the
measurement should be calculated (where needed) and specifies the
period over which each calculation should be made. The proposed
quantitative measurements attempt to incorporate, wherever possible,
measurements already used by banking entities to manage risks
associated with their trading activities. Of the measurements proposed,
the Agencies expect that a large majority of measurements proposed are
either (i) already routinely calculated by banking entities or (ii)
based solely on underlying data that are already routinely calculated
by banking entities. However, calculating these measurements according
to the specifications described in proposed Appendix A and at the
various levels of organization mandated may require banking entities to
implement new processes to calculate and furnish the required data.
    The extent of the burden associated with calculating and reporting
quantitative measurements will likely vary depending on the particular
measurements and differences in the sophistication of management
information systems at different banking entities. As noted, the
proposal tailors these data collections to the size and type of
activity conducted by each banking entity in an effort to minimize the
burden in particular on firms that engage in few or no trading
activities subject to the proposed rule.
    The Agencies have also attempted to provide, to the extent
possible, a standardized description and general method of calculating
each quantitative measurement that, while taking into account the
potential variation among trading practices and asset classes, would
facilitate reporting of sufficiently uniform information across
different banking entities so as to permit horizontal reviews and
comparisons of the quantitative profile of trading units across firms.
    The Agencies request comment on the proposed quantitative
measurements. In particular, the Agencies request comment on the
following questions:
    Question 168. Are the proposed quantitative measurements
appropriate in general? If not, what alternative(s) would be more
appropriate, and why? Should certain quantitative measurements be
eliminated, and if so, why? Should additional quantitative measurements
be added? If so, which measurements and why? How would those additional
measurements be described and calculated?
    Question 169. How many of the proposed quantitative measurements do
banking entities currently utilize? What are the current benefits and
costs associated with calculating such quantitative measurements? Would
the reporting and recordkeeping requirements proposed in Appendix A for
such quantitative measurements impose any significant, additional
benefits or costs?

    Question 170. Which of the proposed quantitative measurements do
banking entities currently not utilize? What are the potential benefits
and costs to calculating these quantitative measurements and complying
with the proposed reporting and recordkeeping requirements? Please
quantify your answers, to the extent feasible.
    Question 171. Is the scope and frequency of required reporting
appropriate? If not, what alternatives would be more appropriate? What
burdens would be associated with reporting quantitative measurements on
that basis, and how could those burdens be reduced or eliminated in a
manner consistent with the purpose and language of the statute? Please
quantify your answers, to the extent feasible.
    Question 172. For each of the categories of quantitative
measurements (e.g., quantitative measurements relating to risk
management), what factors should be considered in order to further
refine the proposed category of quantitative measurements to better
distinguish prohibited proprietary trading from permitted trading
activity? For example, should the timing of a calculation be considered
significant in certain contexts (e.g., should specific quantitative
measurements be calculated during the middle of a trading day instead
of the end of the day)? Please quantify your answers, to the extent
feasible.
    Question 173. In light of the size, scope, complexity, and risk of
covered trading activities, do commenters anticipate the need to hire
new staff with particular expertise in order to calculate the required
quantitative measurements (e.g., collect data and make computations)?
Do commenters anticipate the need to develop additional infrastructure
to obtain and retain data necessary to compute the proposed
quantitative measurements? Please explain and quantify your answers, to
the extent feasible.
    Question 174. For each individual quantitative measurement that is
proposed:
     Is the use of the quantitative measurement to help
distinguish between permitted and prohibited trading activities
effective? If not, what alternative would be more effective? Does the
quantitative measurement provide any additional information of value
relative to other quantitative measurements proposed?
     Is the use of the quantitative measurement to help
determine whether an otherwise-permitted trading activity is consistent
with the requirement that such activity must not result, directly or
indirectly, in a material exposure by the banking entity to high-risk
assets and high-risk trading strategies effective? If not, what
alternative would be more effective?
     What factors should be considered in order to further
refine the proposed quantitative measurement to better distinguish
prohibited proprietary trading from permitted trading activity? For
example, should the timing of a calculation be considered significant
in certain contexts (e.g., should specific quantitative measurements be
calculated during the middle of a trading day instead of at the end of
the day)?
     If the quantitative measurement is proposed to be applied
to a trading unit that is engaged in activity pursuant to Sec. Sec.
--.4(a), --.5, or --.6(a) of the proposed rule, is the quantitative
measurement calculable in relation to such activity? Is the
quantitative measurement useful for determining whether underwriting,
risk-mitigating hedging, or trading in certain government obligations
is resulting, directly or indirectly, in a material exposure by the
banking entity to high-risk assets or high-risk trading strategies?
     Is the description of the quantitative measurement
sufficiently clear? What alternative would be more appropriate or
clearer? Is the description of the quantitative measurement
appropriate, or is it overly broad or narrow? If it is overly broad,
what additional clarification is needed? Should the Agencies provide
this additional clarification in the appendix's description of the
quantitative measurement? If the description is overly narrow, how
should it be modified to appropriately describe the quantitative
measurement, and why?
     Is the general calculation guidance effective and
sufficiently clear? If not, what alternative would be more effective or
clearer? Is more or less specific calculation guidance necessary? If
so, what level of specificity is needed to calculate the quantitative
measurement? What are the different calculation options and
methodologies that could be used to reach the desired level of
specificity? What are the costs and benefits of these different
options? If the proposed calculation guidance is not sufficiently
specific, how should the calculation guidance be modified to reach the
appropriate level of specificity? For example, rather than provide this
level of specificity in proposed Appendix A, should the Agencies
instead make each banking entity responsible for determining the best
method of calculating the quantitative measurement at this level of
specificity, based on the banking entity's business and profile, which
would then be subject to supervision, review, or examination by the
relevant Agency? If the proposed calculation guidance is overly
specific, why is it too specific and how should the guidance be
modified to reach the appropriate level of specificity?
     Is the general calculation guidance for the measurement
consistent with how banking entities currently calculate the
quantitative measurement, if they do so? If not, how does the proposed
guidance differ from methodology currently used by banking entities?
What is the purpose of the current calculation methodology used by
banking entities?
     What operational or logistical challenges might be
associated with performing the calculation of the quantitative
measurement and obtaining any necessary informational inputs?
     Is the quantitative measurement not calculable for any
specific type of trading unit? If so, what type of trading unit, and
why is the quantitative measurement not calculable for that type of
trading unit? Is there an alternative quantitative measurement that
would reflect the same trading activity but not pose the same
calculation difficulty? Are there particular challenges to documenting
that a specific quantitative measurement is not calculable?
     Is the quantitative measurement substantially likely to
frequently produce false negatives or false positives that suggest that
prohibited proprietary trading is occurring when it is not, or vice
versa? If so, why? If so, what alternative quantitative measurement
would better help identify prohibited proprietary trading?
     Should the quantitative measurement better account for
distinctions among trading activities, trading strategies, and asset
classes? If so, how? For example, should the quantitative measurements
better account for distinctions between trading activities in cash and
derivatives markets? If so, how? Are there any other distinctions for
which the quantitative measurements may need to account? If so, what
distinctions, and why?
     Does the quantitative measurement provide useful
information as applied to all types of trading activities, or only a
certain subset of trading activities? If it only provides useful
information for a subset of trading activities, how should this issue
be addressed? How beneficial is the information that the quantitative
measurement provides for this subset of trading activities? Do any of
the other quantitative measurements provide the

same level of beneficial information for this subset of trading
activities? Should the quantitative measurement be required to be
reported for all trading activities, only a relevant subset of trading
activities, or not at all?
     Does the quantitative measurement provide useful
information as applied to all asset classes, or only a certain subset
of asset classes? If it only provides useful information for a subset
of asset classes, how should this issue be addressed? How beneficial is
the information the quantitative measurement provides for this subset
of asset classes? Do any of the other quantitative measurements provide
the same level of beneficial information for this subset of asset
classes? Should the quantitative measurement be required to be reported
for all asset classes, only a relevant subset of asset classes, or not
at all?
     Is the calculation period effective and sufficiently
clear? If not, what alternative would be more effective or clearer?
     How burdensome and costly would it be to calculate the
measurement at the specified calculation frequency and calculation
period? Are there any difficulties or costs associated with calculating
the measurement for particular trading units? How significant are those
potential costs relative to the potential benefits of the measurement
in monitoring for impermissible proprietary trading? Are there
potential modifications that could be made to the measurement that
would reduce the burden or cost? If so, what are those modifications?
Please quantify your answers, to the extent feasible.
    Question 175. In light of the size, scope, complexity, and risk of
covered trading activities, are there certain types of quantitative
measurements that will not be appropriate for some types of banking
entities, desks, or levels? If so, would it be appropriate to require
only certain quantitative measurements for such banking entities,
desks, or levels?
    Question 176. How might the number of quantitative measurements
impact behavior of banking entities? Is there a cost of requiring more
quantitative measurements, such as the cost of increased uncertainty
regarding the combined results of such quantitative measurements? To
what extent and in what ways might uncertainty as to how the
quantitative measurements are applied and evaluated impact behavior?
Proposed Appendix B--Commentary Regarding Identification of Permitted
Market Making-Related Activities
    Proposed Appendix B provides commentary that is intended to assist
a banking entity in distinguishing permitted market making-related
activities from trading activities that, even if conducted in the
context of a banking entity's market making operations, would
constitute prohibited proprietary trading. As noted in Part I of
proposed Appendix B, the commentary applies to all banking entities
that are engaged in market making-related activities in reliance on
Sec.  --.4(b) of the proposed rule. Part II of proposed Appendix B
clarifies that all defined terms used in Appendix B have the meaning
given those terms in Sec. Sec.  --.2 and --.3 of the proposed rule and
Appendix A.
    The commentary regarding identification of permitted market making-
related activities, which is contained in Part III of proposed Appendix
B, includes three principal components. The first component provides an
overview of market making-related activities and describes, in detail,
typical practices in which market makers engage and typical
characteristics of market making-related activities, articulating the
general framework within which the Agencies view market making-related
activities.\196\ For example, the commentary provides that market
making-related activities, in the context of a banking entity acting as
principal, generally involve either (i) in the case of market making in
a security that is executed on an organized trading facility or
exchange, passively providing liquidity by submitting resting orders
that interact with the orders of others on an organized trading
facility or exchange and acting as a registered market maker, where
such exchange or organized trading facility provides the ability to
register as a market maker, or (ii) in other cases, providing an
intermediation service to its customers by assuming the role of a
counterparty that stands ready to buy or sell a position that the
customer wishes to sell or buy. The second component of the commentary
provides an overview of prohibited proprietary trading activities,
which describes the general framework within which the Agencies view
prohibited proprietary trading and contrasts that activity to the
practices and characteristics of market making-related activities.\197\
The third component describes certain challenges that arise in
distinguishing permitted market making-related activities and
prohibited proprietary trading, particularly in cases in which both of
these activities occur within the context of a market making
operation,\198\ and proposes guidance that the Agencies would apply in
distinguishing permitted market making-related activities from
prohibited proprietary trading. This guidance includes six factors that
would cause a banking entity to be considered, absent explanatory
circumstances, to be engaged in prohibited proprietary trading, and not
permitted market making-related activity. The six factors are:
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    \196\ See proposed rule Appendix B, Sec.  III.A. The practices
and characteristics that are described generally reinforce and
augment the specific requirements that a banking entity must meet in
order to rely on the market-making exemption under Sec.  ----.4(b)
of the proposed rule.
    \197\ See proposed rule Appendix B, Sec.  III.B.
    \198\ See proposed rule Appendix B, Sec.  III.C. Proposed
Appendix B notes, for example, that it may be difficult to
distinguish (i) inventory positions that appropriately support
market making-related activities from (ii) positions taken for
proprietary purposes. See id.
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     Trading activity in which a trading unit retains risk in
excess of the size and type required to provide intermediation services
to customers; \199\
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    \199\ For simplicity and ease of reading, the Agencies have used
the term ``customer'' throughout the discussion of market making-
related activity. However, as discussed in proposed Appendix B, a
market maker's ``customers'' generally vary depending on the asset
class and market in which the market maker is providing
intermediation services. In the context of market making in a
security that is executed on an organized trading facility or an
exchange, a ``customer'' is any person on behalf of whom a buy or
sell order has been submitted by a broker-dealer or any other market
participant. In the context of market making in a covered financial
position in an over-the-counter market, a ``customer'' generally
would be a market participant that makes use of the market maker's
intermediation services, either by requesting such services or
entering into a continuing relationship with the market maker with
respect to such services. In certain cases, depending on the
conventions of the relevant market (e.g., the over-the-counter
derivatives market), such a ``customer'' may consider itself or
refer to itself more generally as a ``counterparty.''
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     Trading activity in which a trading unit primarily
generates revenues from price movements of retained principal positions
and risks, rather than customer revenues;
     Trading activity in which a trading unit: (i) Generates
only very small or very large amounts of revenue per unit of risk
taken; (ii) does not demonstrate consistent profitability; or (iii)
demonstrates high earnings volatility;
     Trading activity in which a trading unit either (i) does
not transact through a trading system that interacts with orders of
others or primarily with customers of the banking entity's market
making desk to provide liquidity services, or (ii) holds principal
positions in excess of reasonably expected near term customer demands;
     Trading activity in which a trading unit routinely pays
rather than earns fees, commissions, or spreads; and

     The use of compensation incentives for employees of a
particular trading activity that primarily reward proprietary risk-
taking.\200\
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    \200\ See proposed rule Appendix B, Sec.  III.C.1-6. The
Agencies note that each of these six criteria is directly related to
the overview of market making-related activities provided in section
III.A. of proposed Appendix B.
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    The proposed commentary makes clear that the enumerated factors are
subject to certain facts and circumstances that may explain why a
trading activity may meet one or more factors but does not involve
prohibited proprietary trading, and provides a range of examples of
such explanatory facts and circumstances.\201\ The Agencies emphasize
that these examples are not meant to be exhaustive, as a variety of
other circumstances may exist to explain why a particular trading
activity, even if meeting one of the factors, may nonetheless be a
permitted market making-related activity.\202\
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    \201\ The proposed commentary does not contemplate explanatory
facts and circumstances for the compensation incentives factor,
given that the choice of compensation incentives provided to trading
personnel is under the full control of the banking entity.
    \202\ The Agencies also note that, although a particular trading
activity may not meet the requirements applicable to permitted
market making-related activities, it may still be exempt under
another available exemption.
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    In addition, for each of these six factors, the proposed rule
provides general guidance as to (i) the types of facts and
circumstances on which the relevant Agency may base any determination
that a banking entity's trading activity met the relevant factor and
(ii) which quantitative measurements, if furnished by a banking entity
pursuant to Appendix A, the relevant Agency would use to help assess
the extent to which a banking entity's activities met the relevant
factor.
    The Agencies request comment on the proposed commentary regarding
identification of permitted market making-related activities. In
particular, the Agencies request comment on the following questions:
    Question 177. Is the overview of permitted market making-related
activities and prohibited proprietary trading proposed in Appendix B
accurate? If not, what alternative overview would be more accurate?
Does the overview appropriately account for differences in market
making-related activities across different asset classes? If not, which
type of market making-related activity does the overview not
sufficiently describe or account for?
    Question 178. Is the requirement that a market maker engaged in
market making that is executed on an exchange or an organized trading
facility must be a registered market maker, provided the relevant
exchange or organized trading facility provides the ability to
register, appropriate, or is it over- or under-inclusive? Please
discuss and provide detailed examples of any such markets where
registering as a market maker is not feasible or should not be required
for purposes of this rule, and unregistered market makers provide
similar services or perform similar functions.
    Question 179. With respect to market making that is executed on an
exchange or an organized trading facility, what potential impact or
unintended consequences might result from limiting the market making
exemption to registered market makers when the relevant exchange or
organized trading facility registers market makers? Would such a
requirement result in any potential decrease in the passive provision
of liquidity by the submission of resting orders? Do you anticipate
that any such decrease would be exacerbated in times of market stress?
If yes, please describe the impact on liquidity and the marketplace in
general. Please discuss whether and how any potential decrease in
liquidity could be mitigated. In addition, would such a requirement
result in additional costs that would be borne by market participants
purchasing and selling on an exchange or organized trading facility?
Please identify and discuss any other additional costs. Please discuss
whether and how any such consequences can be mitigated.
    Question 180. In addition to benefits discussed in the
Supplementary Information, are there other benefits that would be
achieved by requiring that a market maker be registered with respect to
market making on an exchange or an organized trading facility? Is there
a way to amplify these benefits? Could these benefits be realized
through alternative means? If so, how?
    Question 181. In addition to registered market makers on exchanges
or organized trading facilities, what other classes of liquidity
providers exist? Are their obligations and activities similar to, or
different than those of registered market makers? If so, how? Are the
compensated in a different manner?
    Question 182. How much liquidity is provided by registered market
makers versus other liquidity providers by asset class (e.g., equities,
etc.) with respect to trading on an exchange or an organized trading
facility? The Agencies encourage commenters to provide data in support
of comments.
    Question 183. Is there any specific element of market making-
related activity that the overview does not take into account in its
description of market making? If so, how should the overview account
for this element? Are there any descriptions of market making-related
activity in the overview that should not be considered to be market
making-related activity? If so, why? Is there any specific element of
prohibited proprietary trading activity that the overview does not take
into account in its description of prohibited proprietary trading? If
so, how should the overview account for this element? Are there any
descriptions of prohibited proprietary trading activity in the overview
that should not be considered to be prohibited proprietary trading? If
so, why?
    Question 184. Are each of the six factors specified for helping to
distinguish permitted market making-related activity from prohibited
proprietary trading appropriate? If not, how should they be changed,
and why? Should any factors be eliminated or added? If so, which ones
and why? Could any of the proposed factors occur as a result of the
banking entity engaging in one of the other permitted activities (e.g.,
underwriting, trading on behalf of customers)? If so, would the facts